Question 1

How do the current rate and temporal methods handle translation gains and losses?

Accepted Answer

A major difference between the two methods is the treatment of translation gains and losses. Recording them in a separate CTA account is not permitted under the temporal method. Instead, translation gains and losses are "flowed through" the income statement, hence they have a direct impact on reported earnings. There are no tax consequences from these translation gains or losses because they are unrealized, but they do change reported earnings and increase earnings variability over time. Table 7-1 in the text summarizes the rules for translating foreign financial statements using the two methods.

Question 2

What unique characteristics does the cumulative translation adjustment (CTA) account possess?

Accepted Answer

The translation gain or loss is recorded directly in the equity section without flowing it through the income statement as would normally be done when changes in equity are recorded. The addition or subtraction to the CTA account represents an unrealized gain or loss that results from the periodic reporting requirement, and it could reverse by the next reporting date if exchange rates move in the opposite direction. Moreover, the CTA adjustment has no tax consequence.

Question 3

Differentiate between local, functional, and reporting currencies.

Accepted Answer

The local currency is the currency that is used in the host country of a subsidiary. The functional currency is the currency in which most of the subsidiary's business is conducted. For small, developing countries, the functional and local currencies may not be the same. For example, a subsidiary in Korea might find all of its revenues and expenses denominated in Japanese yen. For larger, more developed countries, the local and functional currencies are the same. The reporting currency is the currency in which the parent firm's consolidated financial statements must be cast.

Question 4

Generally speaking, accounting translation gains and losses have no economic impact on the firm's cash flows and do not reflect a change in the firm's value. What are some exceptions to this conclusion?

Accepted Answer

If the translation gain or loss is expec

Question 5

When a country experiences hyperinflation, special challenges are created for accounting and extraordinary measures are required to preserve the economic integrity of financial statements. Which of the following statements about the accounting treatment of hyperinflation is incorrect?

Accepted Answer

A)  If a country is experiencing hyperinflation, loosely defined as cumulative annual inflation of approximately 100 percent over three years, then the FASB in the U.S. requires that the U.S. dollar be deemed the functional currency, the financial statements are remeasured into dollars using the temporal method, and gains or losses are recorded in the cumulative translation adjustment or CTA account. 
B)  The treatment of hyperinflation under international accounting standards differs from the procedure in the U.S. in the sense that in local currency financial statements, nonmonetary assets are "grossed up" or restated in current-value money units by applying an inflation index (such as the consumer price index or CPI) adjustment. 
C)  The bias caused by hyperinflation exists when nonmonetary assets are listed on the balance sheet (and the associated depreciation on the income statement) at historical costs, and when inflation is high the accounting records no longer approximate their real economic value-in fact, they will be grossly undervalued. 
D)  The problem with the financial statements caused by hyperinflation is that the local money unit no longer serves as a stable storehouse of value (which is implicitly assumed to be the case in accounting), so the procedures required by both FASB and IASB are intended to restore this real economic stability. 
E)  None of the statements above; all are correct correct. 
A)  If a country is experiencing hyperinflation, loosely defined as cumulative annual inflation of approximately 100 percent over three years, then the FASB in the U.S. requires that the U.S. dollar be deemed the functional currency, the financial statements are remeasured into dollars using the temporal method, and gains or losses are recorded in the cumulative translation adjustment or CTA account. 
B)  The treatment of hyperinflation under international accounting standards differs from the procedure in the U.S. in the sense that in local currency financial statements, nonmonetary assets are "grossed up" or restated in current-value money units by applying an inflation index (such as the consumer price index or CPI) adjustment. 
C)  The bias caused by hyperinflation exists when nonmonetary assets are listed on the balance sheet (and the associated depreciation on the income statement) at historical costs, and when inflation is high the accounting records no longer approximate their real economic value-in fact, they will be grossly undervalued. 
D)  The problem with the financial statements caused by hyperinflation is that the local money unit no longer serves as a stable storehouse of value (which is implicitly assumed to be the case in accounting), so the procedures required by both FASB and IASB are intended to restore this real economic stability. 
E)  None of the statements above; all are correct correct.

Question 6

Inflation introduces several types of distortions in accounting data, some of which have very real economic consequences for the firm. Which of the following statements regarding inflation is incorrect?

Accepted Answer

A)  Nonmonetary assets that are carried at their historical cost, have substantially greater real economic value during periods of high inflation than implied by the current money unit, so if they are translated into the reporting currency using the current rate method, the dollar-equivalent amount does not reflect the real value of the underlying assets (they would be seriously undervalued). 
B)  When calculating taxable income for a period in which inflation was high, one uses current period revenues but deducts historical costs that were recorded when the purchasing power of the currency was higher. Hence, costs are understated, taxable income is overstated, and taxes due are overstated. 
C)  In periods of high inflation, the first-in-first-out or FIFO method for inventory valuation should be used to calculate taxable income so that old inventory, whose true economic value is higher than implied at the current value of the money unit, will be eliminated quickly from the accounting records and the company will not have to take a large loss when their value is written down. 
D)  Accounting principles assume that the money unit in which the accounting records are maintained remains essentially stable over time, serves as a unit of exchange, and functions as a storehouse of value. These principles are violated during periods of high inflation, and that is why special accounting treatment is required during hyperinflation. 
E)  None of the statements above; all are correct. 
A)  Nonmonetary assets that are carried at their historical cost, have substantially greater real economic value during periods of high inflation than implied by the current money unit, so if they are translated into the reporting currency using the current rate method, the dollar-equivalent amount does not reflect the real value of the underlying assets (they would be seriously undervalued). 
B)  When calculating taxable income for a period in which inflation was high, one uses current period revenues but deducts historical costs that were recorded when the purchasing power of the currency was higher. Hence, costs are understated, taxable income is overstated, and taxes due are overstated. 
C)  In periods of high inflation, the first-in-first-out or FIFO method for inventory valuation should be used to calculate taxable income so that old inventory, whose true economic value is higher than implied at the current value of the money unit, will be eliminated quickly from the accounting records and the company will not have to take a large loss when their value is written down. 
D)  Accounting principles assume that the money unit in which the accounting records are maintained remains essentially stable over time, serves as a unit of exchange, and functions as a storehouse of value. These principles are violated during periods of high inflation, and that is why special accounting treatment is required during hyperinflation. 
E)  None of the statements above; all are correct.

Question 7

What is the difference between remeasuring and restating financial statements?

Accepted Answer

When the translation is from a local cur

Question 8

What is a balance sheet hedge?

Accepted Answer

Multinational firms often maintain subsi

Question 9

A U.S.-based MNE has four operating units/subsidiaries in the U.S., Mexico, Germany, and Poland. The following are the operating relationships existing among them: 1. The U.S. supplies all production inputs to Mexico except for labor (invoiced in dollars) and all Mexican production is sold to the U.S. parent and invoiced in dollars.
2) Germany supplies all production inputs to Poland except for labor (invoiced in euros) and all Polish production is sold to Germany and is invoiced in euros.
3) The global marketplace for the company's products is divided into two non-overlapping areas, one supplied from the U.S. and the other one from Germany. Only when demand is particularly high in one region or the other is part of it supplied by other than the designated supplier.
In order to prepare consolidate financial statements, each subsidiary's financial statements must be translated into the reporting currency (the U.S. dollar). For each subsidiary, the functional currency is __________ and the required translation method is _______________.

Accepted Answer

A)  U.S.: dollar, none; Mexico: peso, current rate; Germany: euro, current rate; Poland: zloty, current rate. 
B)  U.S.: dollar, none; Mexico: dollar, temporal; Germany: euro, current rate; Poland: euro, temporal to euros then current rate to dollars. 
C)  U.S.: dollar, none; Mexico: dollar, current rate; Germany: euro, current rate; Poland: dollar, temporal. 
D)  U.S.: dollar, none; Mexico: peso, temporal; Germany: euro, current rate; Poland: euro, current rate to euros then temporal to dollars. 
E)  None of the statements above is correct. 
A)  U.S.: dollar, none; Mexico: peso, current rate; Germany: euro, current rate; Poland: zloty, current rate. 
B)  U.S.: dollar, none; Mexico: dollar, temporal; Germany: euro, current rate; Poland: euro, temporal to euros then current rate to dollars. 
C)  U.S.: dollar, none; Mexico: dollar, current rate; Germany: euro, current rate; Poland: dollar, temporal. 
D)  U.S.: dollar, none; Mexico: peso, temporal; Germany: euro, current rate; Poland: euro, current rate to euros then temporal to dollars. 
E)  None of the statements above is correct.

Question 10

Culverson Manufacturing had sales of $150 million last year. It is deciding whether to use FIFO or LIFO to value its inventory costs. If FIFO is used, the inventory cost is $120 million, but if LIFO is used, the inventory cost is $132 million. The firm's marginal tax rate is 40 percent. If the LIFO method is used over the FIFO method, what is the change in net inflow the company realizes?

Accepted Answer

A)  +$2.6 million 
B)  +$3.8 million 
C)  +$4.8 million 
D)  +$6.2 million 
E)  +$7.6 million 
A)  +$2.6 million 
B)  +$3.8 million 
C)  +$4.8 million 
D)  +$6.2 million 
E)  +$7.6 million

Question 11

Why is it important for financial managers to have a basic understanding of the financial statement translation and consolidation process?

Accepted Answer

There are three primary reasons why this

Question 12

Differentiate between self-sustaining and integrated foreign subsidiaries, and describe how financial statements are translated differently in each case.

Accepted Answer

A self-sustaining foreign entity is an o

Question 13

Tomlinson Industries had sales of $162 million last year. It is analyzing the difference in cash flows between certain inventory valuation methods. It is looking at both the FIFO and replacement cost valuation methods. If FIFO is used, the inventory cost is $135 million, but if the replacement value method is used, the inventory cost is $157 million. The firm's marginal tax rate is 40 percent. If the LIFO method is used over the replacement value method, what is the change in net inflow the company would realize?

Accepted Answer

A)  -$5.4 million 
B)  +$6.2 million 
C)  -$6.8 million 
D)  +$7.2 million 
E)  -$8.8 million 
A)  -$5.4 million 
B)  +$6.2 million 
C)  -$6.8 million 
D)  +$7.2 million 
E)  -$8.8 million

Question 14

Differentiate between the current rate and temporal translation methods.

Accepted Answer

In the current rate method, assets and l

Question 15

Which of the following statements are correct?

Accepted Answer

A)  On the balance sheet, monetary items include cash and marketable securities on the assets side and investor supplied debt capital on the passive side. All other entries are nonmonetary. 
B)  Monetary items are denominated in nominal money units while nonmonetary items can only be measured in nominal money units. 
C)  When exchange rates change, the real value of nonmonetary items tends to be preserved to a greater extent than if the items were monetary in nature. 
D)  All of the statements above are correct. 
E)  Only statements b and c are correct. 
A)  On the balance sheet, monetary items include cash and marketable securities on the assets side and investor supplied debt capital on the passive side. All other entries are nonmonetary. 
B)  Monetary items are denominated in nominal money units while nonmonetary items can only be measured in nominal money units. 
C)  When exchange rates change, the real value of nonmonetary items tends to be preserved to a greater extent than if the items were monetary in nature. 
D)  All of the statements above are correct. 
E)  Only statements b and c are correct.

Question 16

If a subsidiary is in a country with dangerously high inflation, how should the translation of its financial statements be handled? Consider both FASB and IASB procedures in your discussion.

Accepted Answer

Hyperinflation is defined as cumulative

Question 17

Gard Tennis Supply, a U.S. multinational, has a subsidiary in France with the following balance sheet (denominated in euros).
   The spot exchange rate is $0.97380/euro. The company's CFO has estimated the following average exchange rates for inventories, fixed assets, common stock, and retained earnings: $0.96152, $0.9558, $1.1041, and $1.0853, respectively. The subsidiary is classified as a self-sustaining foreign entity. Translate the balance sheet into U.S. dollars, which is the reporting currency. (Hint: Depending upon the translation method used, all of the exchange rates may not be used.)

Accepted Answer

Since the subsidiary is a self-sustainin

Question 18

If the temporal method for translating foreign currency financial statements into the reporting or functional currency is used, then

Accepted Answer

A)  Any gains or losses must flow through the income statement and affect directly the amount of net income reported. 
B)  The current spot exchange rate on the statement date is used to translate all monetary items. 
C)  A decrease in the value of the local currency relative to the reporting or functional currency will always result in a translation loss. 
D)  All of the statements above are correct. 
E)  Only statements a and b are correct. 
A)  Any gains or losses must flow through the income statement and affect directly the amount of net income reported. 
B)  The current spot exchange rate on the statement date is used to translate all monetary items. 
C)  A decrease in the value of the local currency relative to the reporting or functional currency will always result in a translation loss. 
D)  All of the statements above are correct. 
E)  Only statements a and b are correct.

Question 19

Regarding translation methodologies, which of the following statements are correct?

Accepted Answer

A)  The current spot exchange rate is always used to translate monetary assets and liabilities in all permitted translation methods. 
B)  Equity accounts are always translated at a weighted average historical exchange rate in all permitted translation methods. 
C)  The current rate method for translating financial statements almost always results in a net asset exposure. 
D)  All of the statements above are correct. 
E)  Only statements b and c are correct. 
A)  The current spot exchange rate is always used to translate monetary assets and liabilities in all permitted translation methods. 
B)  Equity accounts are always translated at a weighted average historical exchange rate in all permitted translation methods. 
C)  The current rate method for translating financial statements almost always results in a net asset exposure. 
D)  All of the statements above are correct. 
E)  Only statements b and c are correct.

Question 20

After all foreign entity financial statements have been translated into the reporting currency, they must be combined to prepare consolidated financial statements. This is a straight-forward process but several adjustments must be made prior to consolidation. These include

Accepted Answer

A)  Cancellation of all accounts receivable and accounts payable. 
B)  Cancellation of short-term debts and marketable securities (on the assets side). 
C)  Cancellation of subsidiary equity and investment in subsidiaries (on the assets side). 
D)  All of the adjustments above must be made. 
E)  Only adjustments a and c must be made. 
A)  Cancellation of all accounts receivable and accounts payable. 
B)  Cancellation of short-term debts and marketable securities (on the assets side). 
C)  Cancellation of subsidiary equity and investment in subsidiaries (on the assets side). 
D)  All of the adjustments above must be made. 
E)  Only adjustments a and c must be made.

How do the current rate and temporal methods handle translation gains and losses?

What unique characteristics does the cumulative translation adjustment (CTA) account possess?

Differentiate between local, functional, and reporting currencies.

Generally speaking, accounting translation gains and losses have no economic impact on the firm's cash flows and do not reflect a change in the firm's value. What are some exceptions to this conclusion?

When a country experiences hyperinflation, special challenges are created for accounting and extraordinary measures are required to preserve the economic integrity of financial statements. Which of the following statements about the accounting treatment of hyperinflation is incorrect?

Inflation introduces several types of distortions in accounting data, some of which have very real economic consequences for the firm. Which of the following statements regarding inflation is incorrect?

What is the difference between remeasuring and restating financial statements?

What is a balance sheet hedge?

Why is it important for financial managers to have a basic understanding of the financial statement translation and consolidation process?

Differentiate between self-sustaining and integrated foreign subsidiaries, and describe how financial statements are translated differently in each case.

Differentiate between the current rate and temporal translation methods.

Which of the following statements are correct?

If a subsidiary is in a country with dangerously high inflation, how should the translation of its financial statements be handled? Consider both FASB and IASB procedures in your discussion.

If the temporal method for translating foreign currency financial statements into the reporting or functional currency is used, then

Regarding translation methodologies, which of the following statements are correct?

After all foreign entity financial statements have been translated into the reporting currency, they must be combined to prepare consolidated financial statements. This is a straight-forward process but several adjustments must be made prior to consolidation. These include

An Introduction to International Financial Management

The Global Financial Environment: Markets, Institutions, Interest Rates, and Exchange Rates

Exchange Rate Analysis

International Trade and Foreign Direct Investment

Risk and Return

Financial Statement Analysis

Debt Instruments and Markets

Stocks and Stock Markets

The Cost of Capital

Capital Budgeting: The Basics

Capital Budgeting: Risk Analysis and Real Options

Capital Structure and Distribution Policy

Working Capital Management and Global Cash Flow Integration

Derivatives and Risk Management

International Tax Planning

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Exam 7: Translating and Consolidating Subsidiary Financial Statements

How do the current rate and temporal methods handle translation gains and losses?

What unique characteristics does the cumulative translation adjustment (CTA) account possess?

Differentiate between local, functional, and reporting currencies.

Generally speaking, accounting translation gains and losses have no economic impact on the firm's cash flows and do not reflect a change in the firm's value. What are some exceptions to this conclusion?

When a country experiences hyperinflation, special challenges are created for accounting and extraordinary measures are required to preserve the economic integrity of financial statements. Which of the following statements about the accounting treatment of hyperinflation is incorrect?

Inflation introduces several types of distortions in accounting data, some of which have very real economic consequences for the firm. Which of the following statements regarding inflation is incorrect?

What is the difference between remeasuring and restating financial statements?

What is a balance sheet hedge?

Why is it important for financial managers to have a basic understanding of the financial statement translation and consolidation process?

Differentiate between self-sustaining and integrated foreign subsidiaries, and describe how financial statements are translated differently in each case.

Differentiate between the current rate and temporal translation methods.

Which of the following statements are correct?

If a subsidiary is in a country with dangerously high inflation, how should the translation of its financial statements be handled? Consider both FASB and IASB procedures in your discussion.

If the temporal method for translating foreign currency financial statements into the reporting or functional currency is used, then

Regarding translation methodologies, which of the following statements are correct?

After all foreign entity financial statements have been translated into the reporting currency, they must be combined to prepare consolidated financial statements. This is a straight-forward process but several adjustments must be made prior to consolidation. These include

An Introduction to International Financial Management

The Global Financial Environment: Markets, Institutions, Interest Rates, and Exchange Rates

Exchange Rate Analysis

International Trade and Foreign Direct Investment

Risk and Return

Financial Statement Analysis

Debt Instruments and Markets

Stocks and Stock Markets

The Cost of Capital

Capital Budgeting: The Basics

Capital Budgeting: Risk Analysis and Real Options

Capital Structure and Distribution Policy

Working Capital Management and Global Cash Flow Integration

Derivatives and Risk Management

International Tax Planning

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