Deck 13: Translation Exposure

Question 1

The ________ determines accounting policy for U.S. firms.

A)Securities and Exchange Commission (SEC)
B)Federal Reserve System (Fed)
C)Financial Accounting Standards Board (FASB)
D)General Agreement on Tariffs and Trade (GATT)

Answer 1

Financial Accounting Standards Board (FASB)

Question 2

The basic advantage of the ________ method of foreign currency translation is that foreign nonmonetary assets are carried at their original cost in the parent's consolidated statement while the most important advantage of the ________ method is that the gain or loss from translation does not pass through the income statement.

A)monetary; current rate
B)temporal; current rate
C)temporal; monetary
D)current rate; temporal

Answer 2

current rate; temporal

Question 3

Generally speaking, translation methods by country define the translation process as a function of what two factors?

A)size; location
B)a firm's functional currency; location
C)location; foreign subsidiary independence
D)foreign subsidiary independence; a firm's functional currency

Answer 3

foreign subsidiary independence; a firm's functional currency

Question 4

Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the local currency is the functional currency, then

A)the translation method to be used is not obvious.
B)translation is accomplished through the temporal method.
C)translation is not required.
D)translation is accomplished through the current rate method.

Question 5

It is possible to use different exchange rates for different line items on a financial statement.

Question 6

A/an ________ subsidiary is one in which the firm operates as an extension of the parent company with cash flows highly interrelated with the parent.

A)self-sustaining foreign
B)integrated foreign entity
C)foreign
D)none of the above

Question 7

The two basic methods for the translation of foreign subsidiary financial statements are the ________ method and the ________ method.

A)current rate; temporal
B)temporal; proper timing
C)current rate; future rate
D)none of the above

Question 8

If the European subsidiary of a U.S. firm has net exposed assets of €500,000, and the euro drops in value from $1.40/euro to $1.30/€ the U.S. firm has a translation ________.

A)gain of $50,000
B)loss of $50,000
C)gain of $450,000
D)loss of €450,000

Question 9

Translation exposure measures

A)changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
B)the potential for an increase or decrease in the parent company's net worth and reported net income caused by a change in exchange rates since the last consolidation of international operations.
C)an unexpected change in exchange rates impact on short run expected cash flows.
D)none of the above

Question 10

If an imbalance results from the accounting method used for translation, the imbalance is taken either to ________ or ________.

A)the bank; the post office.
B)depreciation; the market for foreign exchange swaps.
C)current income; equity reserves.
D)current liabilities; equity reserves.

Question 11

Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S. dollars,

A)translation is accomplished through the current rate method.
B)translation is accomplished through the temporal method.
C)translation is not required.
D)the translation method to be used is not obvious.

Question 12

Historical exchange rates may be used for ________, while current exchange rates may be used for ________.

A)fixed assets and current assets; income and expense items
B)equity accounts and fixed assets; current assets and liabilities
C)current assets and liabilities; equity accounts and fixed assets
D)equity accounts and current liabilities; current assets and fixed assets

Question 13

________ exposure is the potential for an increase or decrease in the parent company's net worth and reported net income caused by a change in exchange rates since the last transaction.

A)Transaction
B)Operating
C)Currency
D)Translation

Question 14

According to your authors, the main purpose of translation is

A)to prepare consolidated financial statements.
B)to help management assess the performance of foreign subsidiaries.
C)to act as an interpreter for managers without foreign language skills.
D)none of the above

Question 15

A foreign subsidiary's ________ currency is the currency used in the firm's day-to-day operations.

A)local
B)integrated
C)notational dollar
D)functional

Question 16

If the same exchange rate were used to remeasure every line on a financial statement, then there would be no imbalances from remeasuring.

Question 17

Translation exposure may also be called ________ exposure.

A)transaction
B)operating
C)accounting
D)currency

Question 18

Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the U.S. dollar is the functional currency, then

A)translation is not required.
B)translation is accomplished through the current rate method.
C)translation is accomplished through the temporal method.
D)none of the above

Question 19

Gains or losses caused by translation adjustments when using the current rate method are reported separately on the ________.

A)consolidated statement of cash flow
B)consolidated income statement
C)consolidated balance sheet
D)none of the above

Question 20

Consider two different foreign subsidiaries of Georgia-Pacific Wood Products Inc. The first subsidiary mills trees in Canada and ships its entire product to the Georgia-Pacific U.S. The second subsidiary is also owned by the parent firm but is located in Japan and retails tropical hardwood furniture that it buys from many different sources. The first subsidiary is likely a/an ________ foreign entity with most of its cash flows in U.S. dollars, and the second subsidiary is more of a/an ________ foreign entity.

A)domestic; integrated
B)self-sustaining; domestic
C)integrated; self-sustaining
D)self-sustaining; integrated

Question 21

If a firm's subsidiary is using the local currency as the functional currency, which of the following is NOT a circumstance that could justify the use of a balance sheet hedge?

A)The foreign subsidiary is about to be liquidated, so that the value of its Cumulative Translation Adjustment (CTA)would be realized.
B)The firm has debt covenants or bank agreements that state the firm's debt/equity ratio will be maintained within specific limits.
C)The foreign subsidiary is operating is a hyperinflationary environment.
D)All of the above are appropriate reasons to use a balance sheet hedge.

Question 22

Exchange rate imbalances that are passed through the balance sheet affect a firm's reported income, but imbalances transferred to the income statement do not.

Question 23

The two methods for the translation of foreign subsidiary financial statements are the current rate and temporal methods. Briefly, describe how each of these methods translates the foreign subsidiary financial statements into the parent company's consolidated statements. Identify when each technique should be used and the major advantage(s)of each.

Question 24

A balance sheet hedge requires that the amount of exposed foreign currency assets and liabilities

A)have a 2:1 ratio of assets to liabilities.
B)have a 2:1 ratio of liabilities to assets.
C)have a 2:1 ratio of liabilities to equity.
D)be equal.

Question 25

If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound increases in value from 1.40/£ to €1.45/£, the European firm has a translation ________.

A)gain of €25,000
B)loss of €25,000
C)gain of £25,000
D)loss of £25,000

Question 26

If the parent firm and all subsidiaries denominate all exposed assets and liabilities in the parent's reporting currency this will ________ exposure but each subsidiary would have ________ exposure.

A)maximize translation; no transaction
B)eliminate translation; transaction
C)maximize transaction; no translation
D)eliminate transaction; translation

Question 27

Translation gains or losses can be quite different from operating gains or losses not only in magnitude but also in sign.

Question 28

The biggest advantage of the current rate method of reporting translation adjustments is the fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet and does not pass through the consolidated income statement.

Question 29

The main technique to minimize translation exposure is called a/an ________ hedge.

A)balance sheet
B)income statement
C)forward
D)translation

Question 30

Under the temporal rate method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item's creation.

Question 31

If the European subsidiary of a U.S. firm has net exposed assets of €500,000, and the euro increases in value from $1.30/€ to $1.35/€ the U.S. firm has a translation ________.

A)gain of $25,000
B)loss of $25,000
C)gain of $525,000
D)loss of €525,000

Question 32

If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound drops in value from €1.40/£ to euro 1.30/£, the European firm has a translation ________.

A)gain of €12,500
B)loss of €12,500
C)loss of £12,500
D)gain of £12,500

Question 33

A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S. dollars. The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a profit on the sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S. dollar amount, the Canadian dollar has appreciated 10% against the U.S. dollar. In this example, the Canadian subsidiary will record a

A)10% foreign exchange loss on the U.S. dollar accounts receivable.
B)10% foreign exchange gain on the U.S. dollar accounts receivable.
C)since the Canadian firm is a U.S. subsidiary neither a gain nor loss will be recorded.
D)any gain or loss will be recorded only by the parent firm.

Question 34

________ occur as a result of changes in the value of currency whereas ________ occur as a result of ongoing business activities.

A)Operating gains or losses; Translation gains or losses
B)Swap losses; Translation gains or losses
C)Translation gains or losses; Operating gains or losses
D)all of the above

Question 35

The temporal method of foreign currency translation gains or losses resulting from remeasurement are carried directly to current consolidated income and thus introduces volatility to consolidated earnings.

Question 36

The current rate method is the most prevalent method today for the translation of financial statements.

Question 37

If a firm's balance sheet has an equal amount of exposed foreign currency assets and liabilities and the firm translates by the temporal method, then

A)the net exposed position is called monetary balance.
B)the change is value of liabilities and assets due to a change in exchange rates will be of equal but opposite direction.
C)both A and B are true.
D)none of the above

Question 38

________ gains and losses are "realized" whereas ________ gains and losses are only "paper."

A)Translation; transaction
B)Transaction; translation
C)Translation; operating
D)none of the above

Question 39

It is possible that efforts to decrease translation exposure may result in an increase in transaction exposure.

Question 40

The temporal rate method is the most prevalent method today for the translation of financial statements.

Question 41

Describe a balance sheet hedge and give at least two examples of when such a hedge could be justified.