Deck 11: Translation Exposure

Question 1

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

Answer 1

equity accounts and fixed assets; current assets and liabilities

Question 2

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

Answer 2

current rate; temporal

Question 3

Most countries specify the translation method to be used by a foreign subsidiary based on its business operations or the functional currency. Explain both subsidiary characterization criteria and the one adopted in the United States.

Answer 3

A foreign subsidiary's business can be categorized as either an integrated foreign entity or a self-sustaining foreign entity. An integrated foreign entity is one that operates as an extension of the parent company, with cash flows and general business lines that are highly interrelated with those of the parent. A self-sustaining foreign entity is one that operates in the local economic environment independent of the parent company. The differentiation is important to the logic of translation. A foreign subsidiary should be valued principally in terms of the currency that is the basis of its economic viability. It is not unusual for a single company to have both types of foreign subsidiaries, integrated and self-sustaining.
A foreign subsidiary's functional currency is the currency of the primary economic environment in which the subsidiary operates and in which it generates cash flows. In other words, it is the dominant currency used by that foreign subsidiary in its day-to-day operations. It is important to note that the geographic location of a foreign subsidiary and its functional currency may be different.
The United States, rather than distinguishing a foreign subsidiary as either integrated or self-sustaining, requires that the functional currency of the subsidiary be determined. Management must evaluate the nature and purpose of each of its individual foreign subsidiaries to determine the appropriate functional currency for each. If a foreign subsidiary of a U.S.-based company is determined to have the U.S. dollar as its functional currency, it is essentially an extension of the parent company (equivalent to the integrated foreign entity designation used by most countries). If, however, the functional currency of the foreign subsidiary is determined to be different from the U.S. dollar, the subsidiary is considered a separate entity from the parent (equivalent to the self-sustaining entity designation).

Question 4

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 5

________ 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 6

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

Question 7

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

Question 8

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

Question 9

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 10

Translation exposure may also be called ________ exposure.

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

Question 11

It is highly unusual for a multinational firm to have both integrated foreign entities AND self-sustaining foreign entities.

Question 12

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

Question 13

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 14

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)

Question 15

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 16

A foreign subsidiary's functional currency is the currency of the primary economic environment in which the subsidiary operates and in which it generates cash flows.

Question 17

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 18

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 19

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 20

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 21

Which of the following primary principles of U.S. translation procedures is NOT true?

A) If the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S. dollars, translation is not required.
B) If the financial statements of the foreign subsidiary are maintained in the local currency and the local currency is the functional currency, they are translated by the temporal method.
C) If the financial statements of the foreign subsidiary are maintained in the local currency and the U.S. dollar is the functional currency, they are remeasured by the temporal method.
D) All of the above are true.

Question 22

If the European subsidiary of a U.S. firm has net exposed assets of €750,000, and the euro drops in value from $1.30/euro to $1.20/€ the U.S. firm has a translation:

A) gain of $75,000.
B) loss of $75,000.
C) gain of $625,000.
D) loss of €576,923.

Question 23

If the financial statements of the foreign subsidiary are maintained in the local currency and the U.S. dollar is the functional currency, they are remeasured by the temporal method.

Question 24

If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound increases in value from €1.40/£ to €1.44/£, the European firm has a translation:

A) loss of €5,000.
B) gain of €5,000.
C) gain of £5,000.
D) loss of £5,000.

Question 25

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 26

If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound drops in value from €1.35/£ to €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 27

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

Question 28

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

Question 29

The current rate method and the temporal method are two basic methods for translation that are employed worldwide.

Question 30

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 31

________ 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 32

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 33

Under U.S. accounting and translation practices, use of the current rate method is termed "translation" while use of the temporal method is termed "remeasurement."

Question 34

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 35

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

Question 36

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 37

If the European subsidiary of a U.S. firm has net exposed assets of €200,000, and the euro increases in value from $1.22/€ to $1.26/€ the U.S. firm has a translation:

A) gain of $8,000.
B) loss of $8,000.
C) gain of $252,000.
D) loss of €252,000.

Question 38

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 39

Under U.S. accounting and translation practices, use of the current rate method is termed ________ while use of the temporal method is termed ________.

A) translation; the same
B) translation; remeasurement
C) remeasurement; the same
D) remeasurement; translation

Question 40

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

Question 41

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 42

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

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

Question 43

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 44

One possible reason for a balance sheet hedge could be because the foreign subsidiary is about to be liquidated, so that value of its Cumulative Translation Adjustment (CTA) would be realized.

Question 45

________ 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 46

One possible reason for a balance sheet hedge could be because the firm has debt covenants or bank agreements that state the firm's debt/equity ratios will be maintained within specific limits.

Question 47

The value contribution of a subsidiary of a multinational firm to the firm can be reported in the income statement or balance sheet of the consolidated firm. Explain the reporting of the changes in the value of a subsidiary as a result of the change in an exchange rate - changes to the income and the assets of the subsidiary - in the consolidated financial statements of the parent company.

Question 48

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

Question 49

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 50

If management expects a foreign currency to depreciate, it could minimize translation exposure by increasing net exposed assets.

Question 51

If management anticipates an appreciation of the foreign currency, it should decrease net exposed assets to benefit from a gain.

Question 52

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 53

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 54

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