Reading 21 - Multinational Operations

Question 1

What are the two ways a foreign currency can affect a multinational firm’s financial statements?

Answer 1

1. The multinational firm may engage in business transactions that are denominated in a foreign currency
2. The multinational firm may invest in subsidiaries that maintain their books and records in a foreign currency

Question 2

What is the local currency ?

Answer 2

the currency of the country being referred to

Question 3

What is the functional currency ?

Answer 3

The currency of the primary economic environment in which the entity operates

**generally where the entity generates and expends cash.

Question 4

What is the presentation (reporting) currency ?

Answer 4

the currency in which the parent company prepares its financial statements

Question 5

How are gains/losses for foreign currency transactions accounting for?

Answer 5

On the income statement.

Question 6

What are the 2 methods used to remeasure or translate the financial statements of a foreign subsidiary to the parent’s presentation (reporting) currency?

Answer 6

1. Remeasurement : involves converting the local currency into a functional currency using the temporal method
2. Translation : involves converting the functional currency into the parent’s presentation (reporting) currency using the current rate method (aka the all-current method)

Question 7

According the IASB, what factors should management consider in deciding on the functional currency?

Answer 7

1. The currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of good and services
3. The currency that influences labor, material, and other costs
4. The currency from which funds are generated
5. The currency in which receipts from operating activities are usually retained

Question 8

According the FASB, what factors should management consider in deciding on the functional currency?

Answer 8

1. If the functional currency and the parent’s presentation currency differ the current rate method is used to translate the foreign currency financal statements
2. If the functional currency is the same as the parent’s presentation currency, the temporal method is used to remeasure the foreign currency financial statements
3. In the case where the local currency, the functional currency, and the presentation currency all differ, both the temporal method and the current rate method are used
4. If a subsidiary is operating in a hyperinflationary environment, the functional current is considered to be the parent’s presentation currency and the temporal method is used under GAAP. Under IFRS, the subsidiary’s financial statements are restated for inflation and then translated using the current rate method

Question 9

What is the current rate ?

Answer 9

the exchange rate as of the balance sheet date

Question 10

What is the average rate ?

Answer 10

the average exchange rate over the reporting period

Question 11

What is the historical rate ?

Answer 11

The actual rate that was in effect when the original transaction occurred

Question 12

What are the procedures for applying the current rate method ?

Answer 12

• All income statement accounts are translated at the average rate
• All balance sheet accounts are translated at the current rate except for common stock, which is translated at the historical (actual) rate that applied when the stock was issued
• Dividends are translated at the rate that applied when they were paid
• Translation gain or loss is reported in shareholder’s equity as part of the cumulative translation adjustment (CTA)

Question 13

What are the procedures for applying the temporal method ?

Answer 13

1. Monetary assets and liabilities are remeasured using the current exchange rate.
2. All other asset and liabilities are considered nonmonetary and are remeasured at the historical rate (**nonmonetary items most commonly are inventory,fixed assets,intangible assets, and unearned(deferred) revenue)
3. Common stock and dividends paid are remeasured at the historical rate
4. Expenses related to nonmonetary assets such as COGS,depreciation expense, and amortization expense are remeasured based on historical rates at the time of their purchase
5. Revenues and all other expenses are translated at the average rate
6. Remeasurement G/L is recognized on the income statement,…… **This results in more volatile net income than the current rate method..

Question 14

If a firm uses the current rate method & the foreign currency is appreciating, who will have the gain or loss, Net Assets or Net Liabilities ?

Answer 14

Net Assets = Gain

Net Liabilities = Loss

Question 15

If a firm uses the current rate method & the foreign currency is depreciating, who will have the gain or loss, Net Assets or Net Liabilities ?

Answer 15

Net Assets : Loss

Net Liabilities : Gain

Question 16

If a firm uses the temporal method & the foreign currency is appreciating, who will have the gain or loss, Net Monetary Assets or Net Monetary Liabilities ?

Answer 16

Net Monetary Assets : Gain

Net Monetary liabilities : Loss

Question 17

If a firm uses the temporal method & the foreign currency is depreciating, who will have the gain or loss, Net Monetary Assets or Net Monetary Liabilities ?

Answer 17

Net monetary assets: Loss

Net monetary liabilities : Gain

Question 18

What rates are used to translate Monetary assets and liabilities under the Temporal and Current Rate Methods?

Answer 18

Temporal: Current Rate

Current Rate: Current Rate

Question 19

What rates are used to translate Nonmonetary assets and liabilities under the Temporal and Current Rate Methods?

Answer 19

Temporal : Historical Rates

Current : Current Rate

Question 20

What rates are used to translate Common Stock under the Temporal and Current Rate Methods?

Answer 20

Temporal : Historical rates

Current : Historical rates

Question 21

What rates are used to translate Equity (taken as a whole) under the Temporal and Current Rate Methods?

Answer 21

Temporal : Mixed Rate ***more info available

Current : Current Rate

Question 22

What rates are used to translate Revenues and SG&A under the Temporal and Current Rate Methods?

Answer 22

Temporal : Average rate

Current : Average rate

Question 23

What rates are used to translate Cost of goods sold (COGS) under the Temporal and Current Rate Methods?

Answer 23

Temporal : Historical rates

Current : Average rate

Question 24

What rates are used to translate Depreciation and Amortization under the Temporal and Current Rate Methods?

Answer 24

Temporal : Historical raes

Current : Average rate

Question 25

Where do gains/losses on exchange rates go under the Temporal and Current Rate Methods?

Answer 25

Temporal : Income Statement Current: Equity

Question 26

What are some key points to remember regarding the original versus the translated financial statements and ratios?

Answer 26

1. Pure balance sheet and pure income statement ratios will be the same 2. If the foreign currency is depreciating, translated mixed ratios will be large than the original ratio 3. If the foreign currency is appreciating , translated mixed ratios will be smaller than the original ratio

Question 27

According to _FASB_, what determines if an environment is hyperinflationary?

Answer 27

Where cumulative inflation exceeds 100% over a 3-year period This is 26% annualized for 3 yrs

Question 28

What is the **_effective tax rate_** ?

Answer 28

the tax expense in the income statement divided by pretax profit

Question 29

What is the **_statutory tax rate_** ?

Answer 29

Is provided by the tax code of the home country

Question 30

What is the general rule of when the **_temporal method_** should be used?

Answer 30

The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency.

Question 31

What is the general rule of when the **_current rate_** method should be used?

Answer 31

The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency.

Question 32

When translating the financial statments with the _Current Rate Method_, do you start with the Balance Sheet or the Income statement? Also answer why....

Answer 32

You start with the income statement. This is b/c we need the new net income figure to calculate the retained earnings on the balance sheet

Question 33

When remeasuring the financial statments with the _Temporal Method_, do you start with the Balance Sheet or the Income statement?

Answer 33

The Balance Sheet