Financial Reporting: Multinational Operations

Question 1

Functional Currency for a Subsidiary Determines which Translation Method?

Answer 1

1. Well integrated with parent when functional currency = parent’s currency: Temporal method
2. Self contained and managed independently when functional currency is local currency: Current rate method

Question 2

Methods for Translating Forex Financial Statement

Answer 2

• Temporal Method: Monetary and non-monetary assets that are carried at current value on the balance sheet are translated at current exchange rate
• Current rate method: Translate IS first at current rate (average over reporting period) All assets and liabilities are translated at current exchange rate and common equity/dividends at historical rate.
• Monetary/non-monetary method: Only monetary assets and liabilites are translated at currency exchange rate. (cash, AR, AP)

Question 3

Quick way to tell whether balance sheet will a translation gain or loss

Answer 3

1. Current rate method: Equity exposure… If exchange rate increased in favor of foriegn then gain is recognized on BS.
2. Temporal method: Cash/receivables vs. liabilities exposure: If liabilities exceed monetary assets then exchange rate increased in favor of foriegn will create a loss on IS.

Question 4

Current Rate Translation of Financial Statement Items

Answer 4

Assets - Current

Liabilities - Current

Common equity - Historical

Dividends - Historical rate at declaration

Retained earnings - Change in RE at average rate (from IS)

IS items - Average rate

Question 5

Temporal Method Translation of Financial Statement items

Answer 5

Monetary Assets - Current

Nonmonetary assets - Historic (unless measured at current market rate like inventory under lower of cost or market)

Liabilities - Current (except deferred rev - historical)

Common equity - Historical

Retained earnings - Beginning balance + translated NI - Divdends (historical)

Revenue - Average

Most expenses - Average

Expenses related to historical BS items - Historical

Question 6

Dealing with Currency Pairs in Translation

Answer 6

1. Base/Quote = 1/X = ratio
2. Converting from quote to base (multiply by ratio)
3. Converting from base to quote (divide by ratio)