Reading 09 - Multinational Operations Flashcards
What are the two ways a foreign currency can affect a multinational firm’s financial statements?
- The multinational firm may engage in business transactions that are denominated in a foreign currency
- The multinational firm may invest in subsidiaries that maintain their books and records in a foreign currency
What is the local currency ?
the currency of the country being referred to
What is the functional currency ?
The currency of the primary economic environment in which the entity operates
**generally where the entity generates and expends cash.
What is the presentation (reporting) currency ?
the currency in which the parent company prepares its financial statements
How are gains/losses for foreign currency transactions accounting for?
On the income statement.
What are the 2 methods used to remeasure or translate the financial statements of a foreign subsidiary to the parent’s presentation (reporting) currency?
- Remeasurement : involves converting the local currency into a functional currency using the temporal method
- Translation : involves converting the functional currency into the parent’s presentation (reporting) currency using the current rate method (aka the all-current method)
According the IASB, what factors should management consider in deciding on the functional currency?
- The currency that influences sales prices for goods and services
- Currency of the country whose competitive forces and regulations mainly determine the sales price of good and services
- The currency that influences labor, material, and other costs
- The currency from which funds are generated
- The currency in which receipts from operating activities are usually retained
According the FASB, what factors should management consider in deciding on the functional currency?
- If the functional currency and the parent’s presentation currency differ the current rate method is used to translate the foreign currency financal statements
- 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
- 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
- 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
What is the current rate ?
the exchange rate as of the balance sheet date
What is the average rate ?
the average exchange rate over the reporting period
What is the historical rate ?
The actual rate that was in effect when the original transaction occurred
What are the procedures for applying the current rate method ?
- 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)
What are the procedures for applying the temporal method ?
- Monetary assets and liabilities are remeasured using the current exchange rate.
- 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)
- Common stock and dividends paid are remeasured at the historical rate
- 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
- Revenues and all other expenses are translated at the average rate
- Remeasurement G/L is recognized on the income statement,…… **This results in more volatile net income than the current rate method..
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 ?
Net Assets = Gain
Net Liabilities = Loss
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 ?
Net Assets : Loss
Net Liabilities : Gain
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 ?
Net Monetary Assets : Gain
Net Monetary liabilities : Loss
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 ?
Net monetary assets: Loss
Net monetary liabilities : Gain
What rates are used to translate Monetary assets and liabilities under the Temporal and Current Rate Methods?
Temporal: Current Rate
Current Rate: Current Rate
What rates are used to translate Nonmonetary assets and liabilities under the Temporal and Current Rate Methods?
Temporal : Historical Rates
Current : Current Rate
What rates are used to translate Common Stock under the Temporal and Current Rate Methods?
Temporal : Historical rates
Current : Historical rates
What rates are used to translate Equity (taken as a whole) under the Temporal and Current Rate Methods?
Temporal : Mixed Rate ***more info available
Current : Current Rate
What rates are used to translate Revenues and SG&A under the Temporal and Current Rate Methods?
Temporal : Average rate
Current : Average rate
What rates are used to translate Cost of goods sold (COGS) under the Temporal and Current Rate Methods?
Temporal : Historical rates
Current : Average rate
What rates are used to translate Depreciation and Amortization under the Temporal and Current Rate Methods?
Temporal : Historical raes
Current : Average rate
Where do gains/losses on exchange rates go under the Temporal and Current Rate Methods?
Temporal : Income Statement
Current: Equity
What are some key points to remember regarding the original versus the translated financial statements and ratios?
- Pure balance sheet and pure income statement ratios will be the same
- If the foreign currency is depreciating, translated mixed ratios will be large than the original ratio
- If the foreign currency is appreciating , translated mixed ratios will be smaller than the original ratio
According to FASB, what determines if an environment is hyperinflationary?
Where cumulative inflation exceeds 100% over a 3-year period
This is 26% annualized for 3 yrs
What is the effective tax rate ?
the tax expense in the income statement divided by pretax profit
What is the statutory tax rate ?
Is provided by the tax code of the home country
What is the general rule of when the temporal method should be used?
The basis for using the temporal method is when Functional Currency = Parent’s Presentation Currency.
What is the general rule of when the current rate method should be used?
The basis for using the current rate method is when Functional Currency is NOT the same as Parent’s Presentation (reporting) Currency.
When translating the financial statments with the Current Rate Method, do you start with the Balance Sheet or the Income statement?
Also answer why….
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
When remeasuring the financial statments with the Temporal Method, do you start with the Balance Sheet or the Income statement?
The Balance Sheet
