CFA Level 2 - Financial Reporting and Analysis Session 6 - Reading 25 Multinational Operations-LOS c

C FA Level 2 - Financial Reporting and Analysis Session 6 - Reading 25 Multinational Operations-LOS c (Practice Questions, Sample Questions) 1. The U.S. Deter Company operates a subsidiary in the UK, and the functional currency is the British pound. The subsidiary’s 2001 incomestatement shows ￡ 500 of net income and a ￡ 50 dividend that was paid on December 31, when the exchange rate was $1.50 per pound. Thecurrent exchange rate is $1.65 per pound, and the average rate is $1.58per pound. What is the change in retained earnings for the period in U.S.dollars under U.S. GAAP? A) $725. B) $715. C) $750 {Explanation: The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. Thebasis for using the temporal method is when Functional Currency = Parent'sPresentation Currency. Since the functional currency is the local currency, usethe current rate method. The net income is translated at the average rate, anddividends are translated at the rate that applied when they were paid. Hence:1.58( ￡ 500) ? 1.50( ￡ 50) = $715 }

2. Which of the following statements regarding foreign currency translation are least accurate? Under the: A) temporal method, sales are remeasured using the average rate.B) temporal method, COGS and depreciation are remeasured using thehistorical rate. C) current rate method, the foreign currency translation gain or lossappears on the parent firm's income statement {Explanation: Under the current rate method, the foreign currency translation gain or loss appears on the parent firm's balance sheet in the equity accounts } 3. An important distinction between the temporal method and the current rate method is that: A) the current rate method results in an adjustment to the equityaccount on the balance sheet. The temporal method results in a gainor loss appearing on the income statement. B) monetary assets and liabilities are remeasured (temporal method) athistorical rates but translated (current rate method) at current rates.C) depreciation and cost of goods sold (COGS) are a function of thecurrent rate under translation (current rate method), but a function ofthe average rate under remeasurement (temporal method) {Explanation: The current rate method results in an adjustment to the equity account on the balance sheet. The temporal method results in a gain or lossappearing on the income statement. Depreciation and COGS are a function of

the average rate under the current rate method, but a function of the historicalrate under the temporal method. Monetary assets and liabilities are use thecurrent rates under both methods } 4. Global International Corp. (GIC) has three subsidiaries: GIC Europe whose local currency is the euro and whose functional currency is theeuro; GIC China whose local currency is the yuan and whose functionalcurrency is the Hong Kong dollar; and GIC Bahamas whose localcurrency is the Bahamian dollar and whose functional currency is theU.S. dollar. GIC’s reporting currency is the U.S. dollar. Which conversionmethods should be used by GIC for each of its subsidiaries? A) GIC Europe’s data should be remeasured under the temporal method;GIC China’s data should be remeasured under the temporal method intoHong Kong dollars, and then translated under the current rate methodinto U.S. dollars; and GIC Bahamas’ data should be translated under thecurrent rate method into U.S. dollars. B) GIC Europe’s data should be translated under the current ratemethod; GIC China’s data should be remeasured under the temporalmethod into Hong Kong dollars, and then translated under thecurrent rate method into U.S. dollars; and GIC Bahamas’ data shouldbe remeasured under the temporal method into U.S. dollars. C) The financial data for all three subsidiaries should be remeasuredunder the temporal method {Explanation: The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The

basis for using the temporal method is when Functional Currency = Parent'sPresentation Currency. GIC Europe’s data should be translated under thecurrent rate method; GIC China’s data should be remeasured under thetemporal method into Hong Kong dollars, and then translated under the currentrate method into U.S. dollars; and GIC Bahamas’ data should be remeasuredunder the temporal method into U.S. dollars } 5. Which of the following statements regarding the functional currency under US GAAP is least accurate? A) Self-contained, independent subsidiaries whose operations areprimarily located in the local market will use the local currency as thefunctional currency.B) If a firm operates in a country or environment which is subject tocumulative inflation of 100% or more over a three year period, that firmwill use the parent's currency as the functional currency. C) The functional currency is defined as the primary currency of theeconomic environment in which the parent firm operates {Explanation: The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. Thebasis for using the temporal method is when Functional Currency = Parent'sPresentation Currency. The functional currency is defined as the primarycurrency of the economic environment in which the foreign subsidiary operates }

6. Each of the following items is considered a monetary asset or liability account under the temporal method for foreign currency translationEXCEPT: A) accounts payable. B) inventory. C) long-term debt {Explanation: The monetary asset and liability accounts under the temporal method are cash, accounts receivable, accounts payable, and long-term debt } 7. Which of the following statements regarding the foreign currency translation under US GAAP is least accurate? The functional currency isthe: A) parent firm's home currency for self-contained independentforeign subsidiaries. B) parent firm's home currency if the foreign subsidiary operates in acountry with high inflation.C) subsidiary's local currency for self-contained, independent foreignsubsidiaries {Explanation: The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. Thebasis for using the temporal method is when Functional Currency = Parent'sPresentation Currency. This statement is incorrect, both remaining statements

are correct regarding rules that govern the determination of the functionalcurrency of subsidiaries } 8. Which of the following situations does NOT require the use of the temporal method? The: A) foreign subsidiary is operating in a highly inflationary economy.B) functional currency is some currency other that the local currency orthe U.S. dollar. C) local currency is the functional currency {Explanation: The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. Thebasis for using the temporal method is when Functional Currency = Parent'sPresentation Currency.The temporal method is not required in the situation when the local currency isthe functional currency }