Chapter 11 Translation Exposure

The two basic methods for the translation of foreign subsidiary financial statements are the _________________ method and the ____________ method.

Current Rate; Temporal

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.

Eliminate Translation ; Transaction

Historical exchange rates may be used for ________________, while current exchange rates may be used for_____________.

Equity Accounts and Fixed Assets ; Current Assets and Liabilities

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. True or False?

False

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

False

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

False

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

False

The temporal rate method is the most prevalent method today for the translation of financial statements. True or False?

False

Generally speaking, translation methods by country define the translation process as a function of what two factors?

Foreign Subsidiary Independence; A Firm's Functional Currency

A foreign subsidiary's _______________ currency is the currency used in the firm's day - to - day operations.

Functional

If the European subsidiary of a U.S. firm has net exposed assets of Euro200,000, and the euro increases in value from $1.22/Euro to $1.26/Euro the U.S. firm has a translation?

Gain of $8,000

If the British subsidiary of a European firm has net exposed assets of pound250,000, and the pound drops in value from Euro1.35/pound to Euro1.30/pound, the European firm has a translation?

Gain of Euro 12,500

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.

Integrated Foreign Entity

Consider two different foreign subsidiaries of Georgia - Pacific Wood Products Inc. The first subsidiary mills trees in Canada and sips 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.

Integrated; Self-Sustaining

If the European subsidiary of a U.S. firm has net exposed assets of Euro750,000, and the euro drops in value from $1.30/euro to $1.20/Euro the U.S. firm has a translation?

Loss of $75,000

If the British subsidiary of a European firm has net exposed assets of pound125,000, and the pound increases in value from Euro1.40/pound to Euro1.44/pound, the European firm has a translation?

Loss of pound5,000

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. True or False?

True

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. True or False?

True

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. True or False?

True

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

True

The current rate method is the most prevalent method today for the translation of financial statements. True or False?

True

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. True or False?

True

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". True or False?

True

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

True

Which of the following primary principles of U.S. translation procedures is NOT true? A. 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 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 of a U.S. company are maintained in U.S. dollars, translation is not required. D. All of the above are true

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

A balance sheet hedge requires that the amount of exposed foreign currency assets and liabilities?

Be equal

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 change is value of liabilities and assets due to a change in exchange rates will be of equal but opposite direction B. the net exposed position is called monetary balance C. both A and B are true D. none of the above

Both A and B are true

If an imbalance results from the accounting method used for translation, the imbalance is taken either to _________________ or ____________________.

Current Income; Equity Reserves

The basic advantage of the ____________ method of foreign currency translation is that foreign non monetary assets are carried at their original cost in the parent's consolidated while the most important advantage of the ________________ method is that the gain or loss from translation does not pass through the income statement.

Current Rate; Temporal

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

Balance Sheet

Translation exposure may also be called ________________ exposure.

Accounting

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 firm has debt covenants or bank agreements that state the firm's debt/equity ratio will be maintained within specific limits B. The foreign subsidiary is about to be liquidated, so that the value of its Cumulative Translation Adjustment (CTA) would be realized C. The foreign subsidiary is operating is a hyper inflationary environment D. All of the above are appropriate reasons to use a balance sheet hedge

All of the above are appropriate reasons to use a balance sheet hedge

Translation exposure measures?

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

According to your authors, the main purpose of translation is?

To prepare consolidated financial statements

__________________ gains and losses are "realized" whereas _________________ gains and losses are only "paper".

Transaction; Translation

_____________ occur as a result of changes in the value of currency, whereas ______________ occur as a result of ongoing business activities.

Translation gains or losses; Operating gains or losses

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, then?

Translation is accomplished through the current rate method

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?

Translation is accomplished through the temporal method

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?

Translation is not required

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

Translation; Remeasurement

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. True or False?

True

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. True or False?

True

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

True

It is possible that effects to decrease translation exposure may result in an increase in transaction exposure. True or False?

True

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

True