Reading 18 Multinational Operations FinQuiz.

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CFA Level II Item-set - Solution
Study Session 5
June 2017

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Reading 18 Multinational Operations FinQuiz.com

FinQuiz Level II 2017 Item-sets Solution

Reading 18: Multinational Operations

1. Question ID: 11628

Correct Answer: A
In order to determine where foreign currency translation gains/losses are recorded, it is necessary to
determine the method to be used to translate El-Co Fiestas financial statements into U.S. $. This
method, in turn, is determined by the relationship of the functional currency of the subsidiary and the
presentation currency of the parent (Bernstake Ltd.).

The relevant functional currency is determined primarily by the currency in which the subsidiary
generates and expends cash; the currency which influences the sales price of goods and services; and
the currency of the country whose competitive forces and regulations mainly determine the sales price
of its goods and services.

In the case of the El-Co Fiesta, the relevant functional currency is the ARP. Since this currency
differs from the parent companys presentation currency, the relevant translation method to use is the
current rate method. The current rate method records translation gains/losses as part of
comprehensive income, a component of stockholders equity.

2. Question ID: 11629

Correct Answer: A
The appropriate translation method is the current rate method (see the solution to part 1). Under this
method all monetary and non-monetary assets are translated at the current rate (at December 31,
2009). Thus total assets, in U.S. $ terms, amount to $603,478.26 (ARP 3,470,000 ARP 5.75/U.S. $)
or approximately $603,000.

3. Question ID: 11630

Correct Answer: B
Under the temporal method, Bernstake Ltd. would incur a foreign currency translation loss if the
subsidiarys monetary assets were less than its monetary liabilities (or vice-versa) and foreign
currency weakened (or strengthened). The parent company would incur a translation gain if the
subsidiarys monetary assets were greater than its monetary liabilities (or vice-versa) and foreign
currency strengthened (or weakened).

Based on the exchange rate trend, the ARP has weakened (over the year 2009) from being worth 4.45
to 5.75 for every US$. Additionally, translating El-Co Fiestas financial statements would result in a
translation gain as it as has a net monetary liability exposure (the monetary assets, ARP 1,420,000,
are less than the monetary liabilities, ARP 1,730,000) and the ARP has depreciated.

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Reading 18 Multinational Operations FinQuiz.com

4. Question ID: 11631

Correct Answer: A
The temporal method will produce an inventory turnover ratio that is identical to the pre-translation
ratio. Pre-translation ratio is 0.85 (ARP 850,000/ARP 1,000,000) and ratio under the temporal method
is 0.85 [(ARP 850,000 4.85)/ (ARP 1,000,000 4.85)].

The ratio produced under current rate method will be 0.96 [(ARP 850,000 5.10)/(ARP 1,000,000
5.75)]. This ratio is higher to the one calculated from the temporal method. This is because the ARP
has depreciated relative to the dollar, resulting in a lower US$ value for the inventory figure (which is
converted at the current rate) under the current method, hence a lower denominator for the ratio. On
the other hand, inventory under the temporal method is translated by using the rate at which inventory
was acquired. As the rate at which inventory was acquired is historical, the inventory translated under
this method has a higher US$ value producing a higher denominator and decreasing the inventory
turnover ratio.

If El-Co Fiesta used the LIFO method for inventory valuation (instead of FIFO), all inventory units
on the balance sheet would have comprised of older items and thus valued at relatively older
exchange rates, resulting in higher translated inventory values. Thus LIFO method produces a higher
denominator and hence a lower inventory turnover ratio also decreasing the ratio is the lower
translated value of the cost of goods sold (translated at a newer, lower exchange rate). Current FIFO
inventory valuation method would have resulted in lower translated inventory values (relative to the
LIFO method), as the inventory would have relatively recent items with more recent rates being used.
This produces a smaller denominator and hence a higher inventory turnover ratio. Also increasing the
ratio is the higher translated value of the cost of goods sold (translated at a newer, lower exchange
rate).

5. Question ID: 11632

Correct Answer: A
Since long-term bonds are monetary liabilities, these are translated using current exchange rates under
the temporal method. Thus the U.S. $ value of notes payable amounts to $222,608.70 (ARP
1,280,000 ARP5.75/U.S. $) or approximately $223,000.

6. Question ID: 11633

Correct Answer: A
Under hyperinflationary periods, IFRS requires nonmonetary assets to be restated for the general
purchasing power unit of the monetary unit. These restated assets will then be translated under the
current rate method at the current exchange rate.

Inflation-adjusted inventory = ARP 1,000,000 130/100

= ARP 1,300,000

Translated Inventory = ARP 1,300,000 ARP 8.00/U.S. $

= $162,500

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Reading 18 Multinational Operations FinQuiz.com

7. Question ID: 15956

Correct Answer: C
Since France Co has a net monetary liability exposure and the Euro has appreciated relative to the
dollar (Exhibit 4), the best course of action for the subsidiary would be to finance the purchase of the
plant using equity rather than debt (long-term notes payable) since capital stock is not exposed to
foreign exchange risk under the temporal method.

The subsidiary has a net monetary liability exposure of 6,740 million as its monetary assets (cash
and accounts receivable), 3,825, are less than its monetary liabilities (total liabilities), 10,565
million.

Eliminating capital stock is not a recommended course of action since the notes payable are exposed
to foreign exchange risk under the temporal method (which is used as the translation method since the
presentation and functional currencies are identical), whereas capital stock is not.

France Cos existing cash balance of 175 million can only partially reduce its liabilities of 10,565
million. If the parent were required to pay off France Cos remaining liabilities of 10,390 million
(10,565 million 175 million), it would need to send US$ 6,754 million (10,390 million US$
0.65/) on January 1, 2010. On December 31, 2010 Arioco-P would be required to send US$ 7,793
million (10,390 million US$ 0.75/) to pay 10,390 million. This will result in a foreign exchange
loss of US$ 1,038 million (US$ 7793 million US$ 6,754 million), thereby failing to eliminate
exposure.

8. Question ID: 15957

Correct Answer: B
Given that the Euro has appreciated from 0.65 to 0.75 relative to the US dollar, France Co will report
a translation loss under the temporal method as its monetary liabilities are greater than its monetary
assets (see the previous solution) resulting in a reduction in net income and hence its total equity
balance.

On the other hand, since the current exchange rate used to translate total assets under the current
method is greater relative to the historical exchange rates used to translate assets under the temporal
method and since it has a net asset exposure of 4,566 million (15,131 million 10,565 million),
there will be a positive translation adjustment. Since the positive translation adjustment will increase
the total equity balance, this will result in a higher total balance being reported for the subsidiary
under the current rate method.

9. Question ID: 15958

Correct Answer: A
A higher gross profit margin will be reported under the temporal method.

Under both methods, sales will be translated at the average rate. The rate at which cost of goods sold
is to be translated will determine the method to produce the highest gross profit margin for the
subsidiary.

Under the current rate method, cost of goods sold is translated at the average rate, i.e. US$ 0.70 per .
The rate at which cost of goods sold is translated under the historical method will be an older and
lower rate, given the increase in the value of Euro over the 2010 period. Thus, the cost of goods sold
will be higher and gross profit lower under the current rate method, which produces a lower gross
profit margin using this method.

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Reading 18 Multinational Operations FinQuiz.com

10. Question ID: 15959

Correct Answer: A
Given that France Co.s functional currency is identical to Arioco-Ps presentation currency, US$, the
temporal method is used to determine its translated retained earnings as follows:

(millions) Exchange rate (US$ $ (millions)

per )
Cash 175 0.75 131.25
Accounts Receivable 3,650 0.75 2,737.50
Inventory 4,530 0.67 3,035.10
Total current assets 8,355 5,903.85
Property, plant, and
equipment 15,136 0.65 9,838.40
Less: accumulated
depreciation (8,360) 0.65 (5,434.00)
Total assets 15,131 10,308.25
Total liabilities 10,565 0.75 7,923.75
Capital stock 2,000 0.65 1,300.00
Retained earnings 2,566 to balance 1,084.50
Total 15,131 10,308.25

Since France Co was established on January 1, 2010 it has no opening retained earnings.

11. Question ID: 15960

Correct Answer: C
Implication 1 has been inaccurately identified. Implication 2 has been inaccurately identified.

In scenarios of hyperinflation, U.S. GAAP simply requires the foreign currency financial statements
of the concerned subsidiary to be translated using the temporal method. On the other hand, IAS 21
(IFRS) requires foreign currency financial statements to be restated for inflation and then translated
using the current rate.

Under the temporal method and U.S. GAAP, liabilities will be translated at an exchange rate of AD
125.53 per US$. Under IFRS, liabilities will not be restated for inflation as they are expressed in
terms of the monetary unit current at the balance sheet date. Thus under the current rate method and
IFRS, these liabilities will be translated at the same exchange rate as used under the temporal method,
i.e. AD 125.53 per US$. Thus the translated liabilities under the two standards are identical.

Inflation in Algeria increased by 300% or by 3 times over the 2010 period. At the same time, the AD
lost about 26% [(125.53 100)/100] of its value. Since the decrease in currency value is not matched
by the change in local inflation, IFRS and U.S. GAAP will produce different results.

12. Question ID: 15961

Correct Answer: A
Using the temporal method (see the solution to part 4), France Cos closing inventory account balance
is approximately US$ 3,035 million (4,530 million US$ 0.67 per ).

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