You are on page 1of 10

Problem 13.

1 Trident Europe (A)

Using facts in the chapter for Trident Europe, assume that the exchange rate on January 2, 2011, in Exhibit 13.4 dropped in value from $1.2000/€ to
$0.9000/€ rather than to $1.0000/€. Recalculate Trident Europe’s translated balance sheet for January 2, 2011 with the new exchange rate using the current
rate method.

a. What is the amount of translation gain or loss?


b. Where should it appear in the financial statements?

Translation Using the Current Rate Method: euro depreciates from $1.2000/euro to $0.9000/euro.

Just before devaluation Just after devaluation


Translated Translated
Euros Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (US$/euro) US dollars (US$/euro) US dollars
Cash 1,600,000 1.2000 $1,920,000 0.9000 $1,440,000
Accounts receivable 3,200,000 1.2000 3,840,000 0.9000 2,880,000
Inventory 2,400,000 1.2000 2,880,000 0.9000 2,160,000
Net plant & equipment 4,800,000 1.2000 5,760,000 0.9000 4,320,000
Total 12,000,000 $14,400,000 $10,800,000

Liabilities & Net Worth


Accounts payable 800,000 1.2000 $960,000 0.9000 $720,000
Short-term bank debt 1,600,000 1.2000 1,920,000 0.9000 1,440,000
Long-term debt 1,600,000 1.2000 1,920,000 0.9000 1,440,000
Common stock 1,800,000 1.2760 2,296,800 1.2760 2,296,800
Retained earnings 6,200,000 1.2000 7,440,000 1.2000 7,440,000
CTA account (loss) - $(136,800) $(2,536,800)
Total 12,000,000 $14,400,000 $10,800,000

a. The translation gain (loss) is: $(2,536,800)


136,800
$(2,400,000)

b. The translation gain (loss) for the year is added to the balance in the Cumulative Translation adjustment account, which is carried as a separate balance
sheet account within the equity section of the consolidated balance sheet. The lsos does not pass through the income statement under the Current Rate
Method, in which the currency of the foreign subsidiary is local currency functional.
Problem 13.2 Trident Europe (B)

Using facts in the chapter for Trident Europe, assume as in Trident Europe (A) that the exchange rate on January 2, 2011, in Exhibit 13.4 dropped in value
from $1.2000/€ to $0.9000/€ rather than to $1.0000/€. Recalculate Trident Europe’s translated balance sheet for January 2, 2011 with the new exchange rate
using the temporal rate method.

Translation Using the Temporal Method: euro depreciates from $1.2000/euro to $0.9000/euro.

Just before devaluation Just after devaluation


Translated Translated
Euros Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (US$/euro) (US dollars) (US$/euro) (US dollars)
Cash 1,600,000 1.2000 $1,920,000 0.9000 $1,440,000
Accounts receivable 3,200,000 1.2000 3,840,000 0.9000 2,880,000
Inventory 2,400,000 1.2180 2,923,200 1.2180 2,923,200
Net plant & equipment 4,800,000 1.2760 6,124,800 1.2760 6,124,800
Total 12,000,000 $14,808,000 $13,368,000

Liabilities & Net Worth


Accounts payable 800,000 1.2000 $960,000 0.9000 $720,000
Short-term bank debt 1,600,000 1.2000 1,920,000 0.9000 1,440,000
Long-term debt 1,600,000 1.2000 1,920,000 0.9000 1,440,000
Common stock 1,800,000 1.2760 2,296,800 1.2760 2,296,800
Retained earnings 6,200,000 1.2437 7,711,200 1.2437 7,711,200
CTA account (loss) - $(0) $(240,000)
Total 12,000,000 $14,808,000 $13,368,000

a. The translation gain (loss) is: $(240,000)


0
$(240,000)

b. Under the Temporal Method, the translation loss of $240,000 would be closed into retained earnings through the income statement,
rather than as a separate line item. It is shown as a separate line item above for pedagogical purposes only. Actual year-end retained
earnings would be $7,711,200 - $240,000 = $7,471,200.

c. The translation gain (loss) differs from the Current Rate Method because "exposed assets" under the Current Rate Method are larger than
under the temporal method by the amount of inventory and net plant & equipment.
Problem 13.3 Trident Europe ( C )

Using facts in the chapter for Trident Europe, assume that the exchange rate on January 2, 2011, in Exhibit 13.4 appreciated from $1.2000/€ to $1.500/€.
Calculate Trident Europe’s translated balance sheet for January 2, 2011 with the new exchange rate using the current rate method.

Translation Using the Current Rate Method: euro appreciates from $1.2000/euro to $1.5000/euro.

Just before revaluation Just after revaluation


Translated Translated
Euros Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (US$/euro) US dollars (US$/euro) US dollars
Cash 1,600,000 1.2000 $1,920,000 1.5000 $2,400,000
Accounts receivable 3,200,000 1.2000 3,840,000 1.5000 4,800,000
Inventory 2,400,000 1.2000 2,880,000 1.5000 3,600,000
Net plant & equipment 4,800,000 1.2000 5,760,000 1.5000 7,200,000
Total 12,000,000 $14,400,000 $18,000,000

Liabilities & Net Worth


Accounts payable 800,000 1.2000 $960,000 1.5000 $1,200,000
Short-term bank debt 1,600,000 1.2000 1,920,000 1.5000 2,400,000
Long-term debt 1,600,000 1.2000 1,920,000 1.5000 2,400,000
Common stock 1,800,000 1.2760 2,296,800 1.2760 2,296,800
Retained earnings 6,200,000 1.2000 7,440,000 1.2000 7,440,000
CTA account (loss) - $(136,800) $2,263,200
Total 12,000,000 $14,400,000 $18,000,000

a. The translation gain (loss) is: $2,263,200


136,800
$2,400,000

b. The translation gain for the year is added to the balance in the Cumulative Translation adjustment account, which is carried as a
separate balance sheet account within the equity section of the consolidated balance sheet. The gain does not pass through the income
statement under the current rate method in which the currency of the foreign subsidiary is a local currency functional.
Problem 13.4 Trident Europe (D)

Using facts in the chapter for Trident Europe, assume as in Trident Europe (C) that the exchange rate on January 2, 2011, in Exhibit 13.4 appreciated from
$1.2000/€ to $1.5000/€. Calculate Trident Europe’s translated balance sheet for January 2, 2011 with the new exchange rate using the temporal rate method.

Translation Using the Temporal Method: euro appreciates from $1.2000/euro to $1.5000/euro.

Just before revaluation Just after revaluation


Translated Translated
Euros Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (US$/euro) (US dollars) (US$/euro) (US dollars)
Cash 1,600,000 1.2000 $1,920,000 1.5000 $2,400,000
Accounts receivable 3,200,000 1.2000 3,840,000 1.5000 4,800,000
Inventory 2,400,000 1.2180 2,923,200 1.2180 2,923,200
Net plant & equipment 4,800,000 1.2760 6,124,800 1.2760 6,124,800
Total 12,000,000 $14,808,000 $16,248,000

Liabilities & Net Worth


Accounts payable 800,000 1.2000 $960,000 1.5000 $1,200,000
Short-term bank debt 1,600,000 1.2000 1,920,000 1.5000 2,400,000
Long-term debt 1,600,000 1.2000 1,920,000 1.5000 2,400,000
Common stock 1,800,000 1.2760 2,296,800 1.2760 2,296,800
Retained earnings 6,200,000 1.2437 7,711,200 1.2437 7,711,200
CTA account (loss) - $(0) $240,000
Total 12,000,000 $14,808,000 $16,248,000

a. The translation gain (loss) is: $240,000


0
$240,000

b. Under the Temporal Method, the translation loss of $240,000 would be closed into retained earnings through the income statement,
rather than as a separate line item. It is shown as a separate line item above for pedagogical purposes only. Actual year-end retained
earnings would be $7,711,200 - $240,000 = $7,471,200.

c. The translation gain (loss) differs from the Current Rate Method because "exposed assets" under the Current Rate Method are larger than
under the temporal method by the amount of inventory and net plant & equipment.
Problem 13.5 Productos Montevideo, S.A. (A)

Montevideo Products, S.A., is the Uruguayan subsidiary of a U.S. manufacturing company. Its balance
sheet for January 1 follows. The January 1st exchange rate between the U.S. dollar and the peso Uruguayo
($U) is $U20/$.

Determine Montevideo’s contribution to the translation exposure of its parent on January 1, using the
current rate method.

Balance Sheet (thousands of pesos Uruguayo, $U)


Exchange Rate
Assets January 1st ($U/US$)
Cash 60,000 20.00
Accounts receivable 120,000 20.00
Inventory 120,000 20.00
Net plant & equipment 240,000 20.00
540,000

Liabilities & Net Worth


Current liabilities 30,000 20.00
Long-term debt 90,000 20.00
Capital stock 300,000 15.00
Retained earnings 120,000 15.00
540,000

January 1st
$U/US$
Calculation of Accounting Exposures: $U (000s) 20.00
Exposed assets (all assets) 540,000 $27,000
Less exposed liabilities (curr liabs + lt debt) (120,000) (6,000)
Net exposure 420,000 $21,000
Problem 13.6 Productos Montevideo, S.A. (B)

Calculate Montevideo’s contribution to its parent’s translation loss if the exchange rate on December 31 is
$U22/$. Assume all peso accounts remain as they were at the beginning of the year.

Balance Sheet (thousands of pesos Uruguayo, $U)


Exchange Rate
Assets January 1st ($U/US$)
Cash 60,000 20.00
Accounts receivable 120,000 20.00
Inventory 120,000 20.00
Net plant & equipment 240,000 20.00
540,000

Liabilities & Net Worth


Current liabilities 30,000 20.00
Long-term debt 90,000 20.00
Capital stock 300,000 15.00
Retained earnings 120,000 15.00
540,000

January 1st
$U/US$
Calculation of Accounting Exposures: $U (000s) 20.00
Exposed assets (all assets) 540,000 $27,000
Less exposed liabilities (curr liabs + lt debt) (120,000) (6,000)
Net exposure 420,000 $21,000
Problem 13.7 Productos Montevideo, S.A. (C)

Calculate Montevideo’s contribution to its parent’s translation gain or loss using the current rate method if
the exchange rate on December 31 is $U12/$. Assume all peso accounts remain as they were at the
beginning of the year.

Balance Sheet (thousands of pesos Uruguayo, $U)


Exchange Rate
Assets January 1st ($U/US$)
Cash 60,000 20.00
Accounts receivable 120,000 20.00
Inventory 120,000 20.00
Net plant & equipment 240,000 20.00
540,000

Liabilities & Net Worth


Current liabilities 30,000 20.00
Long-term debt 90,000 20.00
Capital stock 300,000 15.00
Retained earnings 120,000 15.00
540,000

January 1st
$U/US$
Calculation of Accounting Exposures: $U (000s) 20.00
Exposed assets (all assets) 540,000 $27,000
Less exposed liabilities (curr liabs + lt debt) (120,000) (6,000)
Net exposure 420,000 $21,000
Problem 13.8 Bangkok Instruments, Ltd (A)

Bangkok Instruments, Ltd., is the Thai affiliate of a U.S. seismic instrument manufacturer. Bangkok Instruments manufactures the instruments primarily for the
oil and gas industry globally, though with recent commodity price increases of all kinds -- including copper -- its business has begun to grow rapidly. Sales are
primarily to multinational companies based in the United States and Europe. bankok Instruments' balance sheet in thousands of Thai bahts (B) as of March 31 is
as follows.

Using the data presented, assume that the Thai baht dropped in value from B30/$ to B40/$ between March 31 and April 1. Assuming no change in balance sheet
accounts between these two days, calculate the gain or loss from translation by both the current rate method and the temporal method. Explain the translation gain
or loss in terms of changes in the value of exposed accounts.

TRANSLATION BY THE CURRENT RATE METHOD

Balance Sheet (thousands) Before Devaluation After Devaluation


Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $800 40 $600
Accounts receivable 36,000 30 1,200 40 900
Inventory 48,000 30 1,600 40 1,200
Net plant & equipment 60,000 30 2,000 40 1,500
Total ฿168,000 $5,600 $4,200

Liabilities & Net Worth


Accounts payable ฿18,000 30 $600 40 $450
Bank loans 60,000 30 2,000 40 1,500
Common stock 18,000 20 900 20 900
Retained earnings 72,000 34 2,100 34 2,100
CTA account (loss) 0 - $(750)
Total ฿168,000 $5,600 $4,200

Note: Dollar retained earnings before devaluation are the cumulative sum of additions to retained earnings of all prior years, translated at exchange
rates in effect in each of those years.

This cumulative translation account (CTA) loss of $750,000 would be entered into the company's consolidated balance sheet under equity.

TRANSLATION BY THE TEMPORAL METHOD

Balance Sheet (thousands) Before Devaluation After Devaluation


Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $800 40 $600
Accounts receivable 36,000 30 1,200 40 900
Inventory 48,000 30 1,600 30 1,600
Net plant & equipment 60,000 20 3,000 20 3,000
Total ฿168,000 $6,600 $6,100

Liabilities & Net Worth


Accounts payable ฿18,000 30 $600 40 $450
Bank loans 60,000 30 2,000 40 1,500
Common stock 18,000 20 900 20 900
Retained earnings 72,000 23 3,100 23 3,100
CTA account (loss) 0 - $150
Total ฿168,000 $6,600 $6,100

Note a: Dollar retained earnings before devaluation are the cumulative sum of additions to retained earnings of all prior years, translated at exchange
rates in effect in each of those years.
Note b: Retained earnings after devaluation are translated at the same effective rate (see Note a) as before devaluation.

The translation gain of $150,000 would be passed-through to the consolidated income statement.

EXPLANATION OF DIFFERENT OUTCOME BY TRANSLATION METHODOLOGY

The Temporal Method results in a translation gain, as opposed to the CTA loss found under the Current Rate Method, because of the different
exchange rates used against Net plant & equipment and the inventory line items. This gain would be impossible under the Current Rate
Method because ALL assets are exposed under that method, whereas the Temporal Method carries Net plant & equipment and inventory
at relevant historical exchange rates.
Problem 13.9 Bangkok Instruments, Ltd (B)

Using the original data provided for Bangkok Instruments, assume that the Thai baht appreciated in value from B30/$ to B25/$ between March 31 and April 1.
Assuming no change in balance sheet accounts between those two days, calculate the gain or loss from translation by both the current rate method and the
temporal method. Explain the translation gain or loss in terms of changes in the value of exposed accounts.

TRANSLATION BY THE CURRENT RATE METHOD

Balance Sheet (thousands) Before Devaluation After Devaluation


Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $800 25 $960
Accounts receivable 36,000 30 1,200 25 1,440
Inventory 48,000 30 1,600 25 1,920
Net plant & equipment 60,000 30 2,000 25 2,400
Total ฿168,000 $5,600 $6,720

Liabilities & Net Worth


Accounts payable ฿18,000 30 $600 25 $720
Bank loans 60,000 30 2,000 25 2,400
Common stock 18,000 20 900 20 900
Retained earnings 72,000 34 2,100 34 2,100
CTA account (loss) 0 - $600
Total ฿168,000 $5,600 $6,720

Note: Dollar retained earnings before devaluation are the cumulative sum of additions to retained earnings of all prior years, translated at exchange
rates in effect in each of those years.

This cumulative translation account (CTA) gain of $600,000 would be entered into the company's consolidated balance sheet under equity.

TRANSLATION BY THE TEMPORAL METHOD

Balance Sheet (thousands) Before Devaluation After Devaluation


Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $800 25 $960
Accounts receivable 36,000 30 1,200 25 1,440
Inventory 48,000 30 1,600 30 1,600
Net plant & equipment 60,000 20 3,000 20 3,000
Total ฿168,000 $6,600 $7,000

Liabilities & Net Worth


Accounts payable ฿18,000 30 $600 25 $720
Bank loans 60,000 30 2,000 25 2,400
Common stock 18,000 20 900 20 900
Retained earnings 72,000 23 3,100 23 3,100
CTA account (loss) 0 - $(120)
Total ฿168,000 $6,600 $7,000

Note a: Dollar retained earnings before devaluation are the cumulative sum of additions to retained earnings of all prior years, translated at exchange
rates in effect in each of those years.
Note b: Retained earnings after devaluation are translated at the same effective rate (see Note a) as before devaluation.

The translation loss of $120,000 would be passed-through to the consolidated income statement.

EXPLANATION OF DIFFERENT OUTCOME BY TRANSLATION METHODOLOGY

The Temporal Method results in a translation gain, as opposed to the CTA loss found under the Current Rate Method, because of the different
exchange rates used against Net plant & equipment and the inventory line items. This gain would be impossible under the Current Rate
Method because ALL assets are exposed under that method, whereas the Temporal Method carries Net plant & equipment and inventory
at relevant historical exchange rates.
Problem 13.10 Cairo Ingot, Ltd.

Cairo Ingot, Ltd., is the Egyptian subsidiary of Trans-Mediterranean Aluminum, a British multinational that fashions automobile engine blocks from aluminum. Trans-
Mediterranean’s home reporting currency is the British pound. Cairo Ingot’s December 31 balance sheet is shown below. At the date of this balance sheet the exchange
rate between Egyptian pounds and British pounds sterling was £E5.50/UK£.

a. What is Cairo Ingot’s contribution to the translation exposure of Trans-Mediterranean on December 31, using the current rate method?

b. Calculate the translation exposure loss to Trans-Mediterranean if the exchange rate at the end of the following quarter is £E6.00/UK£. Assume all balance sheet
accounts are the same at the end of the quarter as they were at the beginning.

Before Exchange Rate Change After Exchange Rate Change


Balance Sheet of Cairo Ingot, Ltd. Translated Translated
Egyptian pounds Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Egyptian £/UK£) British pounds (Egyptian £/UK£) British pounds
Cash 16,500,000 5.50 £3,000,000.00 6.00 £2,750,000.00
Accounts receivable 33,000,000 5.50 6,000,000 6.00 5,500,000
Inventory 49,500,000 5.50 9,000,000 6.00 8,250,000
Net plant & equipment 66,000,000 5.50 12,000,000 6.00 11,000,000
Total 165,000,000 £30,000,000.00 £27,500,000.00

Liabilities & Net Worth


Accounts payable 24,750,000 5.50 £4,500,000.00 6.00 £4,125,000.00
Long-term debt 49,500,000 5.50 9,000,000 6.00 8,250,000
Invested capital 90,750,000 5.50 16,500,000 5.50 16,500,000
CTA account (loss) - - -£1,375,000.00
Total 165,000,000 £30,000,000.00 £27,500,000.00

December 31st End of Quarter


a. Calculation of Actg Exposures: Egyptian pounds 5.50 6.00
Exposed assets (all assets) 165,000,000 £30,000,000.00 £27,500,000.00
Less exposed liabilities (c.liabs + lt debt) (74,250,000) (13,500,000) (12,375,000)
Net exposure 90,750,000 £16,500,000.00 £15,125,000.00

b. Change in translation exposure: Gain (Loss) -£1,375,000.00

Alternatively, the translation loss arising from the fall in the value of the Egyptian pound can be found as follows:
Net exposed assets (£) £16,500,000.00
Percentage change in the value of the British pound -8.3%
Translation gain (loss) -£1,375,000.00