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Basic Question 2 of 6
A subsidiary of Shaw Inc. has one asset (Inventory) and one liability (Accounts Payable). The functional currency of this subsidiary is the Euro (€). The inventory was acquired for €90,000 when the exchange rate was $1 = €1.025. Accounts Payable, which has a balance of €50,000, was established when the exchange rate was $1 = €1.0050. At year-end, the exchange rate was $1 = €.9850. Which one of the following statements is true for the consolidated financial statements?
B. A debit translation adjustment must be reported.
C. A credit translation adjustment must be reported.
D. A transaction loss must be reported.
E. A transaction gain must be reported.
A. The consolidated financial statement are not affected by this situation.
B. A debit translation adjustment must be reported.
C. A credit translation adjustment must be reported.
D. A transaction loss must be reported.
E. A transaction gain must be reported.
User Contributed Comments 8
| User | Comment |
|---|---|
| PhiWong | Local currency was appreciating against USD, therefore, with positive Net Asset at the end of the year, each of the local currency will "translate" into more USD asset. In order to balance the B/S, a "credit" translation adjustment should be in place to balance the B/S. |
| jiashufen | are you sure it's a credit, PhiWong? |
| ehc0791 | the problem is that we don't know what is the local currency and reporting currency, only the function currency is known. |
| PASS0808 | Inv eur 90000 /(eur1.025/$)=87,805 A/P Eur 50000 /(eur1.0050/$)=49751 Net asset before adj. 87805-49751=38054 Net asset should be: Eur 40000/(.9850)=40609 Therefore debit of 2556 is needed |
| bmeisner | Recall that assets are increased by debits while liabilities and shareholders equity are increased by credits. Since the affect to net assets is an increase due to the appreciation of the Euro, the translation adjustment (an adjustment to shareholders equity) must be an increase as well, thus it must be a credit. |
| jmcarr02 | When you obtain a translation gain, you need to CREDIT the Cumulative Translation Adjustment (CTA) account. There is clearly a translation gain here since the EUR is rising against the USD. Debiting the CTA account, as PASS0808 suggests, makes no sense since this would deepen the gap between net asset value ($40609) and the shareholder's equity (which includes the CTA account). |
| charliedba | the euro appreciated, so there's a gain. and there should be credit adjustment to the equity account. |
| quanttrader | but actual value of net assets is lower via using end of the year exchange rate, thus shouldn't this be a translation debit-- compare from #1 where it was opposite situation and a translation credit |
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Lina
Learning Outcome Statements
compare the current rate method and the temporal method, evaluate how each affects the parent company's balance sheet and income statement, and determine which method is appropriate in various scenarios;
calculate the translation effects and evaluate the translation of a subsidiary's balance sheet and income statement into the parent company's presentation currency;
CFA® 2025 Level II Curriculum, Volume 2, Module 12.