CFA Level II ExamFinancial Statement AnalysisMedium
A U.S. company (reporting currency USD) owns a 40% stake in a foreign associate, 'Global Ventures,' located in Japan. Global Ventures' functional currency is the Japanese Yen (JPY), and it reports its financial statements in JPY. The U.S. company accounts for this investment using the equity method. When translating its share of Global Ventures' net income, what exchange rate should the U.S. company primarily use?
- AThe historical exchange rate at the time the investment was made.
- BThe exchange rate at the beginning of the reporting period.
- CThe average exchange rate for the reporting period.
- DThe current (year-end) exchange rate.
Show answer & explanationAnswer & explanation
Correct answer: C. The average exchange rate for the reporting period.
When accounting for an equity method investment in a foreign associate, the investor translates its share of the associate's income statement items using the average exchange rate for the period to reflect the economic activity occurring throughout the period.
Why the other options are wrong
- A. Historical rates are used for the initial investment cost, not for translating periodic income.
- B. Beginning-of-period rates are not typically used for income statement translation.
- D. Current rates are used for balance sheet items under the current rate method, not income statement items.
Equity Method - Foreign Associate Income Translation
When an investor accounts for a foreign associate using the equity method, its share of the associate's net income is translated into the investor's reporting currency using the average exchange rate for the reporting period.
- Applies to significant influence (20-50% ownership).
- Investor's share of net income translated at average rate.
- Investor's share of OCI translated at average rate.
- Investment account is adjusted for translated income and dividends.
Memory trick: Equity Income: 'Average' effort for average period earnings.