CFA Level II ExamFinancial Statement AnalysisEasy
A U.S.-based multinational corporation (functional currency USD) is preparing its consolidated financial statements. One of its subsidiaries operates in a country whose local currency is the Euro (EUR), and the subsidiary's functional currency is also the Euro. The subsidiary purchased inventory evenly throughout the year. On December 31, the subsidiary has €500,000 of inventory on hand. The average exchange rate for the year was 1 EUR = 1.10 USD, and the year-end exchange rate was 1 EUR = 1.20 USD. What exchange rate should the parent company use to translate the subsidiary's inventory for consolidation purposes?
- AThe average exchange rate for the period.
- BThe current (year-end) exchange rate.
- CThe exchange rate at the beginning of the year.
- DThe historical exchange rate when each inventory item was purchased.
Show answer & explanationAnswer & explanation
Correct answer: B. The current (year-end) exchange rate.
Under the current rate method, which is used when the subsidiary's functional currency is its local currency, assets and liabilities are translated at the current (year-end) exchange rate. Inventory is an asset and thus is translated at the current rate.
Why the other options are wrong
- A. Average rates are typically used for income statement items under the current rate method.
- C. Beginning-of-year rates are not typically used for balance sheet translations.
- D. Historical rates are generally used for nonmonetary assets under the temporal method, not the current rate method.
Current Rate Method - Balance Sheet Translation
Under the current rate method, when a foreign subsidiary's functional currency is its local currency, all assets and liabilities on its balance sheet are translated into the parent's reporting currency using the current (year-end) exchange rate.
- Used when functional currency is local currency.
- Assets and liabilities translated at current (year-end) rate.
- Equity accounts (common stock, APIC) are translated at historical rates.
- Retained earnings is a plug figure, reflecting translated income and dividends.
Memory trick: Current Rate: 'All Current' for Balance Sheet, 'Average' for Income.