CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsHard
A company, a U.S. parent, has a subsidiary in Germany. The subsidiary's functional currency is the Euro (€), and the U.S. dollar ($) is the reporting currency. At the end of the year, the subsidiary's net assets increased by €500,000 due to operations. The average exchange rate for the year was $1.15/€, and the year-end rate was $1.20/€. What is the impact of this change in net assets on the cumulative translation adjustment (CTA) for the year, assuming the current rate method is used?
- AIncrease of $25,000
- BDecrease of $25,000
- CIncrease of $575,000
- DIncrease of $600,000
Show answer & explanationAnswer & explanation
Correct answer: A. Increase of $25,000
Under the current rate method, the increase in net assets from operations (net income) is translated at the average rate, while the ending net assets are translated at the current (year-end) rate. The difference contributes to the CTA.
Why the other options are wrong
- B. Incorrect direction; an increase in net assets when the exchange rate has strengthened leads to a positive CTA.
- C. This is the net income translated at the average rate, prior to considering the CTA impact.
- D. This is the net income translated at the year-end rate, which is not how net income is typically translated.
Foreign Currency Translation (Current Rate Method) - CTA Impact
The impact on the Cumulative Translation Adjustment (CTA) from changes in a foreign subsidiary's net assets when its functional currency is not the parent's reporting currency.
- Assets and Liabilities translated at current (year-end) rate.
- Equity accounts (except Retained Earnings) translated at historical rates.
- Income Statement items translated at average rate.
- The CTA balances the balance sheet after translation and is reported in OCI.
Memory trick: Current Rate: Assets Now, Income Average, Equity Historical.