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Multinational Learning Example:

Frisco Trading Corp., a U.S. based company, has a subsidiary, Ging Yang Corp., which is located in
Hong Kong.
Friscos finance team, headed by Gorman Thomas, is interested in analyzing the effect of the
consolidation of Ging Yangs financial results on Friscos profitability.
Thomas has summarized key financial data in tables 1 and 2.

Table 1
Ging Yang
Selected Financial Data (in HKD millions)
2012
2011
Net Sales
11,750
7,000
Expenses
9,500
5,400
Net Income
2,250
1,600
Monetary Assets
6,500
6,000
Non-monetary Assets
16,000 14,000
Monetary Liabilities
9,000
8,750
Common Stock
10,000 10,000
Retained Earnings
3,500
1,250

Thomas notes that Ging Yang does not pay any dividends and its management has indicated it does not
expect to pay any dividends in the near future.

Table 2
USD/HKD Exchange Rate
2012
Year-end December 31
$0.140 = 1HKD
Average rate during the year
$0.132 = 1HKD

2011
$0.127 = 1HKD
$0.141 = 1HKD

Complete the following exercises:


1.

Translate Ging Yangs financial statements (balance sheet and income statement) using the
current rate method.

2.

Remeasure Ging Yangs financial statements (balance sheet and income statement) using the
temporal method.

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Solution:
This exercise is probably more complex than the questions you will see on the Level 2 CFA exam, but
it provides good practice to get you comfortable with the possible calculations and interpretation of the
cryptic data you will be given in the Item Set.
1) Current Rate Method
When the current rate method applies, the FX adjustment, (ie. the foreign exchange gain or loss),
will be recorded in Equity as Other Comprehensive Income.
The FX adjustment is found simply as a plug figure to balance the balance sheet!
To solve for the FX adjustment, start on the income statement translating each account at the average
rate:
HKD
11,750 x 0.132 =
9,500 x 0.132 =
2,250

Net Sales
Expenses
Net Income

USD
1,551
1,254
297

(Yes, you could have simply multiplied the Net Income by the average rate to get the answer directly!)
Next, move through the statement of retained earnings:
HKD
1,250 x 0.127 =
2,250 x 0.132 =
0

Beginning RE
+ Net Income
- Dividends
= Ending RE

USD
158.75
+ 297
0
455.75

Then move to the balance sheet, translate the assets and liabilities at the current rate, use the basic
accounting equation (Assets Liabilities = Equity) to find total equity. Translate the common stock at
the historical rate and use your ending retained earnings figure, the foreign exchange gain or loss is
simply a plug figure to make it balance:
HKD
6,500 x 0.14 =
16,000 x 0.14 =
9,000 x 0.14 =
10,000 x 0.127 =

Monetary Assets
Non-monetary Assets
Monetary Liabilities
Common Stock
Retained Earnings
FX Adjustment Plug
Total Equity

USD
910
2,200
1,260
1,270
455.75
+164.25
1,890

In this case since the FX adjustment is a positive value, we have a foreign exchange gain.

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1) Temporal Method
Remember, when the temporal method applies, the FX adjustment, (ie. the foreign exchange gain or
loss), will be recorded on the income statement.
The FX adjustment is found simply as a plug figure.
To solve for the FX adjustment, start on the balance sheet remeasure the monetary assets and monetary
liabilities at the current rate and the non-monetary assets and non-monetary liabilities at the historical
rate:
HKD
6,500 x 0.14 =
16,000 x 0.127 =
9,000 x 0.14 =
10,000 x 0.127 =

Monetary Assets
Non-monetary Assets
Monetary Liabilities
Common Stock
Retained Earnings
Total Equity

USD
910
2,032
1,260
1,270
412
1,682

Next, move through the statement of retained earnings to find net income after FX adjustment:
HKD
1,250 x 0.127 =

Beginning RE
+ Net Income
- Dividends
Ending RE

USD
158.75
253.25
0
412

Then move to the income statement remeasure each account using the average rate to find net income
before FX adjustment. Take the net income after FX adjustment from your statement of retained
earnings, the foreign exchange gain or loss is simply a plug figure to make it balance:

Net Sales
Expenses
Net Income before FX Adjustment
FX Adjustment Plug
Net Income after FX Adjustment

HKD
11,750 x 0.132 =
9,500 x 0.132 =

USD
1,551
1,254
297
- 43.75
253.25

In this case since the FX adjustment is a negative value, we have a foreign exchange loss.

Other Comments:
You wont find Net Income before FX Adjustment or Net Income after FX Adjustment in the text,
those are my terms to help you understand the conceptin the text and for that matter on the exam,
both of these items may just be labeled Net Income! Be careful!

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Why did the results work out this way?


Look at the exchange rate movement.it shows us that the HKD appreciated relative to the USD over
the year 2012.at the beginning of the year 1 HKD bought $0.127 and at the end of the year, 1 HKD
bought $0.140!
Had the foreign currency depreciated, we would have had a foreign exchange gain.
Under the temporal method a quick way to spot the FX gain or loss is to look at your net foreign
monetary asset position:
Foreign Monetary
Assets and Liabilities:
Asset > Liabilities
Assets < Liabilities

If foreign currency appreciates:

If foreign currency depreciates:

FX Adjustment Gain
FX Adjustment Loss

FX Adjustment Loss
FX Adjustment Gain

General Rules
Current rate method applies if the functional currency is the same as the local currency
Temporal method applies if the functional currency is the same as the parents currency
Current Rate Method
Balance Sheet Accounts
- All assets and liabilities translated at the current exchange rate
- Equity is translated at the historical exchange rate
Income Statement Accounts
- All accounts translated at the average exchange rate
Translation gain/loss is reported in OCI in equity on the B/S

Temporal Method (monetary/non-monetary method)


Balance Sheet Accounts
- Monetary assets and liabilities (Cash, A/R, A/P, LTD) are remeasured at the current exchange
rate
- Non-monetary assets and liabilities (FA, CS) are remeasured at the historical exchange rate
- Inventory HRhowevercan be remeasured using the average exchange rate (assume
sales to be evenly spread throughout the year)
Income Statement
- Revenue and expenses are remeasured at the average exchange rate
- COGS, Depreciation and Amortization are remeasured at the historical rate (or Average rate)
Translation gain/loss is reported in on the I/S

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Brian Y. Gordon, CFA, CFP, CIM, MBA, FCSI


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Email: info@examsuccess.ca