Question

14. Translation current rate Please refer to Table 4 in the datafile. If Euro Trade applies the current rate method of translation, then it will make a translation if the EUR/USD exchange rate _. (Note: gain=equity increases, loss=equity decreases) a) gain; increases b) impossible to determine c) loss; increases d) loss; decreases

Answer 1

Solution:-

We live in an era of Multi National Companies who operates in various geographies. While they have independent subsidiaries in different countries operating in local currencies of their respective countries, their financial statements also have to be consolidated into the financial statements of parent company.

For this to happen, the financial statements of subsidiaries must be converted from the local currency to the currency of the parent company, i.e. currency in which parent company makes its financial statements.

Meaning of translation gains and losses:

The translation happens every quarter/half-year/year as the case may be. On the date of conversion, the balance sheet items are converted to the parent currency at the exchange rate prevailing as at that date. The change in values of assets and liabilities as compared to values of the last balance sheet attributable to exchange rate changes is called translation gains or losses.

If the value of net assets/equity goes up in this balance sheet as compared to the last balance sheet due to exchange rate changes, it is called translation gains and vice-versa.

Given situation:

In the given situation, Eurotrade Americas is an American subsidiary of a Dutch company and conducts operations in USD. However for the purpose of consolidation into the parent Dutch company, it must translate its financial statements into Euros.

Since the base currency is USD and the target currency is Euro, the stronger the USD becomes against Euro, more will be the Euro value of its assets and liabilities. For e.g.: If an asset has a value of $100 & exchange rate was 1.5€/1$ as at the last balance sheet, the converted value of asset in Euro would have been €150 (i.e. 100*1.5) and if exchange rate is €2/$1 now for the current balance sheet, the converted value will be €200. Thus, there is a translation gain of €50.

Therefore,the stronger the USD becomes against euro, higher the euro value of net assets or equity and thus higher the translation gain.

However, it can be noted that the question has not provided assets and liabilities values as per last balance sheet without which we can't determine if the exchange rate increase or decrease has resulted in gains or losses.

Analysis of options:

Option (a): If exchange rate increases and USD strengthen against euro, it will result in translation gain as described above. However, we don't have assets and liabilities as per last balance sheet to calculate potential gains or losses. Hence, this option is not correct.

Option (b): The question has not given us the values as at the last balance sheet without which translation gains losses can't be analysed and are impossible to determine. Hence, this option is correct.

Option (c): Since, rise in value of Euro results in translation gain and not loss, this option is not correct.

Option (d): Fall in value of euro eoes result in transit loss as described above. However, we don't have assets and liabilities as per last balance sheet to calculate potential gains or losses. Hence, this option is not correct.

Conclusion: The correct option is (b)