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Free CFA® CFA-Level-II Exam Braindumps (page: 19)

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In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.
For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year- end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.


At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.
For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4

Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

Compute the cumulative translation adjustment reported on Continental Supply's consolidated balance sheet at the end of 2008 assuming International Oilfield is a relatively self-contained and independent, operation of Continental Supply.

  1. -$227 million.
  2. -$200 million.
  3. $298 million.

Answer(s): A

Explanation:

Under the all-current method, gains and losses that occur as a result of the translation process do not show up on the income statement but are instead accumulated in a balance sheet account called the cumulative translation adjustment account (CTA). The translation gain or loss in each year is calculated and added to the account, acting like a running total of translation gains and losses. The CTA is simply an equity account on the balance sheet. To compute the CTA for Continental's balance sheet, force the accounting equation (A = L + E) to balance with the CTA; [(120 million cash and receivables + 631.3 million inventory + 820.7 million equipment - 600 million liabilities) / 1.50] - $350 million capital stock - $525 retained earnings = -$227 million. The LCU 350 capital stock was issued at the end of 2005 at an exchange rate of LCU 1 = $1. The
$525 retained earnings figure was given in the itxt. (Study Session 6, LOS 23.c)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year- end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.

At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

As compared to the temporal method, which of the following best describes the impact of the all- current method on International Oilfield's gross profit margin percentage for 2008 when stated in U.S. dollars? The gross profit margin would be:

  1. lower.
  2. higher.
  3. the same.

Answer(s): B

Explanation:

As compared to the temporal method, the all-current method will result in a higher gross profit margin percentage (higher numerator) when the local currency is depreciating as is the case in this scenario (the exchange rate has risen from LCU 1 per $1 to LCU 1.25 per $1; thus, it costs more LCUs to buy $1 which is the result of a depreciating LCU). Under the temporal method, COGS is remeasured at the historic rate; thus, COGS is not impacted by the depreciating currency.

Under the all-current method, COGS is translated at the average rate; thus, COGS is lower because of the depreciating currency. Lower COGS results in a higher gross profit margin percentage. (Study Session 6, LOS 23.d)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year-end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.

At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 3 50.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

When remeasuring International Oilfield's 2008 financial statements into the presentation currency, which of the following ratios is not affected by changing exchange rates under the temporal method9

  1. Current ratio.
  2. Total asset turnover.
  3. Quick ratio.

Answer(s): C

Explanation:

Both the numerator (cash + receivables) and denominator (current liabilities) of the quick ratio are remeasured at the current exchange rate under the temporal method. Inventories are ignored in the quick ratio. Since the same rate is used to remeasure both the numerator and denominator, the ratio does not change when stated in the presentation currency. (Study Session 6, LOS 23.d)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year-end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.


At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:


LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

Assume the country where International Oilfield is operating has been experiencing 30% annual inflation over the past three years. Which of the following best describes the effect on Continental's consolidated financial statements for the year ended 2008?

  1. A gain is recognized in the income statement.
  2. A loss is recognized in the income statement.
  3. A gain is recognized as a direct adjustment to the balance sheet.

Answer(s): A

Explanation:

The temporal method is required if the foreign subsidiary is operating in a highly inflationary environment, defined as cumulative inflation of more than 100% in a 3-year period. Compounded inflation of 30% annually for three years is approximately 120% (1.30- 1). Under the temporal method, remeasurement gains and losses are recognized in the income statement. In this case. International Oilfield has a net monetary liability position (monetary liabilities of 600 million > monetary assets of 120 million). Holding net monetary liabilities denominated in a currency that is depreciating will result in a gain. (Study Session 6, LOS 23.f)



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