Advanced Accounting 12th Edition By Paul M Fischer – Test Bank

Multiple Choice

1. The functional currency approach adopted by FASB 52 requires:
a. separate statements be maintained by the domestic parent company and the foreign branch both in their own currencies
b. separate statements be maintained by the domestic parent company and the foreign branch with the foreign branch translated into the functional currency
c. results from foreign currency changes to be ignored

d. a focus on whether the domestic reporting entity’s cash flows will be indirectly or directly affected by changes in the exchange rates of the foreign entity’s currency
ANSWER: d
RATIONALE: The FASB adopted a functional approach which focuses on whether the domestic reporting entity’s cash flows will be indirectly or directly affected by changes in the exchange rate of the foreign entity’s currency.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-1

2. Exchange rates will not usually directly affect the cash flows of the parent entity in which of the following cases?
a. The foreign entity operates in a currency other than its own.

b. The foreign entity operates in its local currency.

c. The foreign entity functions in a currency other than its local currency.
d. The foreign entity functions in the parent’s currency.

ANSWER: b
RATIONALE: If the foreign entity operates in its own currency, changes in exchange rates will not usually directly affect the cash flows of the parent entity.
DIFFICULTY: D
LEARNING OBJECTIVES: ADAC.FISC.11-1

3. When the functional currency is the foreign entity’s currency:
a. exchange rate changes do not affect the economic well-being of the parent

b. the subsidiary operates as an entity, independent of the parent

c. exchange rate changes do not have immediate impact on the cash flows of the parent
d. All of the above are correct

ANSWER: d
RATIONALE: When the functional currency is the foreign entity’s currency, the subsidiary primarily generates and expends cash in that currency. Exchanges in the exchange rate between the foreign entity’s currency and the dollar do not have an economic impact on the foreign entity or its parent. The foreign company’s day-to-day operations are not dependent on the economic environment of the dollar, and the exchange rate changes do not have an immediate impact on the cash flows of the parent.
DIFFICULTY: D
LEARNING OBJECTIVES: ADAC.FISC.11-1

4. A U.S. firm owns 100% of a Japanese automobile manufacturer. The cost of automobile parts is typically 75% of the firm’s total product. In which of the following circumstances would neither the U.S. dollar nor the Japanese yen be considered the functional currency?
a. The Japanese firm buys German automobile parts with euros to produce cars sold in Latin America for dollars.
b. The Japanese firm buys German automobile parts with dollars to produce cars sold in Latin America for dollars.
c. The Japanese firm buys German automobile parts with euros to produce cars sold in Latin America for euros.
d. The FASB requires that either the parent’s or the subsidiary’s local currency be used as the functional currency.
ANSWER: c
RATIONALE: In this case, the euro is the currency that primarily influences cash flows.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-1

5. In which of the following circumstances surrounding a Mexican subsidiary of an U.S. parent is the peso most likely to be considered the functional currency?
a. Sales are made globally and collected in U.S. dollars. Plant uses local materials and labor and pays in pesos. Intercompany transaction volume is high.
b. The Mexican subsidiary sells product only in Mexico and receives pesos. The materials and labor are also secured in Mexico and paid for with pesos.
c. The Mexican subsidiary receives their debt capital from a U.S. bank in dollars and products produced are sold globally for U.S. dollars.
d. Raw materials are acquired from the parent and paid for in U.S. dollars. Labor is acquired locally and paid in pesos. Financing is secured from the parent in U.S. dollars.
ANSWER: b
RATIONALE: The functional currency, in this case pesos, is the currency of the primary economic environment in which the entity generates and expends cash.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-1

6. Which of the following suggests that the foreign entity’s functional currency is the parent’s currency?
a. Intercompany transaction volume is low.

b. Debt is serviced through local operations.

c. There is an active and primarily local market.

d. Sale prices are influenced by international factors.
ANSWER: d
RATIONALE: Sales prices that are influenced by international factors and exchange rate changes rather than local factors indicate that the foreign entity’s functional currency is the parent’s currency.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.11-1

7. Changes in the functional currency of a subsidiary
a. are not permitted.

b. are accounted for retroactively.

c. are accounted for prospectively.

d. are reported as extraordinary items.
ANSWER: c
RATIONALE: Changes in a subsidiary’s functional currency are accounted for prospectively.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-1

8. If currency exchange rate changes impact potential cash flows available to the parent and the parent’s economic well-being:
a. the functional currency of the subsidiary is the foreign currency.

b. translation gains or losses should be included in net income.

c. the financial relationships as measured in the translated statements are the same as those measured in the foreign currency.
d. the parent may adopt a change in the subsidiary’s functional currency.

ANSWER: b
RATIONALE: If currency exchange rate changes impact potential cash flows available to the parent and the parent’s economic well-being, the functional currency of the subsidiary is that of the parent. As such, the re-measurement method is used and translation gains and losses should be included in net income.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-2

9. If the translation process is sound, it should:
a. provide information that is compatible with the expected economic effects of rate changes.

b. reflect in the financial statements the financial results of the company in conformity to the accounting principles of the country in which the subsidiary is located.
c. result in translation adjustments that are relatively consistent in amount.

d. None of the above is correct.

ANSWER: a
RATIONALE: If the translation process is sound, it should provide information that is compatible with the expected economic effects of rate changes.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-2

10. If a subsidiary’s functional currency is not the local currency in which it operates, but the parent’s reporting currency:
a. the foreign subsidiary’s translated financial statements are identical to the statements that would have resulted if the transactions had been recorded in dollars.
b. the translation adjustment is recorded as a component of other comprehensive income.

c. there is no indication that exchange rate changes will impact the subsidiary’s or the parent’s cash flows or equity.
d. None of the above is correct.

ANSWER: a
RATIONALE: If the subsidiary’s functional currency is not the local currency in which it operates, the foreign subsidiary merely acted as a conduit through which the U.S. parent operated. The re-measurere-measurement method is used to translate the subsidiary’s financial statements, which results in the translated financial statements being identical to the statements that would have resulted if the transactions had been recorded in dollars.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.11-2