Ratios - FRA

CFA Level II FRA
#1

Which of the following statements regarding the effects of translation on financial statement items/ratios is most accurate?

A) Leverage is higher under the current rate method as compared to under the local currency.
B) Depreciation in the reporting currency under the current rate method is higher than under the temporal method if the local currency has appreciated.
C) Fixed assets are relatively overstated under the temporal method compared to the local currency if the local currency has appreciated.

The correct answer is B with explanation: Fixed assets are relatively understated under the temporal method if the local currency appreciates as they are translated at the weaker historic rate.

Now my question is temporal method uses historical exchange rate to translate non-monetary assets and liabilities while the current rate method applies current rate to all assets and liabilities. If the local currency appreciates, less PPE values under current rate than temporal method because now FC can buy lesser DC. If so, depreciation in the reporting currency under current rate method should be lower, not higher than temporal.

Can somebody please explain where I am wrong.

Thanks in advance.

#2

If the local (foreign) currency appreciates vis-à-vis the presentation (domestic) currency, then FC buys more DC, not less.

1 Like
#3

In the question, local currency = DC = reporting currency, correct? If so, local appreciates mean DC appreciate, meaning it can buy more FC. For example, in Dec19 1 USD = .90 EUR (1 EUR = 1.11 USD) and in Aug22 both the currencies were almost trading at par. Now our subsidiary in EU bought a non-current asset which translated to USD 1,111/- in Dec19. As per temporal method, when we close the books in Aug22, we depreciate the asset based on the original cost of USD 1,111/-. Now if we use current rate method, the original cost become USD 1,000/- and we charge less depreciation.

What is it I am missing here? Please help. Thanks in advance.