The U.S. dollar has been depreciating relative to the local currency over the past year. The use of the current rate method to translate a foreign subsidiary’s financial statements to U.S. dollars will most likely have which of the following effects on return on equity (ROE) relative to what the ratio would have been without the effects of translation? A) ROE will most likely rise. B) ROE will remain unchanged. C) The impact of the depreciation of the US dollar on ROE is indeterminate. D) ROE will most likely decline.
D…LC Appreciates than ratios should decrease??
ROE = NI/E NI -> IS -> AvgR E -> BS -> CurrR USD down, LC up (appreciating) HistRate < AvgRate < CurrRate ROE (After translation) = NI(low)/E(high) = low D?
D. In the all current method, translate Income Statement at the average rate and translate Balance Sheet at the current rate. The LC appreciation will push the average rate below the current rate. Therefore Net Income goes down and Equity goes up.
Nice work, you guys are correct. For some reason I thought that equity is still translated at the historical rate which would lead to a lower denominator.
wow…that one got me too…I also thought equity would be translated at the historical rate, but i guess only common stock would be translated at the historical rate, not the other portions of equity…
even though the seperate equity lines are translated differently… equity all together must be translated at current if all assets and all liabilities are transfered at current.
that doesn’t make sense though. because if you equity consists of only RE and common stock, your common stock should be translated at historical, whereas RE (assuming no dividends) would be translated at average rate…so overall your equity would be a mixed rate… sheesh…i had this down…dunno why this is becoming confusing!!!
chadtap, Is that a rule for all current? When we translate for ratios we use the current for all accounts, and for determining the CTA we use the historical for common stock etc . . . ?
Mumukada… Yeah that would be just for the all current method… All I was saying is that if A = L + E and if Assets and Liabilities are translated at the current rate then by default Stockholders equity will be translated at the current rate as well.
Niblita According to Schweser… When comparing Original Financials vs. All Current If LC is depreciating, translated mixed ratios will be larger If LC is appreciating, translated mixed ratios will be smaller Temporal vs. All Current If LC is appreciating, asset turnover, gross PM, interest coverage, and leverage higer under temporal If LC depreciating, asset turnover, gross PM, interest coverage, and leverage lower under temporal… Is that what you were asking about?
No, what I am asking is that when performing ratio analysis with the all current method, do we use the current rate to translate all assets, liabilities, and equity. When we are asked to find the CTA, we must use the historical rate for capital stock. So, when asked for ratio analysis, do we default to the current rate for everything on the balance sheet when using the all current method, and use the historical rate for capital stock when determining the CTA using the all current method. Hopefully that makes some sense.
For translation question most of the time, Equity usually would contain Common Stock, RE and CTA. - Always, Convert common stock at historical rate. - Calculate CTA based on translation G/L - RE would be the plug figure for equation A = L + E If we are asked to use total equity as in ratio analysis you can use current rate, this would happen because the CTA would effectively bring the equity amount to current rate.
^ Well for this question we could use all current for equity as well because ROE is NI over Stockholders Equity. The reason is because A = L + Stockholders Equity If assets and Liabilities are translated at the current rate then by default SE (as a whole ) has to be translated at the current rate otherwise the balance sheet wont balance. Each item in SE is translated at a different rate: Common Stock - Historic R/E - Accu. of Avg. Rates G/L - I use a plug figure here Although each item in SE is translated at a different rate, because A = L + SE, SE as a whole must be translated at the current rate. Therefore in this case when it asked for ROE (NI/SE) we could use the current rate. I hope that makes sense… Anybody else please feel free to add to…
kabhii…a much better explaination…thanks
^^^ Thanks to both of you guys, it makes perfect sense.
^^ thanks to you two…yeah that makes sense…I guess I was jus thinking of Equity being RE and Common Stock…but the CTA offsets the effect of the translation on the other two items… and yeah intuitively it makes sense…if ALL assets and liabilities are converted at current rate, the Equity ON THE WHOLE should be converted at the current rate too… Nib…so glad you posted this up…that’s one less thing that I can scratch off my “I don’t know” list !!!