a. Gruber PLC operates in England and is a subsidiary of Szudy International. The functional currency of Gruber is the British pound. Gruber reported net income in 2006 of £350 million and paid a £75 million dividend on July 1, 2006 when the exchange rate was $1.55 per pound. The current rate is $1.65 per pound and the average rate for 2006 was 1.60. Compute the change in retained earnings for the period in US dollars.

b. Windsor PLC operates in England and is a subsidiary of Buckingham International. The U.S. dollar is the reporting currency for Buckingham international. The functional currency of Windsor is the British pound, and it prepares financial information in British pounds for internal use.

Windsor's 2005 and 2006 net assets were 10,000 and 11,500, respectively. The 12/31/06 exchange rate was 1.56, the 12/31/05 exchange rate was 1.50 and the average rate for the year was 1.53.

What was the translation gain or loss for the year for Buckingham when it converted Windsor's financial statements into the reporting currency?

Question

a. Gruber PLC operates in England and is a subsidiary of Szudy International. The functional currency of Gruber is the British pound. Gruber reported net income in 2006 of £350 million and paid a £75 million dividend on July 1, 2006 when the exchange rate was $1.55 per pound. The current rate is $1.65 per pound and the average rate for 2006 was 1.60. Compute the change in retained earnings for the period in US dollars.

b. Windsor PLC operates in England and is a subsidiary of Buckingham International. The U.S. dollar is the reporting currency for Buckingham international. The functional currency of Windsor is the British pound, and it prepares financial information in British pounds for internal use.

Windsor's 2005 and 2006 net assets were 10,000 and 11,500, respectively. The 12/31/06 exchange rate was 1.56, the 12/31/05 exchange rate was 1.50 and the average rate for the year was 1.53.

What was the translation gain or loss for the year for Buckingham when it converted Windsor's financial statements into the reporting currency?

Quizplus · Accepted Answer

The Answer is a. The current rate method should be used, as the British pound is the functional currency.

Retained earnings will increase by the net income and decrease by the dividends paid.

Net income is simply translated using the average rate for the year.
£350 × 1.60 = $560

Dividends are translated using the rate at the time they are paid.
£75 × 1.55 = $116.25

Therefore, retained earnings will change by $443.75 (560 - 116.25).

b. The translation gain or loss can be calculated as:

Beginning of year net assets in the local currency × (change in exchange rate over the year),

Plus

Increase in net assets over year × (end of year rate - average exchange rate for year)

Therefore, the translation gain (loss) is:

\begin{array}{ll} ext { Translation gain on beginning net assets }[10,000 imes(1.56-1.50)] & \$ 600 \ ext { Translation gain on increase in net assets }[1,500 imes(1.56-1.53)] & \underline{\$ 45} \ ext { Total } & \underline{\underline{\$ 645}}\end{array}

This translation gain is the change in the cumulative translation adjustment (CTA) in the stockholders' equity. Therefore, in this case there was a translation gain of $645 for the year, due to the appreciation of the British pound during the year and an increase in the net assets in local currency.

A Gruber PLC Operates in England and Is a Subsidiary