Page 70 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

READING 16: MULTINATIONAL OPERATIONS

MODULE 16.7: HYPERINFLATION

Under the temporal method, the monetary assets and liabilities are exposed to
changing exchange rates, hence also to risk of inflation. Purchasing power
gains and losses are same as exchange rate gains and losses when the
foreign currency is depreciating. For example, if a subsidiary has net monetary
liability exposure in a depreciating environment, a gain is recognized under the
temporal method. Likewise, a purchasing power gain is recognized when a net
monetary liability exposure is adjusted for the effects of inflation.

The gain or loss from remeasurement is recognized in the IS as is the net
purchasing power gain or loss that results from inflation. Under IFRS, once the
subsidiary’s financial statements are adjusted for inflation, the restated financial
statements are translated into the parent’s reporting currency using the current
exchange rate.

Analyzing Foreign Currency Disclosure

In practice, multinationals may have many foreign subsidiaries, which means
that the CTA on the balance sheet, the remeasurement gain or loss in the
income statement, and the parent company’s ratios include the effects of all
of the subsidiaries.

Disclosure requirements are limited, so it is difficult for the analyst to get
information about the firm’s currencies and the specific exposure to the
currencies. Might even be difficult to determine what accounting method
(temporal or current rate) the firm uses for its various foreign operations.

You could add the change in the CTA to the firm’s net income. By bringing
the translation gain or loss into the IS, comparisons with a temporal method
firm are improved. The solution does not totally resolve the problem but it is
a good start. The same solution can be applied to all non-owner changes in
shareholders’ equity. For example, adding the unrealized gains and losses
from available-for-sale securities to net income would allow an analyst to
compare the company to a firm that owns held-for-trading securities.
Including the gains and losses (that are reported in shareholders’ equity) in
net income is known as clean-surplus accounting in the analytical
community. The term dirty-surplus is used to describe gains and losses that
are reported in shareholders’ equity.