P2A.4 Special Issues

Question 1

Foreign Exchange Fluctuations

Answer 1

1. Local Currency: Location
2. Reporting Currency: Financial statements, usually USD
3. Functional Currency: Primary economic environment

Question 2

Foreign Currency Translation

Answer 2

Converting a foreign currency into the reporting currency of the reporting entity.

Question 3

Exchange Rate

Answer 3

The ratio of two different currencies at a particular point in time.

Question 4

Direct vs Indirect Quote

Answer 4

Direct: the equivalent of 1 foreign currency to local currency.
Example: $1 USD / 22,000 Euro: direct Euro, indirect USD

Indirect: the equivalent of 1 local currency to a foreign currency.
Example: 1 Euro / 0.4545 USD Euro: indirect, direct USD

Question 5

Historical vs Current Rate

Answer 5

Historical: rate at which item was acquired. Ex: equity and capital accounts.

Current: exchange rate at the time of measurement. Ex: assets and liabilities at balance sheet date.

Question 6

Treatment of Translation Gains and Losses

Answer 6

1. Reported as ordinary gains and losses.

2. Not treated as extraordinary because they are expected in normal course of foreign operations.

Question 7

Change in Accounting Principles

Answer 7

1. Change or shift from one GAAP to another.
2. Ex: Change from FIFO to weighted average.
3. Reported retrospectively.

Question 8

Change in Accounting Estimates

Answer 8

1. Results from new information to fairly represent accounting estimate of future expected benefits or obligations.
2. Ex: estimates in allowance for bad debt.
3. Reported prospectively.

Question 9

Change in Reporting Entity/Accounting Errors

Answer 9

1. Mathematic errors or errors in application of accounting principles.
2. Change in accounting errors must be restated.
3. Reported retrospectively.
4. Correction of error is treated as a prior period adjustment.

Question 10

Accounting Profit

Answer 10

Profit measured using accounting standards and appears on income statements

= Accounting revenue - accounting costs
= Revenue - explicit costs

Question 11

Economic Profit

Answer 11

Profit measured using economic theories.

= Accounting revenue - accounting costs - opportunity costs
= Revenues - explicit costs - implicit costs

Implicit costs = costs not actually paid or incurred; opportunity costs of choosing an alternative over another.

Question 12

Earnings Quality

Answer 12

Degree of accurate representation and predictive reliability of company’s financial performance.

Question 13

Determinants and Indicator of Earnings Quality

Answer 13

1. Volatility of business environment
2. Compliance with GAAP
3. Reliability of Management

Question 14

Earnings Persistence

Answer 14

Refers to whether or not the earnings of a company are repeatable in the future.

Question 15

Inflation Effects on Financial Ratios

Answer 15

Negative effect on assets: devalue
Positive effect on liabilities

Need to adjust price index to be comparable and useful.