CFA Level II · CFA Level II Exam

Multinational Operations: formula sheet

Full chapter guide

Key formulas

Transaction gain or loss (receivable): Gain/loss = foreign amount × (settlement or closing spot − transaction spot); Rates quoted as functional currency per 1 unit of foreign currency (direct quote). Positive means gain for an asset.
Transaction gain or loss (payable): Gain/loss = −foreign amount × (settlement or closing spot − transaction spot); A payable gains when the foreign currency weakens against the functional currency.
Direct quote: Functional currency per 1 unit of foreign currency; Check the quote direction in the vignette. If it is inverted, take the reciprocal first.
Forward premium or discount: Forward points = forward rate − spot rate; Positive means the foreign currency trades at a forward premium in direct quote terms.
Hedge effect: Net gain/loss = transaction gain/loss + forward contract gain/loss; A matched forward hedge largely offsets the exposure, leaving mainly the forward points.
Monetary item rule: Monetary items: remeasure at closing rate. Non-monetary at cost: keep historical rate; Only monetary items generate transaction gains and losses.
Functional currency definition: Functional currency = currency of the primary economic environment of the entity; Determined from facts and indicators, with management judgment when indicators are mixed. It is not simply a preference or the country of incorporation.
Indicators pointing to the local currency (self-contained, independent operation): Local sales prices and market, local costs, local financing, low intercompany flows → functional = local currency; Then translate with the current rate method.
Indicators pointing to the parent currency (extension of the parent): Sales prices and market tied to the parent, inputs from the parent, parent financing, high intercompany flows → functional = parent currency; Then remeasure with the temporal method (curriculum framework).
Method mapping (CFA curriculum framework): Functional = local (≠ presentation) → current rate method; Functional = presentation currency → temporal method; If functional equals the local currency and the presentation currency, no translation is needed. IAS 21 describes this as translation into the functional currency, then into the presentation currency.
Rate by item type: Monetary items → current rate; nonmonetary items at historical cost → historical rate; revenue and most expenses → average rate; COGS and depreciation are the exceptions. Use historical rates for them.
Exposure: Net monetary position = monetary assets − monetary liabilities; Positive means net asset exposure. Negative means net liability exposure.
Direction of gain or loss: Foreign currency depreciates: net monetary assets → loss, net monetary liabilities → gain. Foreign currency appreciates: net monetary assets → gain, net monetary liabilities → loss; Measured against the parent (functional) currency, which is the one you remeasure into.
Remeasurement gain or loss (reconciliation): Gain or loss = ending net monetary position × closing rate − [beginning position × beginning rate + flows at their transaction-date rates]; Flows include sales, cash costs, and dividends. A positive result is a gain. Use average rates for flows unless a date is given.
Where it is reported: Remeasurement gain or loss → net income; Under the current rate method it would go to OCI.
Hyperinflation threshold: Cumulative 3-year inflation ≥ about 100%; Firm test under US GAAP. A strong indicator, not the sole one, under IFRS (IAS 29).
Cumulative inflation: (1 + i₁)(1 + i₂)(1 + i₃) − 1; Compound the annual rates. Do not just add them.
IFRS treatment: Restate by price index, then translate everything at the closing rate; Non-monetary balance sheet items, equity and all income statement items are restated to the reporting-date price level. Monetary items are not restated. All amounts are then translated at the closing rate. When the presentation currency is not hyperinflationary (IAS 21), comparatives are the amounts previously presented.
US GAAP treatment: Temporal method, parent's presentation currency as functional currency; No inflation restatement. Remeasurement gain or loss goes to net income.
Restatement factor: Index at reporting date ÷ Index at date of original transaction; Applies to non-monetary items, equity and income statement items under IFRS, using the index at the date each arose.
Net monetary position (IFRS): Net monetary assets lose purchasing power (loss); net monetary liabilities gain; IFRS purchasing-power restatement only. Gain or loss goes to net income. Under US GAAP the sign depends on exchange-rate movement and net monetary exposure.

Quick revision

The functional currency is the currency of the subsidiary's primary economic environment; the presentation currency is the one the parent reports in.
If the functional currency is the foreign local currency, use the current rate method (translation). If the functional currency is the parent's currency, remeasure the local books using the temporal method.
Current rate method: assets and liabilities at the current rate, income statement items at the average rate, equity at historical rates.
Under the current rate method, the translation gain or loss goes to equity (other comprehensive income), not net income.
Temporal method: monetary items at the current rate; non-monetary items carried at historical cost at historical rates; non-monetary items carried at current value (for example inventory at net realisable value) at the current rate.
Temporal method, income statement: items at the average rate, except cost of goods sold and depreciation or amortisation of non-monetary assets, which use the historical rates of the related assets.
Under the temporal method, the remeasurement gain or loss goes to net income.
Exposure under the current rate method is net assets. Under the temporal method, exposure is net monetary assets or liabilities, plus any non-monetary items carried at current value. Non-monetary items carried at historical cost are not exposed.
Transaction gains and losses on foreign currency receivables and payables go to net income.
Hyperinflation under IFRS (IAS 29): restate the statements using a general price index first, then translate at the current rate. The purchasing power gain or loss on the net monetary position goes to net income. When translating into a non-hyperinflationary presentation currency, comparative amounts are not restated; they stay as previously presented. Under US GAAP, a highly inflationary economy (cumulative inflation of about 100% or more over three years) means the temporal method is used. Check the definition and conditions given in the vignette.
Always check the direction of the exchange rate change before deciding whether a ratio rises or falls.
Read the quote convention in every question, since a flipped quote reverses the answer.

Common mistakes

Using the wrong quote direction Fix: Write the quote as 'functional per 1 foreign' before any calculation. Invert if needed.
Getting the sign wrong on payables Fix: Gains on assets come from a stronger foreign currency. For liabilities, a stronger foreign currency is a loss.
Assuming the functional currency is always the local currency. Fix: Test the indicators. An extension of the parent, with parent-linked sales, costs and financing, has the parent's currency as functional.
Treating the functional currency as a free management choice. Fix: Functional currency is determined from the facts. Judgment applies only when indicators are mixed. Presentation currency is the one that is a reporting choice.
Remeasuring PP&E and inventory at the closing rate. Fix: Under the temporal method, only monetary items use the closing rate. Cost-based nonmonetary items keep their historical rates.
Putting the remeasurement gain or loss in OCI. Fix: Temporal method gains and losses go to net income. Link the temporal method to volatile earnings.
Adding the three annual inflation rates instead of compounding them. Fix: Multiply (1 + i) for each year, then subtract 1. For 30%, 30%, 30% the answer is 119.7%, not 90%.
Saying US GAAP restates financial statements for inflation. Fix: Only IFRS restates. US GAAP switches to the temporal method with no price-index restatement.

Exam tips

Write the quote as 'functional per foreign' first. Most lost marks on this topic come from inverted quotes.
Decide long or short the foreign currency before you do any arithmetic, then check the sign at the end.
If a hedge is described, expect a net result close to the forward points. Use that as a check on your answer.
Watch for a balance sheet date between transaction and settlement. It splits the gain or loss across two periods.
Do not confuse transaction gains with translation adjustments. Transaction items go to profit or loss; translation goes to other comprehensive income.
Expect a vignette listing a subsidiary's sales, costs and financing; classify each fact quickly and pick the majority.
Remember that functional currency can be a third currency, not only local or parent.
Link the currency conclusion to the method, since later questions in the same item set often ask for it.