_____ Parrex has a foreign subsidiary, Sarrex, in a country in which the direct exchange rate decreased from $.70 at 1/1/06 to $.60 at 12/31/06. During 2006, Sarrex had (a) an average net asset position of 400,000 LCUs and (b) an average net monetary liability position of 600,000 LCUs (900,000 LCUs - 300,000 LCUs). Under the current rate method, what is the effect of the 2006 exchange rate change?
A) $40,000 favorable.
B) $40,000 unfavorable.
C) $60,000 favorable.
D) $60,000 unfavorable.
E) None of the above.

Question

Quizplus · Accepted Answer

Under the current rate method, all assets and liabilities are translated at the current exchange rate at the balance sheet date. The net asset position of 400,000 LCUs would translate to a lesser dollar amount due to the depreciation of the local currency (from $.70 to $.60), resulting in a translation loss. Similarly, the net monetary liability position of 600,000 LCUs would also translate to a lesser dollar amount, but since these are liabilities, the reduction in their dollar equivalent would be favorable. However, the net effect is determined by the overall position, which in this case is a net liability position. The change in exchange rate from $.70 to $.60 on the net asset position of 400,000 LCUs would result in a decrease of $40,000 (400,000 LCUs * ($.70 - $.60) = $40,000), making it unfavorable because it decreases the value of net assets when converted to dollars.

_____ Parrex Has a Foreign Subsidiary, Sarrex, in a Country