Chartered Financial Analyst (CFA) Practice Exam Level 2

What does the term 'integrated subsidiary' refer to in currency translation methods?

1. One that uses the ACR method

2. One that uses the temporal rate method

3. A subsidiary with diverse currency operations

4. A subsidiary that operates solely in the parent company's currency

The correct answer is: One that uses the temporal rate method

The term 'integrated subsidiary' refers specifically to a subsidiary that operates in a hyperinflationary environment or has close operational and financial ties to the parent company, and therefore utilizes the temporal rate method for currency translation. This method involves translating the subsidiary's financial statements using the historical exchange rates for monetary items, while non-monetary items are translated at historical or current rates based on their nature. When a subsidiary is considered integrated, it means that its operations are closely linked to the parent company's currency, leading to the use of the temporal rate method, which reflects the economic reality more accurately by considering historical cost. This method is particularly suited for businesses where the functional currency is primarily that of the parent company, often in cases where there is significant exposure to currency risks. The other options present alternatives that either do not fit the definition of an integrated subsidiary or pertain to different currency translation methods that are not consistent with an integrated operational context. Thus, the selection of the temporal rate method is crucial for accurately reflecting the financial position and results of operations for an integrated subsidiary.