Mega Concerns Inc. (MCI) is a publicly traded, Canadian-based, diversified multinational corporation with numerous subsidiaries located throughout the world. On January 1, 20X9, MCI acquired 100% of the voting shares of Vamos Cogele Ltd. (VCL), a Mexican-based manufacturing subsidiary. Pertinent details of VCL follow:

MCI has the right to appoint all seven members of the VCL board of directors. However, MCI left six pre-existing members in place because of their expertise and local connections, and appointed only one new member, who is the chair of the board.

MCI has not been required to subsidize the operating cash flow to VCL, because VCL generates sufficient cash flow from its own operations to service its debt. VCL has remained largely autonomous from MCI and makes its own strategic decisions about what products to manufacture. At the end of 20X9, VCL distributed excess cash to MCI by way of dividends.

MCI maintains a bonus plan for its key senior executives with bonuses based on consolidated earnings per share (EPS). MCI reports its financial results in Canadian dollars. You have determined that MCI's EPS for the year will be $6.59, including a foreign exchange gain of $0.32 per share if the functional currency of VCL is determined to be the Canadian dollar and $6.31 if the functional currency is the Mexican peso.

VCL prepares its stand-alone financial results in accordance with IFRS, in Mexican pesos (MXN$). VCL's accounting policies are generally consistent with those of MCI.

VCL sells all its production in Canada with the sales denominated in Canadian dollars (C$). Approximately 70% of sales are made to MCI, with the remaining 30% sold to other, arm's-length wholesalers. VCL sources most of its labour and materials locally, paying Mexican pesos for those items. VCL's Canadian dollar sales proceeds are converted to Mexican pesos as needed to meet operational requirements and debt-servicing obligations. Approximately 60% of excess cash is retained in Canadian dollars with the balance held in Mexican pesos.

During the last 10 years, the inflation rate in Mexico has fluctuated between 2% and 6% per annum.

You, CPA, are a member of the accounting group at MCI. The chief financial officer (CFO) is preparing for a senior management meeting, where accounting policies will be discussed before the financial results are presented to the board of directors.

Required:

In advance of this meeting, the CFO has requested that you do the following:

a) Evaluate the factors that should be considered to determine whether the functional currency of VCL is the Canadian dollar or the Mexican peso. (7 marks)

b) Explain how foreign exchange gains and losses are determined and accounted for: (2 marks)

i. If VCL's functional currency is determined to be the Canadian dollar

ii. If VCL's functional currency is determined to be the Mexican peso

c) Recommend the translation method that MCI should use when consolidating the financial results of VCL with that of MCI's own operations. (1 mark)