Chap 010

Chapter 10 - Translation of Foreign Currency Financial Statements

CHAPTER 10TRANSLATION OF FOREIGN

CURRENCY FINANCIAL STATEMENTS

Chapter Outline

I. In today's global economy, many companies have invested in operations in foreign countries. A. In preparing consolidated financial statements on a worldwide basis, the foreign

currency accounts prepared by foreign operations must be restated into the parent company's reporting currency.

B. There are two major issues related to the translation of foreign currency financial statements.1. Which method should be used? 2. How should the resulting translation adjustment be reported on the consolidated

financial statements?C. Translation methods differ on the basis of which accounts are translated at the current

exchange rate and which are translated at a historical exchange rate. Translating accounts at the current exchange rate creates a translation adjustment.

D. Historically, accountants have experimented with a number of different translation methods. The dominant methods currently in use are the temporal method and the current rate method.

E. Translation adjustments can be either (1) reported as a gain or loss in income or (2) deferred in the stockholders' equity section of the balance sheet.

II. The primary objective of the temporal method is to maintain the underlying valuation method used by the foreign entity to account for its assets and liabilities.A. Assets and liabilities carried at current or future value are translated at the current

exchange rate. Assets and liabilities carried at cost and stockholders' equity items are translated at a historical exchange rate.

B. By translating some assets at the current exchange rate and others at historical rates the temporal method distorts financial ratios calculated in the foreign currency.

C. Most income statement items are translated at average-for-the-period rates. However, cost-of-goods-sold, depreciation, and amortization expense are translated at relevant historical exchange rates.

D. Balance sheet exposure under the temporal method is defined as cash, marketable securities, and receivables minus total liabilities. A net liability exposure often exists.1. When a liability balance sheet exposure exists, depreciation of the foreign currency

results in a positive translation adjustment (gain) and appreciation of the foreign currency results in a negative translation adjustment (loss).

2. Reporting a translation loss when the foreign currency appreciates is thought to be inconsistent with economic reality.

III. With the current rate method, the net investment in a foreign operation is considered to be exposed to foreign exchange risk.A. Assets and liabilities are translated at the current exchange rate; equity is translated at

historical rates. B. Translating assets which are carried at cost using the current exchange rate results in a

translated value which is not readily interpretable; it is neither a current value nor a historical cost.

C. However, translating all assets at the current rate does maintain underlying ratios and

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relationships that exist in the foreign currency statements.D. Revenues and expenses which occur evenly throughout the period are translated at the

average-for-the-period exchange rate. Income items, such as gains and losses, which are

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the result of a discrete event, are translated at the actual exchange rate on the date of occurrence.

E. Balance sheet exposure under the current rate method is equal to the foreign entity's net assets (stockholders' equity).1. Appreciation in the foreign currency results in a positive translation adjustment

(gain); depreciation results in a negative translation adjustment (loss).

IV. U.S. GAAP provides guidelines for the translation of foreign currency financial statements by U.S.-based multinational corporations. The appropriate translation method and disposition of translation adjustment depends upon the functional currency of the foreign entity.A. The functional currency is the primary currency of the foreign entity's operating

environment. It can be either the U.S. dollar or a foreign currency.1. Authoritative literature (FASB ASC paragraph 830-10-55-5) lists six indicators that

are to be used in determining an entity's functional currency. There are no guidelines as to how these indicators are to be weighted.

B. If a foreign currency is the functional currency, the foreign entity's financial statements are "translated" using the current rate method and the resulting translation adjustment is reported as a separate component of equity. The average-for-the-period exchange rate is used to translate the foreign entity's income statement. 1. Upon the sale or liquidation of a specific foreign entity, the cumulative translation

adjustment related to that entity is taken to income as an adjustment to the gain or loss on sale or liquidation.

C. If the U.S. dollar is the functional currency, foreign currency financial statements are "remeasured" using the temporal method with "remeasurement" gains and losses reported in operating income.

D. If a foreign entity operates in a highly inflationary economy (cumulative three-year inflation greater than 100%), its financial statements are remeasured into U.S. dollars using the temporal method and remeasurement gains and losses are reported in income.

V. Some companies hedge the balance sheet exposures of their foreign entities so as to avoid adverse effects on income and/or stockholders' equity. A. This is referred to as a hedge of a net investment in a foreign operation and U.S. GAAP

stipulates that gains and losses on hedging instruments used in this manner should be treated in the same fashion as the translation adjustment (remeasurement gain/loss) being hedged.

B. The paradox of hedging balance sheet exposure is that by avoiding a translation adjustment (remeasurement gain/loss), realized foreign exchange gains and losses can arise.

Learning Objectives

Having completed Chapter 10 of this textbook, "Translation of Foreign Currency Financial Statements," students should be able to fulfill each of the following learning objectives:

1. Explain the theoretical underpinnings and limitations of the current rate and temporal methods.

2. Describe guidelines as to when foreign currency financial statements are to be "translated" using the current rate method and when they are to be "remeasured" using the temporal method.

3. Translate a foreign subsidiary's financial statements into its parent's reporting currency using the current rate method and calculate the related translation adjustment.

4. Remeasure a foreign subsidiary's financial statements using the temporal method and 10-3


calculate the associated remeasurement gain or loss.

5. Understand the rationale for hedging a net investment in a foreign operation and describe the treatment of gains and losses on forward contracts used for this purpose.

6. Prepare a consolidation worksheet for a parent and its foreign subsidiary.

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Answer to Discussion Question

How Do We Report This?

This case represents the ongoing debate as to the proper reporting of foreign currency balances. Southwestern has invested the equivalent of $30,000 (150,000 vilseks) in each of three assets. The relative value of the vilsek has now changed. Thus, 150,000 vilseks now can be converted into $34,500. However, the subsidiary does not have vilseks--only land, inventory, and investments. Although the current exchange rate is given, the company has no apparent plans to convert its assets into dollars. Instead, these three assets are being held, each with a historical cost of 150,000 vilseks. Under the temporal method, these assets (except for the investments if carried at market value) would be reported in the parent's balance sheet at the original cost of $30,000. Unfortunately, as the Finance Director points out, an old, outdated rate is being utilized if the $30,000 figure is reported. (Of course, given that prices tend to change over time, the same can be said for any asset reported at historical cost.)

Conversely, the current rate method requires that each of the three assets be reported at $34,500 based on the current exchange rate. As the controller indicates, though, $34,500 was not the original cost expended by Southwestern. In addition, using the current rate means that each of the assets will constantly report a "floating" value, one that will change with each exchange rate fluctuation. Finally, the $34,500 figure is based on the current value of the vilsek ($.23) and the historical cost in vilseks (150,000 vilseks) for the three assets. The current exchange rate is only significant if the assets are sold with the proceeds being converted into U.S. dollars. Since an imminent sale is not indicated, the validity of reporting the $34,500 might again be questioned. In addition, even if the assets were sold, $34,500 does not accurately reflect the proceeds in U.S. dollars because 150,000 vilseks is the historical cost and not the current market value of each of these assets.

As a classroom exercise or written assignment, students could be required to select a reported value for each of the three assets and then defend their position. What figure is actually the fairest representation of each of the three assets? What figure is the best conveyor of information to an outside party? There is no single best answer to these questions. The purpose of this type of exercise is to encourage students to consider the objectives of financial reporting. Students should not just assume that the current official pronouncement is correct. One possible approach to the case is to assign several students to represent banks or stockholders and discuss the types of information that is most needed by these users. Another group of students can take the position of the company responsible for preparing the information and discuss management's preference for providing one type of information over another. Yet another group could take a purely theoretical approach and discuss the goals that accounting has attempted to reach. Although a final resolution may not be achieved, some excellent class discussion is possible.

The temporal and current rate methods of translation differ primarily with regard to the exchange rate used to translate those assets that are reported at historical cost--inventories, prepaids, fixed assets, and intangibles. The debate regarding the appropriate exchange rate for translating assets exists only because some assets are reported at historical cost. If all assets were reported at their current value, there would be no need to use the historical exchange rate for translating assets in order to maintain the asset's historical cost in U.S. dollar terms. All assets would be translated at the current exchange rate. The differences between the temporal method and current rate method would disappear.

Answers to Questions

1. The two major issues related to the translation of foreign currency financial statements are: (a) which method should be used and (b) where should the resulting translation adjustment be reported in the consolidated financial statements. The first issue relates to determining the appropriate exchange rate (historical, current, or average for the current period) for the translation of foreign currency balances. Those items translated at the current exchange rate are exposed to translation adjustment. The second issue relates to whether the

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translation adjustment should be treated as a gain or loss in income, or should be deferred as a separate component of stockholders’ equity.

2. Balance sheet exposure arises when a foreign currency balance is translated at the current

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exchange rate. By translating at the current exchange rate, the foreign currency item in essence is being revalued in U.S. dollar terms on the consolidated financial statements. There will be either a net asset balance sheet exposure or net liability balance sheet exposure depending upon whether assets translated at the current rate are greater or less than liabilities translated at the current rate. Balance sheet exposure generates a translation adjustment which does not result in an inflow or outflow of cash. Transaction exposure, which results from the receipt or payment of foreign currency, generates foreign exchange gains and losses which are realized in cash.

3. Although balance sheet exposure does not result in cash inflows and outflows, it does nevertheless affect amounts reported in consolidated financial statements. If the foreign currency is the functional currency, translation adjustments will be reported in stockholders’ equity. If translation adjustments are negative and therefore reduce total stockholders’ equity, there is an adverse (inflationary) impact on the debt to equity ratio. Companies with restrictive debt covenants requiring them to stay below a maximum debt to equity ratio, may find it necessary to hedge their balance sheet exposure so as to avoid negative translation adjustments being reported. If the U.S. dollar is the functional currency or an operation is located in a high inflation country, remeasurement gains and losses are reported in income. Companies might want to hedge their balance sheet exposure in this situation to avoid the adverse impact remeasurement losses can have on consolidated income and earnings per share.

The paradox in hedging balance sheet exposure is that, by agreeing to receive or deliver foreign currency in the future under a forward contract, a transaction exposure is created. This transaction exposure is speculative in nature, given that there is no underlying inflow or outflow of foreign currency that can be used to satisfy the forward contract. By hedging balance sheet exposure, a company might incur a realized foreign exchange loss to avoid an unrealized negative translation adjustment or unrealized remeasurement loss.

4. The gains and losses arising from financial instruments used to hedge balance sheet exposure are treated in a similar manner as the item the hedge is intended to cover. If the foreign currency is the functional currency, gains and losses on hedging instruments will be taken to accumulated other comprehensive income. If the U.S. dollar is the functional currency, gains and losses on the hedging instruments will be offset against the related remeasurement gains and losses.

5. The major concept underlying the temporal method is that the translation process should result in a set of translated U.S. dollar financial statements as if the foreign subsidiary’s transactions had actually been carried out using U.S. dollars. To achieve this objective, assets carried at historical cost and stockholders’ equity are translated at historical exchange rates; assets carried at current value and liabilities (carried at current value) are translated at the current exchange rate. Under this concept, the foreign subsidiary’s monetary assets and liabilities are considered to be foreign currency cash, receivables, and payables of the parent which are exposed to transaction risk. For example, if the foreign currency appreciates, then the foreign currency receivables increase in U.S. dollar value and a gain is recognized. Balance sheet exposure under the temporal method is analogous to the net transaction exposure which exists from having both receivables and payables in a particular foreign currency.

The major concept underlying the current rate method is that the entire foreign investment is exposed to foreign exchange risk. Therefore all assets and liabilities are translated at the current exchange rate. Balance sheet exposure under this concept is equal to the net investment.

6. The Retained Earnings balance is created by a multitude of transactions: all revenues, expenses, gains, losses, and dividends since the company’s inception. Identifying each component of this account (so that a separate translation can be made) would be virtually impossible. Therefore, in the initial year that Statement 52 was applied, the ending balance calculated under Statement 8 was merely brought forward. Thereafter, the ending

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balance translated each year for retained earnings becomes the beginning figure to be reported for the following year.

7. The major differences relate to non-monetary assets carried at historical cost and related expenses, i.e., inventory and cost of goods sold; property, plant, and equipment and depreciation expense; and intangible assets and amortization expense. Under the temporal method, these items are all translated at historical exchange rates. Under the current rate method, the assets are translated at the current exchange rate and the related expenses are translated at the

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average exchange rate for the current period.

8. The functional currency is the currency of the subsidiary’s primary economic environment. It is usually identified as the currency in which the company generates and expends cash. SFAS 52 recommends that several factors such as the location of primary sales markets, sources of materials and labor, the source of financing, and the amount of intercompany transactions should be evaluated in identifying an entity’s functional currency. SFAS 52 does not provide any guidance as to how these factors are to be weighted (equally or otherwise) when identifying an entity’s functional currency.

9. The foreign subsidiary's net asset position in foreign currency at the beginning of the period is first determined. Changes in net assets are determined to explain the net asset balance in foreign currency at the end of the period. The beginning net asset position and changes in net assets are translated at appropriate exchange rates and the ending net asset position in dollars is determined.

The ending net asset balance in foreign currency is then translated at the current rate and this result is subtracted from the ending net asset position in dollars (already calculated). The difference is the translation adjustment. It is positive if the actual dollar net asset position is less than the net asset position based on the current exchange rate. The translation adjustment is negative if the actual dollar net asset position is greater than if translated at the current rate.

10. One theory views the translation adjustment as a measure of unrealized increases and decreases that have occurred in the value of the foreign subsidiary because of exchange rate changes. A second theory argues that this adjustment is no more than a mechanically derived number that must be included to keep the balance sheet in equilibrium although the figure has no intrinsic meaning. The FASB did not indicate that either theory is more correct.

11. Remeasurement is required in two situations:

a. The U.S. dollar is the functional currency.b. The foreign subsidiary operates in a highly inflationary country.

Translation is required when a foreign currency is the functional currency.Remeasurement is carried out using the temporal method, with remeasurement gains and losses reported in consolidated income. Translation is done using the current rate method and the resulting translation adjustment is carried as a separate component of stockholders’ equity.

12. The temporal method must be used to remeasure the financial statements of operations in highly inflationary countries. One reason for mandating the use of the temporal method is that it avoids the disappearing plant problem that exists when the current rate method is used. Under the current rate method, fixed assets are translated at current exchange rates. With high rates of inflation, the foreign currency will depreciate significantly. When the historical cost of fixed assets is translated at a significantly lower current exchange rate, the dollar value of fixed assets “disappears.” This problem is avoided by translating at the historical exchange rate as is done under the temporal method.

13. Differences exist between IFRS and U.S. GAAP with regard to (a) the hierarchy of factors used to determine the functional currency and (b) the method used to translate the financial statements of a subsidiary located in a hyperinflationary country. IAS 21 establishes primary factors and other factors to be considered in determining an entity’s functional currency. When the indicators are mixed and the functional currency is not obvious, the parent must give priority to the primary indicators in determining the foreign entity’s functional currency. U.S. GAAP does not have a similar hierarchy. In translating the foreign currency financial statements of a subsidiary located in a highly inflationary economy, IAS 21 requires financial statements to first be restated for local

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inflation and then translated into the parent’s currency using the current exchange rate for all financial statement items. In contrast, U.S. GAAP requires use of the temporal method with no adjustment for inflation in this situation.

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Answers to Problems

1. C Definition of Functional Currency (LO2)

2. C Comparison of Current Rate and Temporal Methods (LO3, LO4)

3. C Translation Process (Current Rate Method) (LO3)

4. B Determine Appropriate Translation Method and Resulting Translation Adjustment (LO2, LO3)Because the peso is the functional currency, the financial statements must be translated using the current rate method. Therefore, answers a and d can be eliminated. Because the subsidiary has a net asset position and the peso has appreciated from $.16 to $.19, a positive translation adjustment will result.

5. A Translation Process (Current Rate Method) – Asset and Related Expense (LO3)All asset accounts are translated at current rates.

6. A Translation Process (Current Rate Method) – Assets (LO2, LO3)Because the foreign currency is the functional currency, a translation is required. All assets accounts are translated at current rates.

7. C Remeasurement Process (Temporal Method) – Assets (LO2, LO4)Because the U.S. dollar is the functional currency, a remeasurement is required. All receivables are remeasured at current rates. Assets carried at historical cost, such as prepaid insurance and goodwill, are remeasured at historical rates.

8. B Translation Process (Current Rate Method) – Inventory (LO2, LO3)The foreign currency is the functional currency, so a translation is appropriate. All assets (including inventory) are translated at the current exchange rate [100,000 x $.17].

9. C Translation Process (Current Rate Method) – Cost of Goods Sold (LO2, LO3)Cost of goods sold is translated at the exchange rate in effect at the date of accounting recognition, which is the date the goods were sold [100,000 x $.18].

10. D Translation Process (Current Rate Method) – Marketable Securities and Inventory (LO2, LO4)The foreign currency is the functional currency, so a translation is appropriate. All assets are translated at the current exchange rate of $.19.

11. C Remeasurement Process (Temporal Method) – Marketable Securities and Inventory (LO2, LO4)The U.S. dollar is the functional currency, so a remeasurement is appropriate. Inventory (carried at cost) is remeasured at the historical exchange rate of $.16. Marketable equity securities (carried at market value) are remeasured at the current exchange rate of $.19.

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12. C Highly Inflationary Economy (Temporal Method) – Cost of Goods Sold (LO2, LO4)

Beginning inventory FCU 200,000 x $1.00 = $ 200,000Purchases 10,300,000 x $0.80 = 8,240,000 Ending inventory (500,000) x $0.75 = (375,000)Cost of goods sold FCU 10,000,000 $8,065,000

13. C Calculation of Translation Adjustment (LO3)Beginning net assets, 1/1………….. P20,000 x $.15 = $ 3,000Increase in net assets:

Income......................................... 10,000 x $.19 = 1,900Ending net assets, 12/31................. P30,000 $ 4,900Ending net assets at

current exchange rate................ P30,000 x $.21 = $ 6,300Translation Adjustment (positive) $(1,400)

14. C Concepts Underlying Current Rate and Temporal Methods (LO1)By translating items carried at historical cost by the historical exchange rate, the temporal method maintains the underlying valuation method used by the foreign subsidiary.

15. A Calculation of Remeasurement Gain/Loss (LO4) Beginning net monetary assets, 1/1 P100,000 x $.16 = $16,000

Increases in net monetary assets: Sale of inventory........................ 50,000 x $.20 = 10,000Decreases in net monetary assets: Purchase of equipment............. (60,000) x $.16 = (9,600) Purchase of inventory............... (30,000) x $.18 = (5,400) Transfer to parent...................... (10,000) x $.21 = (2,100)Ending net monetary assets, 12/31 P 50,000 ...............................................$ 8,900Ending net monetary assets at

the current exchange rate......... P 50,000 x $.22 = (11,000)Remeasurement gain...................... $(2,100)

16. C Remeasurement Process (Temporal Method) (LO4)Marketable equity securities are carried at market value and therefore translated at the current exchange rate under the temporal method.

17. B Determine Appropriate Translation Method and Treatment of Translation Adjustment (LO2)When the U.S. dollar is the functional currency, SFAS 52 requires remeasurement using the temporal method with remeasurement gains and losses reported in income.

18. B Translation Process (Current Rate Method) – Wages Expense and Wages Payable (LO3)Wages expense is translated at the average exchange rate; wages payable are translated at the current exchange rate.

19. C Treatment of Gains and Losses on Hedges of Net Investments (LO5)

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Gains and losses on hedges of net investments (whether through a forward contract, borrowing, or other technique) are offset against the translation adjustment being hedged.

20. D Presentation of Remeasurement Gain/Loss on Income Statement (LO4) Remeasurement gains are reported in the income statement as a part of income from continuing operations.

21. Specify Appropriate Exchange Rates for the Translation of Foreign Currency Financial Statements under the Current Rate Method (LO3) (10 minutes)

Rent expense—use actual (historical) rate at time of recording. Rent expense would often be recorded evenly throughout the year so that an average rate for the period is acceptable.

Dividends paid—use historical rate at time of recording, the date of declaration.

Equipment—as an asset, use current rate at the balance sheet date.

Notes payable—as a liability, use current rate at the balance sheet date.

Sales—use actual (historical) rate at time of recording. Sales often occur evenly throughout the year so that an average rate is acceptable. However, if sales are more prevalent at a particular time during the year, historical rates should be used.

Depreciation expense—use historic rate at time of recording. In most cases, average rate for the year is acceptable, because depreciation occurs evenly throughout the year. Depreciation is recorded at year-end only as a matter of convenience.

Cash—as an asset, use the current rate at the balance sheet date.

Accumulated depreciation—as a contra-asset account, use the current ex-change rate at the balance sheet date.

Common stock—as an equity account, use historic rate at time of recording, the date of issuance.

22. Determine Translated Values under the Current Rate Method (LO3) (5 minutes)

As a translation, both the asset (inventory) and the liability (accounts payable) utilize the current exchange rate at the balance sheet date (December 31). Thus, the translated values are as follows:

Inventory LCU120,000 x 25% left = LCU30,000 x 1/3.0 = $10,000Accounts payable LCU120,000 x 40% unpaid = LCU48,000 x 1/3.0 = $16,000

23. Determine Appropriate Exchange Rates under the Current Rate Method (Translation) and Temporal Method (Remeasurement) (LO3, LO4) (10 minutes)

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Translation RemeasurementAccounts payable $.16 C $.16 CAccounts receivable $.16 C $.16 CAccumulated depreciation $.16 C $.26 HAdvertising expense $.19 A $.19 AAmortization expense $.19 A $.25 HBuildings $.16 C $.26 HCash $.16 C $.16 CCommon stock $.28 H $.28 HDepreciation expense $.19 A $.26 HDividends paid (10/1) $.20 H $.20 HNotes payable $.16 C $.16 CPatents (net) $.16 C $.25 HSalary expense $.19 A $.19 ASales $.19 A $.19 A

* C = current rate, H = historical rate, A = average rate

24. Calculate Translation Adjustment and Remeasurement Gain/Loss and Explain Their Economic Relevance (LO1, LO3, LO4) (20 minutes)The translation adjustment and remeasurement gain/loss can be determined as the plug figure that keeps the dollar balance sheet in balance:

Translation Remeasurement CHF Rate US$ Rate US$

Cash............................ 500,000 $.75 C 375,000 $.75 C 375,000Inventory..................... 1,000,000 $.75 C 750,000 $.70 H 700,000Fixed assets............... 3,000,000 $.75 C 2,250,000 $.70 H 2,100,000 Total assets............... 4,500,000 3,375,000 3,175,000Notes payable.......... 800,000 $.75 C 600,000 $.75 C 600,000Owners equity............ 3,700,000 $.70 H 2,590,000 $.70 H 2,590,000 Translation adjustment 185,000Retained earnings (remeasurement loss) (15,000) Total ......................... 4,500,000 3,375,000 3,175,000Alternatively, the translation adjustment and remeasurement loss can be calculated by analyzing the subsidiary’s balance sheet exposure:

Translation Beginning net assets, 12/1 CHF3,700,000 x $.70 = $2,590,000Ending net assets, 12/31 at

current exchange rate CHF3,700,000 x $.75 = (2,775,000)Translation adjustment (positive)

$( 185,000)

RemeasurementBeginning net monetary

liability position, 12/1 CHF(300,000) x $.70 = $(210,000)Ending net monetary liability

position, 12/31 at current exchange rate CHF(300,000) x $.75 = (225,000)

Remeasurement loss $ 15,000

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Economic Relevance of Translation AdjustmentThe translation adjustment increases stockholders’ equity by $185,000. The positive translation adjustment arises because the Swiss subsidiary has a net asset position of CHF3,700,000 and the Swiss franc appreciates by $.05 [CHF3,700,000 x $.05 = $185,000]. The positive translation adjustment is not realized in terms of dollar cash flow. It would be a realized gain only if Stephanie sold this operation on December 31 for exactly CHF3,700,000 and converted the sales proceeds into dollars at the current exchange rate of $.75 per Swiss franc.

Economic Relevance of Remeasurement LossThe remeasurement loss arises because the Swiss subsidiary has a net monetary liability position of CHF300,000 (Cash of CHF500,000 less Notes payable of CHF800,000) and the Swiss franc has appreciated by $.05 [CHF300,000 x $.05 = $15,000]. The loss is unrealized. It would be realized only if the Swiss subsidiary converted its Swiss franc cash into dollars at December 31, thereby realizing a transaction gain of $25,000 [CHF500,000 x ($.75-$.70)], and the parent paid off the Swiss franc note payable using U.S. dollars, thereby realizing a transaction loss of $40,000 [CHF800,000 x ($.75-$.70)]. (The note could have been paid at December 1 for $560,000 [CHF800,000 x $.70]. At December 31, it takes $600,000 to pay off the note [CHF800,000 x $.75].)

25. Prepare Financial Statements for a Foreign Subsidiary and Then Translate Them Into U.S. dollars (LO3) (30 minutes)

Fenwicke Company SubsidiaryIncome Statement

LCU U.S. DollarsRent revenue 60,000 x $1.90 A = $114,000Interest expense (10,000) x $1.90 A = (19,000)Depreciation expense (14,000) x $1.90 A = (26,600)Repair expense (4,000) x $1.85*H = (7,400)

Net income 32,000 $ 61,000

* Repair expense is the only expense not incurred evenly throughout the year.

Statement of Retained Earnings LCU U.S. Dollars

Retained earnings, 1/1 -0- -0-Net income 32,000 (above) $61,000Dividends paid (5,000) x $1.80 H = (9,000)Retained earnings, 12/31 27,000 $52,000

Balance Sheet LCU U.S. Dollars

Cash 41,000 x $1.80 C = $ 73,800Accounts receivable 10,000 x $1.80 C = 18,000 Building 140,000 x $1.80 C = 252,000Accumulated depreciation (14,000 ) x $1.80 C = (25,200)

Total assets 177,000 $318,600Interest payable 10,000 x $1.80 C = $ 18,000Note payable 100,000 x $1.80 C = 180,000Common stock 40,000 x $2.00 H = 80,000Retained earnings 27,000 (above) 52,000Translation adjustment (below) (11,400)

Total liabilities and equities177,000 $318,600

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Computation of Translation AdjustmentBeginning net assets -0- -0-Increase in net assets:

Issued common stock 40,000 x $2.00 = $ 80,000Net income 32,000 (above) 61,000

Decrease in net assets:Dividends paid (5,000) x $1.80 = (9,000)

Ending net assets 67,000 $132,000Ending net assets at current

exchange rate 67,000 x $1.80 = 120,600Translation adjustment (negative) $ 11,400

26. Prepare a Statement of Cash Flows for a Foreign Subsidiary and Then Translate It Into U.S. dollars (LO3) (30 minutes)

Fenwicke Company SubsidiaryStatement of Cash Flows

LCU U.S. DollarsOperating Activities:

Net income 32,000 (from prob 25) $ 61,000 plus: depreciation 14,000 x $1.9 A = 26,600less: increase in accounts receivable (10,000) x $1.9 A = (19,000)plus: increase in interest payable 10,000 x $1.9 A = 19,000Cash flow from operations 46,000 87,600

Investing Activities:Purchase of building (140,000) x $2.0 H = (280,000)

Financing Activities:Sale of common stock 40,000 x $2.0 H = 80,000Borrowing on note 100,000 x $2.0 H = 200,000Dividends paid (5,000) x $1.8 H = (9,000)

135,000 271,000Increase in cash 41,000 78,600Effect of exchange rate change on cash (4,800)Cash, 1/1 -0- -0-Cash, 12/31 41,000 x $1.80 C = $ 73,800

27. Compute Translation Adjustment and Remeasurement Gain/Loss (LO3, LO4) (25 minutes)

a. Translation—only changes in net assets have an impact on the computation of the translation adjustment.

Net asset balance 1/1 KM30,000 x $.32 = $ 9,600Increases in net assets (income):

Sold inventory at a profit 5/1 5,000 x $.34 = 1,700Sold land at a gain 6/1 1,000 x $.35 = 350

Decreases in net assets: Paid a dividend 12/1 (3,000) x $.41 = (1,230)Depreciation recorded (2,000) x $.37 = ( 740)

Net asset balance 12/31 KM31,000 $ 9,680Net asset balance 12/31

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at current exchange rate KM31,000 x $.42 = (13,020)Translation adjustment—positive $(3,340)

b. Remeasurement—only changes in net monetary assets and liabilities have an impact on the computation of the remeasurement gain.

Beginning net monetaryliability position KM (3,000) x $.32 = $ ( 960)

Increases in monetary assets:Sold inventory 5/1 15,000 x $.34 = 5,100Sold land 6/1 5,000 x $.35 = 1,750

Decreases in monetary assets:Bought inventory 10/1 (12,000) x $.39 = (4,680)Bought land 11/1 (4,000) x $.40 = (1,600) Paid a dividend 12/1 (3,000) x $.41 = (1,230)

Ending net monetary liability position KM(2,000) $(1,620)

Ending net monetary liability position at current exchange rate KM(2,000 ) x $.42 = (840)

Remeasurement gain $ (780)

Note: The purchase of land on account did not result in a decrease in monetary assets, rather an increase in monetary liabilities. Payment on the note payable and collection of accounts receivable do not affect the net monetary liability position.

28. Compute Translation Adjustment and Remeasurement Gain/Loss (LO3, LO4) (20 minutes)

a. The translation adjustment is based on changes in the net assets of the subsidiary.

Net assets, 1/1 82,000 LCU x $.24 = $19,680Changes in net assetsRendered services 30,000 LCU x $.25 = 7,500 Incurred expense (18,000) LCU x $.26 = (4,680)Net assets, 12/31 94,000 LCU 22,500Net assets, 12/31 at current exchange rate 94,000 LCU x $.29 = 27,260Translation adjustment (positive) $(4,760)

b. The remeasurement gain or loss is based on changes in the net monetary assets of the subsidiary.

Net monetary assets, 1/1 22,000 LCU x $.24 = $ 5,280Changes in net monetary assetsRendered services 30,000 LCU x $.25 = 7,500 Incurred expense (18,000) LCU x $.26 = (4,680)Net monetary assets, 12/31 34,000 LCU $ 8,100Net monetary assets, 12/31 at current exchange rate 34,000 LCU x $.29 = 9,860

10-17


Remeasurement gain $(1,760)

c. Translated value of land 60,000 LCU x $.29 = $17,400Remeasured value of land 60,000 LCU x $.23 = $13,800

29. Determine the Appropriate Exchange Rate under the Current Rate Method (Translation) and Temporal Method (Remeasurement) (LO3, LO4) (10 minutes)

(a) Current Rate Method (b) Temporal MethodAccount Translation RemeasurementSales 20 A 20 AInventory 22 C 19 HEquipment 22 C 13 HRent expense 20 A 20 ADividends 21 H 21 HNotes receivable 22 C 22 CAccumulated depreciation--equipment 22 C 13 HSalary payable 22 C 22 CDepreciation expense 20 A 13 H

C = current exchange rate, A = average exchange rate, H = Historical exchange rate

30. Determine Translation Adjustment; Prepare Journal Entries for Forward Contract Hedge of Balance Sheet Exposure; Determine Amount to be Reported in Accumulated Other Comprehensive Income (LO3, LO5) (30 minutes)

a. Net assets, 1/1 (132,000 – 54,000) 78,000 kites x $0.80 = $62,400 Change in net assets:

Net income 26,000 kites x $0.77 = 20,020 Dividends, 3/1 (5,000) kites x $0.78 = (3,900) Dividends, 10/1 (5,000) kites x $0.76 = (3,800)

Net assets, 12/31 94,000 kites $74,720Net assets at current

exchange rate, 12/31 94,000 kites x $0.75 = 70,500Translation adjustment (negative) $ 4,220

b. Forward contract journal entries10/1 No entry

12/31 Forward Contract.................................. 2,000 Translation Adjustment (positive).. 2,000(To record the change in the value of the forward contract as an adjustment to the translation adjustment)

Foreign Currency (kites)...................... 150,000 Cash.................................................. 150,000(To record the purchase of 200,000 kites at the spot rate of $.75)

Cash ..................................................... 152,000

Foreign Currency (kites)................. 150,000Forward Contract............................. 2,000

10-18


(To record delivery of 200,000 kites, receipt of $152,000, and close the forward contract account.)

c. The net negative translation adjustment (debit balance) to be reported in Accumulated Other Comprehensive Income at 12/31 is $2,220 ($4,220 – $2,000).

31. Translation and Remeasurement of Foreign Subsidiary Trial Balance (LO3, LO4)(45 minutes)

a. Translation of Subsidiary Trial BalanceDebits Credits

Cash…………………………………. 8,000 KQ x 1.62 $12,960Accounts Receivable…………….. 9,000 KQ x 1.62 14,580Equipment………………………….. 3,000 KQ x 1.62 4,860Accumulated Depreciation……… 600 KQ x 1.62 $ 972Land………………………………… 5,000 KQ x 1.62 8,100Accounts Payable………………… 3,000 KQ x 1.62 4,860Notes Payable…………………….. 5,000 KQ x 1.62 8,100Common Stock…………………… 10,000 KQ x 1.71 17,100Dividends Paid……………………. 4,000 KQ x 1.66 6,640Sales………………………………… 25,000 KQ x 1.64 41,000Salary Expense…………………… 5,000 KQ x 1.64 8,200Depreciation Expense…………… 600 KQ x 1.64 984Miscellaneous Expense…………. 9,000 KQ x 1.64 14,760

$71,084Translation Adjustment (negative) 948

$72,032 $72,032Calculation of Translation AdjustmentNet assets, 1/1………………………….. -0- -0-Increase in net assets: Common stock issued………………. 10,000 KQ x 1.71 $17,100 Sales……………………………………. 25,000 KQ x 1.64 41,000Decrease in net assets: Dividends paid……………………….. ( 4,000) KQ x 1.66 (6,640) Salary expense……………………….. ( 5,000) KQ x 1.64 (8,200) Depreciation expense………………. ( 600) KQ x 1.64 ( 984) Miscellaneous expense ……………. ( 9,000) KQ x 1.64 (14,760)

Net assets, 12/31………………………. 16,400* KQ $27,516Net assets, 12/31 at

current exchange rate……………. 16,400 KQ x 1.62 26,568 Translation adjustment (negative) $ 948

* This amount can be verified as ending assets (24,400 KQ) minus ending liabilities (8,000 KQ) – net assets, 12/31 = 16,400 KQ.

31. (continued)b. Remeasurement of Subsidiary Trial Balance

Debits CreditsCash 8,000 KQ x 1.62 $12,960Accounts Receivable 9,000 KQ x 1.62 14,580

10-19


Equipment 3,000 KQ x 1.71 5,130Accumulated Depreciation 600 KQ x 1.71 $ 1,026Land 5,000 KQ x 1.59 7,950Accounts Payable 3,000 KQ x 1.62 4,860Notes Payable 5,000 KQ x 1.62 8,100Common Stock 10,000 KQ x 1.71 17,100Dividends Paid 4,000 KQ x 1.66 6,640Sales 25,000 KQ x 1.64 41,000Salary Expense 5,000 KQ x 1.64 8,200Depreciation Expense 600 KQ x 1.71 1,026Miscellaneous Expense 9,000 KQ x 1.64 14,760

$71,246 Remeasurement loss (debit) 840

$72,086 $72,086Calculation of Remeasurement LossNet monetary assets, 1/1 -0- -0-Increase in net monetary assets: Common stock issued 10,000 KQ x 1.71 $17,100 Sales 25,000 KQ x 1.64 41,000Decrease in net monetary assets: Acquired equipment (3,000) KQ x 1.71 (5,130) Acquired land (5,000) KQ x 1.59 (7,950) Dividends paid (4,000) KQ x 1.66 (6,640) Salary expense (5,000) KQ x 1.64 (8,200) Miscellaneous expense (9,000) KQ x 1.64 (14,760)

Net monetary assets, 12/31 9,000* KQ $15,420Net monetary assets, 12/31

at current exchange rate 9,000 KQ x 1.62 14,580 Remeasurement loss (debit) $ 840

* This amount can be verified as ending assets (17,000 KQ) minus ending liabilities (8,000 KQ) – net assets, 12/31 = 9,000 KQ.

32. Translate Financial Statements of a Foreign Subsidiary (LO3) (30 minutes)

LIVINGSTON COMPANYIncome Statement

For Year Ending December 31, 2011 Goghs U.S. Dollars

Sales 270,000 x 1/.63 = 428,571Cost of Goods Sold (155,000) x 1/.63 = (246,032)Gross Profit 115,000 182,539Operating Expenses (54,000) x 1/.63 = (85,714)Gain on Sale of Equipment 10,000 x 1/.58 = 17,241Net Income 71,000 114,066

Statement of Retained EarningsFor Year Ending December 31, 2011

Goghs U.S. DollarsRetained Earnings, 1/1/11 216,000 given 395,000Net Income 71,000 above 114,066 Dividends Paid (26,000) x 1/.62 = (41,935)

10-20


Retained Earnings, 12/31/11 261,000 467,131

Balance SheetDecember 31, 2011

Goghs U.S. DollarsCash 44,000 x 1/.65 = 67,692Receivables 116,000 x 1/.65 = 178,462Inventory 58,000 x 1/.65 = 89,231 Fixed Assets (net) 339,000 x 1/.65 = 521,538Total 557,000 856,923

Liabilities 176,000 x 1/.65 = 270,769Common Stock 120,000 x 1/.48 = 250,000Retained Earnings 261,000 above 467,131Translation Adjustment (130,977)Total 557,000 856,923

Translation Adjustment Goghs U.S. DollarsNet assets, 1/1/11 336,000 x 1/.60 = 560,000Net income, 2011 71,000 above 114,066Dividends paid (26,000) above (41,935)Net assets, 12/31/11 381,000 632,131Net assets at current exchange rate,

12/31/11 381,000 x 1/.65 = 586,154

Translation adjustment, 2011 (negative) 45,977Cumulative translation adjustment, 1/1/11 (negative) 85,000Cumulative translation adjustment, 12/31/11 (negative) 130,977

33. Compute Remeasurement Gain/Loss and Translation Adjustment (LO3, LO4) (35 minutes)

a. Remeasurement Gain or Loss

Net monetary assets, 1/1/11* 2,000 KR x 2.50 = $ 5,000Increases in net monetary assets:

Issued Common Stock (4/1/11) 10,000 KR x 2.60 = 26,000Sold Building** (7/1/11) 22,000 KR x 2.80 = 61,600Sales (2011) 80,000 KR x 2.70 = 216,000

Decreases in net monetary assets:Purchased Equipment (4/1/11) (30,000) KR x 2.60 = (78,000)Paid Dividends (10/1/11) (32,000) KR x 2.90 = (92,800) Rent Expense (2011) (14,000) KR x 2.70 = (37,800)Salary Expense (2011) (20,000) KR x 2.70 = (54,000) Utilities Expense (2011) ( 5,000) KR x 2.70 = (13,500 )

Net monetary assets, 12/31/11 13,000 KR $ 32,500Net monetary assets, 12/31/11 at

current exchange rate 13,000 KR x 3.00 = 39,000Remeasurement gain (credit) $ (6,500)

* Net monetary assets: (Cash + Accounts Receivable) - (Account Payable + Bonds Payable)

10-21


** To determine cash proceeds from the sale of the building, changes in the Accumulated Depreciation and Buildings accounts must be analyzed along with Depreciation Expense and Gain on Sale of Building. Depreciation expense is KR 15,000; KR 5,000 is attributable to equipment (Accumulated Depreciation—Equipment increases by KR 5,000), KR 10,000 is depreciation of buildings. Accumulated Depreciation—Buildings increases by only KR 5,000 during 2011, therefore, the accumulated depreciation related to the building sold during 2008 is KR 5,000. The Buildings account is decreased by KR 21,000, thus the book value of the building sold must have been KR 16,000 (as given). The Gain on Sale of Building is KR 6,000; therefore, cash proceeds from the sale are KR 22,000.

33. (continued)

b. Translation Adjustment

Net assets, 1/1/11* 100,000 KR x 2.50 = $250,000Increases in net assets

Issued Common Stock (4/1/11) 10,000 KR x 2.60 = 26,000Gain on Sale of Building** (7/1/11) 6,000 KR x 2.80 = 16,800Sales (2011) 80,000 KR x 2.70 = 216,000

Decreases in net assetsPaid Dividends (10/1/11) (32,000) KR x 2.90 = (92,800) Depreciation Expense (2011) (15,000) KR x 2.70 = (40,500)Rent Expense (2011) (14,000) KR x 2.70 = (37,800)Salary Expense (2011) (20,000) KR x 2.70 = (54,000) Utilities Expense (2011) ( 5,000) KR x 2.70 = (13,500)

Net assets, 12/31/11 110,000 KR $270,200Net monetary assets, 12/31/11 at

current exchange rate 110,000 KR x 3.00 = 330,000Translation adjustment (positive) $(59,800)

* Net assets: Common stock + Retained earnings** Selling a building at a gain of KR 6,000 increases net assets by that

amount.Although not required by Part b, the beginning translation adjustment as of January 1, 2011 can be computed by translating the January 1 accounts and assuming that the translation adjustment is the balancing figure:Common Stock, 1/1/11 70,000 KR x 2.40 = $168,000Retained Earnings, 1/1/11 30,000 KR given 62,319 Net assets, 1/1/11 100,000 KR $230,319Net assets, 1/1/11 at current

exchange rate 100,000 KR x 2.50 = 250,000Cumulative translation adjustment (positive), 1/1/11 $ (19,681)Translation adjustment (positive), 2011 (59,800)Cumulative translation adjustment (positive), 12/31/11 $ (79,481)

34. Remeasure Non-functional Currency Accounts into Foreign Functional Currency and Then Translate Foreign Functional Currency Financial Statements into U.S. Dollars (LO3, LO4) (90 minutes)

10-22


a. Remeasurement of Mexican Operations Canadian Dollars

Pesos Debit CreditAccounts payable 49,000 x .35 C 17,150Accumulated depreciation 19,000 x .25 H 4,750Building and equipment 40,000 x .25 H 10,000Cash 59,000 x .35 C 20,650Depreciation expense 2,000 x .25 H 500Inventory (beginning

—income statement) 23,000 x .30 A (’10) 6,900Inventory (ending

—income statement) 28,000 x .34 A(’11) 9,520Inventory (ending—balance sheet) 28,000 x .34 A(’11) 9,520Purchases 68,000 x .34 A(’11) 23,120Receivables 21,000 x .35 C 7,350Salary expense 9,000 x .34 A 3,060Sales 124,000 x .34 A 42,160Main office 30,000 given 7,530

Remeasurement loss Schedule One 10 Total 81,110 81,110

Schedule One—Remeasurement Loss Pesos Canadian DollarsNet monetary liabilities, 1/1/11* (16,000) x .32 (5,120)Increases in net monetary assets

Sales 124,000 x .34 42,160Decreases in net monetary assets

Purchases (68,000) x .34 (23,120)Salary Expense ( 9,000) x .34 ( 3,060)

Net monetary assets, 12/31/11** 31,000 10,860Net monetary assets, 12/31/11 at

current exchange rate 31,000 x .35 10,850Remeasurement loss 10

* Net monetary liabilities, 1/1/11, can be determined by first determining the net monetary assets at 12/31/11 and then backing out the changes in monetary assets and liabilities during 2011—sales, purchases, and salary expense.

** Net monetary assets, 12/31/11: Cash + Receivables – Accounts Payable

34. (continued)

b. The following C$ financial statements are produced by combining the figures from the main operation with the remeasured figures from the branch operation. The Branch Operation and Main Office accounts offset each other. Cost of goods sold for the Mexican branch is determined by combining beginning inventory, purchases, and ending inventory as remeasured in C$.

Income Statement c. Translation into U.S. dollars—For the Year Ended December 31, 2011 Current Rate Method

Sales C$ 354,160 x .67 A = $ 237,287.20

10-23


Cost of goods sold (223,500) x .67 A = (149,745 .00 )Gross profit 130,660 87,542.20Depreciation expense (8,500) x .67 A = (5,695.00)Salary expense (29,060) x .67 A = (19,470.20)Utility expense (9,000) x .67 A = (6,030.00)Gain on sale of equipment 5,000 x .68 H = 3,400.00Remeasurement loss (10) x .67 A = (6 .70 )

Net income C$ 89,090 $ 59,740 .30

Statement of Retained EarningsFor the Year Ended December 31, 2011

Retained earnings, 1/1/11 C$ 135,530 Given $ 70,421.00Net income (above) 89,090 Above 59,740.30Dividends paid ( 28,000) x .69 H = (19,320 .00 )Retained earnings, 12/31/11 C$ 196,620 $110,841 .30

34. (continued)

c. Balance SheetDecember 31, 2011

Cash C$ 46,650 x .65 C = $ 30,322.50Receivables 75,350 x .65 C = 48,977.50Inventory 107,520 x .65 C = 69,888.00Buildings and equipment 177,000 x .65 C = 115,050.00Accumulated depreciation (31,750) x .65 C = (20,637 .50 )

Total C$ 374,770 $243,600 .50

Accounts payable C$ 52,150 x .65 C = $ 33,897.50Notes payable 76,000 x .65 C = 49,400.00Common stock 50,000 x .45 H = 22,500.00Retained earnings 196,620 Above 110,841.30Cumulative translation adjustment Schedule Two 26,961 .70

Total C$ 374,770 $ 243,600 .50

Schedule Two—Translation AdjustmentNet assets, 1/1/11 C$ 185,530 x .70 = $129,871.00Changes in net assets

Net income 89,090 Above 59,740.30Dividends (28,000) x .69 = (19,320 .00 )

Net assets, 12/31/11 C$ 246,620 $170,291.30Net assets, 12/31/11 at

current exchange rate C$ 246,620 x .65 = 160,303 .00 Translation adjustment, 2011 (negative) $ 9,988.30Cumulative translation adjustment, 1/1/11 (positive) (36,950 .00 )Cumulative translation adjustment, 12/31/11 (positive) $(26,961 .70 )

35. Translate Foreign Currency Financial Statements and Prepare Consolidation Worksheet (LO3, LO6) (90 minutes)

Step One

10-24


Simbel's financial statements are first translated into U.S. dollars after reclassification of the 10,000 pound expenditure for rent from rent expense to prepaid rent. Credit balances are in parentheses.

Translation Worksheet Exchange

Account Pounds Rate DollarsSales (800,000) 0.274 (219,200)Cost of goods sold 420,000 0.274 115,080Salary expense 74,000 0.274 20,276Rent expense (adjusted) 36,000 0.274 9,864Other expenses 59,000 0.274 16,166Gain on sale of fixed

assets, 10/1/11 (30,000) 0.273 (8,190)Net income (241,000) (66,004)

R/E, 1/1/11 (133,000) Schedule 1 (38,244)Net income (241,000) Above (66,004)Dividends paid 50,000 0.275 13,750R/E,12/31/11 (324,000) (90,498)

Cash and receivables 146,000 0.270 39,420Inventory 297,000 0.270 80,190Prepaid rent (adjusted) 10,000 0.270 2,700Fixed assets 455,000 0.270 122,850Total 908,000 245,160

Accounts payable (54,000) 0.270 (14,580)Notes payable (140,000) 0.270 (37,800)Common stock (240,000) 0.300 (72,000)Add’l paid-in capital (150,000) 0.300 (45,000)Retained earnings, 12/31/11 (324,000) Above (90,498)Subtotal (259,878)Cumulative translation adjustment (negative) Schedule 2 14,718Total (908,000) (245,160)

35. (continued)

Schedule 1—Translation of 1/1/11 Retained Earnings

Pounds DollarsRetained earnings, 1/1/10 -0- -0- Net income, 2010 (163,000) 0.288 (46,944)Dividends, 6/1/10 30,000 0.290 8,700 Retained earnings, 1/1/11 (133,000) (38,244)

Schedule 2—Calculation of Cumulative Translation Adjustment at 12/31/11

Pounds Dollars

10-25


Net assets, 1/1/10 (390,000) 0.300 (117,000)Net income, 2010 (163,000) 0.288 (46,944)Dividends, 6/1/10 30,000 0.290 8,700 Net assets, 12/3/10 (523,000) (155,244)Net assets, 12/31/10 at

current exchange rate (523,000) 0.280 (146,440)Translation adjustment, 2010 (negative) (8,804)Net assets, 1/1/11 (523,000) 0.280 (146,440)Net income, 2011 (241,000) Above (66,004)Dividends, 6/1/11 50,000 0.275 13,750 Net assets, 12/31/11 (714,000) (198,694)Net assets, 12/31/11 at

current exchange rate (714,000) 0.270 (192,780)Translation adjustment, 2011 (negative) (5,914)Cumulative translation adjustment, 12/31/11 (negative) (14,718)

35. (continued)

Step Two

Cayce and Simbel's U.S. dollar accounts are then consolidated. Necessary adjustments and eliminations are made.

Consolidation Worksheet Adjustments and Consolidated

Cayce Simbel Eliminations BalancesAccount Dollars Dollars Debit Credit DollarsSales (200,000) (219,200) (419,200)Cost of goods sold 93,800 115,080 208,880Salary expense 19,000 20,276 39,276Rent expense 7,000 9,864 16,864Other expenses 21,000 16,166 37,166Dividend income (13,750) -0- (I) 13,750 -0-Gain, 10/1/11 -0- (8,190) (8,190)Net income (72,950) (66,004) (125,204)

Ret earn, 1/1/11 (318,000) (38,244) (S) 38,244 (*C) (38,244) (356,244)Net income (72,950) (66,004) (125,204)Dividends paid 24,000 13,750 (I) (13,750) 24,000Ret earn, 12/31/11 (366,950) (90,498) (457,448)

Cash and receivables 110,750 39,420 150,170Inventory 98,000 80,190 178,190Prepaid rent 30,000 2,700 32,700Investment 126,000 -0- (*C) 38,244 (S)(164,244) -0-Fixed assets 398,000 122,850 (S) 9,000 (E) (900) 528,950Total 762,750 245,160 890,010

Accounts payable (60,800) (14,580) (75,380)Notes payable (132,000) (37,800) (169,800)Common stock (120,000) (72,000) (S) 72,000 (120,000)

10-26


Additional PIC (83,000) (45,000) (S) 45,000 (83,000)Ret earn, 12/31/11 (366,950) (90,498) (457,448)Subtotal (259,878) (905,628)Cum trans adjust 14,718 (E) 900 15,618Total (762,750) (245,160) 217,138 217,138 (890,010)

35. (continued)

Explanation of Adjustment and Elimination Entries

Entry *CInvestment in Simbel.................................................... 38,244 Retained earnings, 1/1/11........................................ 38,244To accrue 2011 increase in subsidiary book value (see Schedule 1). Entry is needed because parent is using the cost method.

Entry SCommon Stock (Simbel) ................ 72,000Add'l Paid-in-capital (Simbel)............ 45,000Retained earnings, 1/1/11 (Simbel)... 38,244Fixed assets (revaluation) ................ 9,000 Investment in Simbel ................ 164,244To eliminate subsidiary's stockholders' equity accounts and allocate the excess of purchase price over book value to land (fixed assets).

The excess of cost over book value is calculated as follows:Purchase price.................................................... $126,000 Book value, 1/1/11..............................................

Common stock................................................. (72,000) Add’l paid-in capital......................................... (45,000)Excess of purchase price over book value..... $ 9,000 The excess of cost over book value is 30,000 pounds. The U.S. dollar equivalent at 1/1/11, the date of purchase, is $9,000 (£E30,000 x $.30).

Entry IDividend income................................................. 13,750 Dividends paid............................................... 13,750To eliminate intercompany dividend payments recorded by parent as

income.Entry ECumulative translation adjustment.................. 900 Fixed assets (revaluation) ........................... 900To revalue (write-down) the excess of cost over book value for the change in exchange rate since the date of acquisition with the counterpart recognized in the consolidated cumulative translation adjustment. The revaluation of "excess" is calculated as follows:Excess of cost over book valueU.S. dollar equivalent at 12/31/11 £E30,000 x $.27 = $8,100 U.S. dollar equivalent at 1/1/11 £E30,000 x $.30 = 9,000 Cumulative translation adjustment related to excess, 12/31/11 (negative) $( 900)

10-27


36. Translate [Remeasure] Foreign Currency Financial Statements using U.S. GAAP and Explain Sign of Translation Adjustment [Remeasurement Gain/Loss] (LO1, LO3, LO4) (90 minutes)

Part I (a). Czech koruna is the functional currency—current rate method

Exchange KčS Rate US$

Sales 25,000,000 0.035 875,000Cost of goods sold (12,000,000) 0.035 (420,000)Depreciation expense—equipment (2,500,000) 0.035 (87,500)Depreciation expense—building (1,800,000) 0.035 (63,000)Research and development expense (1,200,000) 0.035 (42,000)Other expenses (1,000,000) 0.035 (35,000)

Net income 6,500,000 227,500Retained earnings, 1/1/11 500,000 given 22,500Dividends paid, 12/15/11 (1,500,000) 0.031 (46,500)

Retained earnings, 12/31/11 5,500,000 203,500

Cash 2,000,000 0.030 60,000Accounts receivable 3,300,000 0.030 99,000Inventory 8,500,000 0.030 255,000Equipment 25,000,000 0.030 750,000Accum. deprec.—equipment (8,500,000) 0.030 (255,000)Building 72,000,000 0.030 2,160,000Accum. deprec.—equipment (30,300,000) 0.030 (909,000)Land 6,000,000 0.030 180,000

Total assets 78,000,000 2,340,000

Accounts payable 2,500,000 0.030 75,000Long-term debt 50,000,000 0.030 1,500,000Common stock 5,000,000 0.050 250,000Additional paid-in capital 15,000,000 0.050 750,000Retained earnings, 12/31/11 5,500,000 above 203,500Translation adjustment - to balance (438,500)

Total liabilities and equities 78,000,000 2,340,000

36. (continued)

Calculation of Translation AdjustmentTranslation adjustment, 2011 (negative) 202,500Net assets, 1/1/11 20,500,000 0.040 820,000Net income, 2011 6,500,000 0.035 227,500Dividends, 12/15/11 (1,500,000) 0.031 (46,500)Net assets, 12/31/11 25,500,000 1,001,000Net assets, 12/31/11 at current exchange rate 25,500,000 0.030 765,000Translation adjustment, 2011 (negative) 236,000Cumulative translation adjustment, 12/31/11 (negative) 438,500

10-28


36. (continued)

Part I (b). U.S. dollar is the functional currency—temporal method


Sales 25,000,000 0.035 875,000Cost of goods sold (12,000,000) Sched.A (493,500)Depreciation expense—equipment (2,500,000) Sched.B (118,000)Depreciation expense—building (1,800,000) Sched.C (85,200)Research and development expense (1,200,000) 0.035 (42,000)Other expenses (1,000,000) 0.035 (35,000)Income before remeasurement gain 6,500,000 101,300Remeasurement gain, 2011 - 408,000

Net income 6,500,000 509,300Retained earnings, 1/1/11 500,000 given 353,000Dividends paid, 12/15/11 (1,500,000) 0.031 (46,500)

Retained earnings, 12/31/11 5,500,000 815,800

Cash 2,000,000 0.030 60,000Accounts receivable 3,300,000 0.03099,000Inventory 8,500,000 0.032 272,000Equipment 25,000,000 Sched.B 1,180,000Accum. deprec.—equipment (8,500,000) Sched.B (418,000)Building 72,000,000 Sched.C 3,408,000Accum. deprec.—equipment (30,300,000) Sched.C (1,510,200)Land 6,000,000 0.050 300,000

Total assets 78,000,000 3,390,800

Accounts payable 2,500,000 0.030 75,000Long-term debt 50,000,000 0.030 1,500,000Common stock 5,000,000 0.050 250,000Additional paid-in capital 15,000,000 0.050 750,000Retained earnings, 12/31/11 5,500,000 above 815,800

Total liabilities and equities 78,000,000 3,390,800

Schedule A—Cost of goods sold

KčS ER US$Beginning inventory 6,000,000 0.043258,000Purchases 14,500,000 0.035 507,500Ending inventory (8,500,000) 0.032 (272,000)Cost of goods sold 12,000,000 493,500

36. (continued)

Schedule B—Equipment KčS ER US$

Old Equipment—at 1/1/11 20,000,000 0.050 1,000,000New Equipment—acquired 1/3/11 5,000,000 0.036 180,000

10-29


Total 25,000,000 1,180,000

Accum. Depr.—Old Equipment 8,000,000 0.050 400,000Accum. Depr.—New Equipment 500,000 0.036 18,000Total 8,500,000 418,000Deprec expense—Old Equipment 2,000,000 0.050 100,000Deprec expense—New Equipment 500,000 0.036 18,000Total 2,500,000 118,000

Schedule C—Building KčS ER US$

Old Building—at 1/1/11 60,000,000 0.050 3,000,000New Building—acquired 3/5/11 12,000,000 0.034 408,000Total 72,000,000 3,408,000Accum. Depr.—Old Building 30,000,000 0.050 1,500,000Accum. Depr.—New Building 300,000 0.034 10,200Total 30,300,000 1,510,200Deprec. expense—Old Building 1,500,000 0.050 75,000Deprec. expense—New Building 300,000 0.034 10,200Total 1,800,000 85,200

Calculation of Remeasurement GainKčS ER US$

Net mon. liab., 1/1/11 (37,000,000) 0.040 (1,480,000)Increase in mon. assets:

Sales 25,000,000 0.035 875,000Decrease in mon. assets:

Purchase of inventory (14,500,000) 0.035 (507,500)Research and development (1,200,000) 0.035 (42,000)

Other expenses (1,000,000) 0.035 (35,000)Dividends paid, 12/15/11 (1,500,000) 0.031 (46,500)

Purchase of equipment, 1/3/11 (5,000,000) 0.036 (180,000)Purchase of buildings, 3/5/11 (12,000,000) 0.034 (408,000 )

Net mon liab, 12/31/11 (47,200,000) (1,824,000)Net mon liab, 12/31/11 at

current exchange rate (47,200,000) 0.030 (1,416,000 ) Remeasurement gain—2011 (408,000)

36. (continued)

Part I (c). U.S. dollar is the functional currency—temporal method (no long-term debt)


Sales 25,000,000 0.035 875,000Cost of goods sold (12,000,000) Sched.A (493,500)Depreciation expense—equipment (2,500,000) Sched.B (118,000)Depreciation expense—building (1,800,000) Sched.C (85,200)Research and development expense (1,200,000) 0.035 (42,000)Other expenses (1,000,000) 0.035 (35,000)

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Income before remeasurement loss 6,500,000 101,300Remeasurement loss, 2011 - (92,000)Net income 6,500,000 9,300Retained earnings, 1/1/11 500,000 given (147,000)Dividends paid, 12/15/11 (1,500,000) 0.031 (46,500)Retained earnings, 12/31/11 5,500,000 (184,200)

Cash 2,000,000 0.030 60,000Accounts receivable 3,300,000 0.030 99,000Inventory 8,500,000 0.032 272,000Equipment 25,000,000 Sched.B 1,180,000Accum. deprec.—equipment (8,500,000) Sched.B (418,000)Building 72,000,000 Sched.C 3,408,000Accum. deprec.—equipment (30,300,000) Sched.C(1,510,200)Land 6,000,000 0.050 300,000Total assets 78,000,000 3,390,800

Accounts payable 2,500,000 0.030 75,000Long-term debt 0 0.030 0Common stock 20,000,000 0.050 1,000,000Additional paid in capital 50,000,000 0.050 2,500,000Retained earnings, 12/31/11 5,500,000 above (184,200)Total liabilities and equities 78,000,0003,390,800

Schedule A—Cost of goods sold - same as in Part I (b)Schedule B—Equipment - same as in Part I (b)

Schedule C—Building - same as in Part I (b)

36. (continued)

Calculation of Remeasurement LossKčS ER US$

Net monetary assets, 1/1/11 13,000,000 0.040 520,000Increase in monetary assets:

Sales 25,000,000 0.035 875,000Decrease in monetary assets: Purchase of inventory (14,500,000) 0.035 (507,500) Research and development (1,200,000) 0.035 (42,000)

Other expenses (1,000,000) 0.035 (35,000) Dividends paid, 12/15/11 (1,500,000) 0.031 (46,500) Purchase of equipment, 1/3/11 (5,000,000) 0.036 (180,000) Purchase of buildings, 3/5/11 (12,000,000) 0.034 (408,000 ) Net monetary assets, 12/31/11 2,800,000 176,000Net monetary assets, 12/31/11 at current exchange rate 2,800,000 0.030 84,000Remeasurement loss—2011 92,000

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36. (continued)

Part II. Explanation of the negative translation adjustment in Part I (a), remeasurement gain in Part I (b), and remeasurement loss in Part I (c).

The negative translation adjustment in Part I (a) arises because of two factors: (1) there is a net asset balance sheet exposure and (2) the Czech koruna has depreciated against the U.S. dollar during 2011 (from $.040 at 1/1/11 to $.030 at 12/31/11). A net asset balance sheet exposure exists because all assets are translated at the current exchange rate and exceed total liabilities which are also translated at the current exchange rate.

The remeasurement gain in Part I (b) arises because of two factors: (1) there is a net monetary liability balance sheet exposure and (2) the Czech koruna has depreciated against the U.S. dollar. Under the temporal method, Cash and Accounts Receivable are the only assets translated at the current exchange rate (total KčS 5,300,000). Accounts Payable and Long-term Debt are also translated at the current exchange rate (total KčS 52,500,000). Because the Czech koruna amount of liabilities translated at the current rate exceeds the Czech koruna amount of assets translated at the current rate, a net monetary liability balance sheet exposure exists.

The remeasurement loss in Part I (c) arises because of two factors: (1) there is a net monetary asset balance sheet exposure and (2) the Czech koruna has depreciated against the U.S. dollar during 2011. Cash and Accounts Receivable are the only assets translated at the current exchange rate (total KčS 5,300,000). Because there is no Long-term Debt in part 1(c), Accounts Payable is the only liability translated at the current exchange rate (total KčS 2,500,000). Because the Czech koruna amount of assets translated at the current rate exceeds the Czech koruna amount of liabilities translated at the current rate, a net monetary asset balance sheet exposure exists.

Answers to Develop Your Skills Cases

Research Case 1—Foreign Currency Translation and Hedging Activities

The responses to this assignment will depend upon the company selected by the student for analysis. It is unlikely that the company selected will disclose the amount of any remeasurement gains and losses. The amount of translation adjustment reported in accumulated other comprehensive income usually can be found in a statement of stockholders’ equity. A positive translation adjustment indicates that the foreign currency in which the company operates, on average, increased in dollar value during the year. A negative translation adjustment indicates the opposite.

Research Case 2—Foreign Currency Translation Disclosures in the Computer Industry

a. In 2008, in addition to providing information related to foreign currency translation and hedging activities in its Form 10-K under 1A. Risk Factors,

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IBM also provided information in its Annual Report to these activities in the following location:i. Management Discussion.ii. Note A. Significant Accounting Policies, under Translation of Non-U.S

Currency Amounts and Derivatives.iii. Note L. Derivatives and Hedging Transactions.

In its Form 10-K for the year ended January 30, 2009, Dell provided information related to foreign currency translation and hedging activities in the following locations:i. Item 1A. Risk Factors. ii. Item 7. Management Discussion and Analysis of Financial Condition

and Results of Operations, under Market Risk.iii. Note 1. Description of Business and Summary of Significant

Accounting Policies, under Foreign Currency Translation and Hedging Instruments.

iv. Note 2. Financial Instruments.

b. IBM’s foreign operations do not have a predominant functional currency. The company indicates that it operates in multiple functional currencies. The majority of Dell’s foreign operations have the U.S. dollar as their functional currency (page 56 in 2008 10-K). Most of IBM’s foreign operations probably have the foreign currency as functional currency and therefore are translated into dollars using the current rate method with translation adjustments reflected in stockholders’ equity. Dell’s foreign operations, on the other hand, are remeasured into dollars using the temporal method with remeasurement gains and losses reflected in net income. These differences in translation method and disposition of the translation adjustment reduces the comparability of information provided by the two companies.

c. From the Statement of Stockholders’ Equity, it can be seen that IBM reported translation adjustments as follows over the period 2006-2008:2006: positive $1,020 million2007: positive $726 million2008: negative $3,552 million

The positive signs of the translation adjustments in 2006 and 2007 indicate that, on average, the foreign currency functional currencies of IBM’s foreign operations increased in value against the U.S. dollar in those years. The negative sign of the translation adjustment in 2008 indicates that, on average, the foreign currency functional currencies of IBM’s foreign operations decreased in value against the U.S. dollar in that year.

Dell reported translation adjustments in other comprehensive income as follows:Fiscal 2006: negative $11 millionFiscal 2007: positive $17 million

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Fiscal 2008: positive $5 millionOn average, the foreign currency functional currencies of Dell’s foreign operations decreased in value against the U.S. dollar in 2006, and increased in value in 2007 and 2008.

The magnitude of the translation adjustments reported in stockholders’ equity is much larger for IBM than for Dell. This undoubtedly occurs because Dell has a much smaller balance sheet exposure related to foreign currency functional currency operations. For Dell, the magnitude of the remeasurement gain/loss reported in net income is probably larger (unless hedged away) than the translation adjustment in stockholders’ equity. Dell indicates that remeasurement gains/losses are reported in Investment and Other Income, Net on the income statement but does not disclose the amount.

d. In Note L. Derivatives and Hedging Transactions, IBM indicates that a significant portion of the company’s foreign currency denominated debt is designated as a hedge of its foreign currency balance sheet exposures. The company also uses foreign currency forward contracts to hedge its net investments in foreign operations. Although Dell hedges forecasted transactions and firm commitments, the company makes no mention of hedging its balance sheet exposures.

e. The response to this requirement will vary from student to student. Much of the information provided in requirements a. – d. above can be included in a formal report to satisfy this requirement.

Accounting Standards Case 1—More than One Functional Currency

Source of guidance: FASB Accounting Standards Codification (paragraph 830-10-55-6): Foreign Currency Matters; Overall; Implementation Guidance and Illustrations: The Functional Currency

Original (pre-codification) source: FAS 52, para. 43

“In some instances, a foreign entity might have more than one distinct and separable operation. For example, a foreign entity might have one operation that sells parent-entity-produced products and another operation that manufactures and sells foreign-entity-produced products. If they are conducted in different economic environments, those two operations might have different functional currencies. Similarly, a single subsidiary of a financial institution might have relatively self-contained and integrated operations in each of several different countries. In those circumstances, each operation may be considered to be an entity as that term is used in this Subtopic, and, based on the facts and circumstances, each operation might have a different functional currency.”

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Accounting Standards Case 2—Change in Functional Currency

Source of guidance: FASB Accounting Standards Codification (paragraph 830-10-45-10): Foreign Currency Matters; General; Other Presentation Matters; Functional Currency Changes from Foreign Currency to Reporting Currency

Original (pre-codification) source: FAS 52, para. 46

“If the functional currency changes from a foreign currency to the reporting currency, translation adjustments for prior periods shall not be removed from equity and the translated amounts for nonmonetary assets at the end of the prior period become the accounting basis for those assets in the period of the change and subsequent periods.”

Analysis Case—BellSouth Corporation

a. The Brazilian operations are equity method investments, which means that BellSouth must report investment income (loss) for its percentage ownership interest in the U.S. dollar translated income (loss) of the operations. The company states that its Brazilian operations had net U.S. dollar denominated liabilities. The U.S. dollar liabilities were revalued upward by the Brazilian operations with offsetting foreign exchange losses reported in Brazilian real (BRL) income.

The foreign exchange loss on U.S. dollar liabilities might have been large enough to cause negative net income (a net loss) in BRL terms, which when translated at the average exchange rate for the quarter (under the current rate method) resulted in a U.S. dollar loss being reported by BellSouth.

Alternatively, the temporal method of translation was used, the Brazilian operations had net BRL asset exposures, and the devaluation caused a large enough remeasurement loss that a net U.S. dollar loss resulted. Given that liabilities were denominated in U.S. dollars, it is likely that BRL assets exceed BRL liabilities generating a net BRL asset exposure.

b. The company appears to be saying that the exchange loss is not yet realized. If, subsequent to the January 1999 devaluation, the Brazilian real appreciates against the U.S. dollar, the unrealized loss will become smaller. On the other hand, the loss will become even larger if the real continues to depreciate.

c. The objective of reporting normalized net income is to remove from net income the effect of one-time only events that do not qualify under U.S. GAAP as extraordinary items or discontinued operations, and therefore are not reported separately in the income statement. The company appears to

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be

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signaling its belief that the foreign currency loss is a nonrecurring (extraordinary) item.

d. This assessment is valid if one compares normalized diluted EPS in the first quarter of 1999, which excluded a large loss, with normalized diluted EPS in the first quarter of 1998, which excluded a large gain. Whether financial analysts would use normalized EPS rather than reported EPS in making decisions about BellSouth is an empirical question.

Excel Case—Translating Foreign Currency Financial Statements

1.2. Spreadsheet for the translation (current rate method) and remeasurement (temporal method) of the FC financial statements of Charles Edward Company’s foreign subsidiary.

Temporal Method Current Rate Method

December 31, 2011 FC Rate USD Rate USD

Sales 5,000 $0.45 A $2,250 $0.45 A $2,250

Cost of goods sold (3,000 ) calculation (1,360 ) $0.45 A (1,350 )

Gross profit 2,000 subtotal 890 subtotal 900

Selling expense (400) $0.45 A (180) $0.45 A (180)

Depreciation expense (600) $0.50 H (300) $0.45 A (270)

Remeasurement gain/loss 0 to balance 355 n/a 0

Income before tax 1,000 subtotal 765 subtotal 450

Income taxes (300 ) $0.45 A (135 ) $0.45 A (135 )

Net income 700 subtotal 630 subtotal 315

Retained earnings, 1/1/11 0 0 0

Retained earn, 12/31/11 700 from B/S 630 total 315

Cash 1,000 $0.38 C 380 $0.38 C 380

Inventory 2,000 $0.43 H 860 $0.38 C 760

Fixed assets 6,000 $0.50 H 3,000 $0.38 C 2,280

Less: accum/deprec (600 ) $0.50 H (300 ) $0.38 C (228 )

Total assets 8,400 total 3,940 total 3,192

Current liabilities 1,500 $0.38 C 570 $0.38 C 570

Long-term debt 3,000 $0.38 C 1,140 $0.38 C 1,140

Contributed capital 3,200 $0.50 H 1,600 $0.50 H 1,600

Cum. trans. adjust. 0 n/a 0 to balance (433)*

Retained earnings 700 to balance 630 from I/S 315

Total liab and stock equity

8,400 A=L+SE 3,940 A=L+SE 3,192

Exchange Rates Temporal method—COGS (on a FIFO basis) January 1-31, 2011 $0.50 BI 1,000 $0.50 H $500

Average 2011 $0.45 P 4,000 $0.43 H 1,720

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December 31, 2011 $0.38 EI (2,000 ) $0.43 H (860 )

Inventory purchases $0.43 COGS 3,000 $1,360

Key:Average Exchange Rate A

Current Exchange Rate C

Historical Exchange Rate H

Excel Case (continued)

*Computation of Translation AdjustmentFC USD

Net assets, 1/1/11 3,200 $0.50 1,600 Net income, 2011 700 $0.45 315 Net assets, 12/31/11 3,900 1,915

Net assets, 12/31/11 at current exchange rate 3,900 $0.38 1,482 Translation adjustment (negative) 433

3. With the FC as functional currency, the U.S. dollar net income reflected in the consolidated income statement is $315. If the U.S. dollar were the functional currency, the amount would be twice as much—$630. The amount of total assets reported on the consolidated balance sheet is 23.4% smaller than if the U.S. dollar were functional currency [($3,940 – $3,192)/$3,192].

The relations between the current ratio, the debt to equity ratio, and profit margin calculated from the FC financial statements and from the translated U.S. dollar financial statements are shown below.


FC Temporal Current RateCurrent ratio

CA 3,000 1,240 1,140 CL 1,500 570 570

2.0 2.1754 2.0

Debt to equity ratioTotal liabilities 4,500 1,710 1,710

Total stockholders’ equity

3,900 2,230 1,482

1.15385 0.76682 1.15385

Profit margin

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NI 700 630 315 Sales 5,000 2,250 2,250

0.14 0.28 0.14

Return on equityNI 700 630 315

Average TSE 3,550 1,915 1,5410.19718 0.32898 0.20441

Inventory turnoverCOGS 3,000 1,360 1,350

Average Inventory 1,000 430 3803 3.16279 3.55263

These results show that the temporal method distorts all ratios as calculated from the original foreign currency financial statements. The current rate method maintains all ratios that use numbers in the numerator and denominator from the balance sheet only (current ratio, debt-to-equity ratio) or the income statement only (profit margin). For ratios that combine numbers from the income statement and balance sheet (return on equity, inventory turnover), even the current rate method creates distortions.

The U.S. dollar amounts reported under the temporal method for inventory and fixed assets reflect the equivalent U.S. dollar cost of those assets as if the parent had sent dollars to the subsidiary to purchase the assets. For example, to purchase FC 6,000 worth of fixed assets when the exchange rate was $.50/FC, the parent would have had to provide the subsidiary with $3,000.


The U.S. dollar amounts reported under the current rate method for inventory and fixed assets reflect neither the equivalent U.S. dollar cost of those assets nor their U.S. dollar current value. By multiplying the FC historical cost by the current exchange rate, these assets are reported at what they would have cost in U.S. dollars if the current exchange rate had been in effect when they were purchased. This is a hypothetical number with little, if any, meaning.

Excel and Analysis Case—Parker Inc. and Suffolk PLC

This assignment requires translation of foreign currency financial statements under three different sets of assumptions regarding changes in the U.S. dollar value of the British pound. Under the first set of assumptions, the British pound appreciates steadily from $1.60 at 1/1/10 to $1.68 at 12/31/11. Under the second set of assumptions, the exchange rate

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remains $1.60 from 1/1/10 to

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12/31/11. Under the third set of assumptions, the British pound depreciates steadily from $1.60 at 1/1/10 to $1.52 at 12/31/11.

Part I—Appreciating Foreign Currency

Relevant exchange rates: January 1, 2010 $1.602010 Average $1.62December 31, 2010 $1.64January 30, 2011 $1.652011 Average $1.66December 31, 2011 $1.68

Excel and Analysis Case (continued)

a. Translation of Suffolk’s December 31, 2011 trial balance from British pounds to U.S. dollars.

Suffolk PLCTrial Balance

December 31, 2011Exchange

Pounds Rate DollarsCash £ 1,500,000 $1.68 $ 2,520,000Accounts receivable 5,200,000 $1.68 8,736,000Inventory 18,000,000 $1.68 30,240,000Property, plant, & equipment (net) 36,000,000 $1.68 60,480,000Accounts payable (1,450,000) $1.68 (2,436,000)Long-term debt (5,000,000) $1.68 (8,400,000)Common stock (44,000,000) $1.60 (70,400,000)Retained earnings, 1/1/11 (8,000,000) Schedule A (12,840,000)Sales (28,000,000) $1.66 (46,480,000)Cost of goods sold 16,000,000 $1.66 26,560,000Depreciation 2,000,000 $1.66 3,320,000Other expenses 6,000,000 $1.66 9,960,000Dividends paid (1/30/11) 1,750,000 $1.65 2,887,500Cumulative translationadjustment—positive (credit balance) (4,147,500)

£ 0 $ 0Note: Amounts in parentheses are credit balances.

ExchangeSchedule A Pounds Rate DollarsRetained earnings, 1/1/10 £(6,000,000) $1.60 $ (9,600,000)Net income, 2010 (2,000,000) $1.62 (3,240,000)Retained earnings, 12/31/10 £(8,000,000) $(12,840,000)

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b. Schedule detailing the change in Suffolk’s cumulative translation adjustment for 2010 and 2011.

Determination of Cumulative Exchange ExchangeTranslation Adjustment Pounds Rate Rate DollarsNet assets, 1/1/10 £50,000,000 $1.64 $1.60 $2,000,000Net income, 2010 2,000,000 $1.64 $1.62 40,000Translation adjustment, 2010 (positive) $2,040,000Net assets, 1/1/11 £52,000,000 $1.68 $1.64 2,080,000Net income, 2011 4,000,000 $1.68 $1.66 80,000Dividends, 2011 (1,750,000 ) $1.68 $1.65 (52,500 ) Translation adjustment, 2011 (positive) 2,107,500Net assets, 12/31/11 £ 54,250,000Cumulative Translation Adjustment, 12/31/11(positive) $4,147,500

ExchangeCost Allocation Schedule Pounds Rate DollarsCost £52,000,000 $1.60 $83,200,000Book value 50,000,000 $1.60 80,000,000Excess of cost over book value £ 2,000,000 $ 3,200,000

Translation Adjustment Related to ExchangeExcess of Cost Over Book Value Pounds Rate DollarsExcess of cost over book value £2,000,000U.S. dollar value at 12/31/11 $1.68 $3,360,000U.S. dollar value at 1/1/10 $1.60 3,200,000Translation adjustment related to excess, 12/31/11—positive $ 160,000


c. Consolidation Worksheet—December 31, 2011

Parker Suffolk Adjustments & Eliminations Consolidated

Sales ($70,000,000) ($46,480,000) ($116,480,000)

Cost of goods sold 34,000,000 26,560,000 60,560,000

Depreciation 20,000,000 3,320,000 23,320,000

Other expenses 6,000,000 9,960,000 15,960,000

Dividend income (2,887,500 ) 2,887,500 0

Net income ($12,887,500 ) ($6,640,000 ) ($16,640,000 )

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Ret. earnings, 1/1/11 ($48,000,000) ($12,840,000) 12,840,000 3,240,000 ($51,240,000)

Net income (12,887,500) (6,640,000) (16,640,000)

Dividends 4,500,000 2,887,500 2,887,500 4,500,000

Ret. earnings, 12/31/11

($56,387,500 ) ($16,592,500 ) ($63,380,000 )

Cash $3,687,500 $2,520,000 $6,207,500

Accounts receivable 10,000,000 8,736,000 18,736,000

Inventory 30,000,000 30,240,000 60,240,000

Investment in Suffolk 83,200,000 3,240,000 83,240,000 0

3,200,000

Prop, plant & eq (net) 105,000,000 60,480,000 3,200,000 168,840,000

160,000

Accounts payable (25,500,000) (2,436,000) (27,936,000)

Long-term debt (50,000,000) (8,400,000) (58,400,000)

Common stock (100,000,000) (70,400,000) 70,400,000 (100,000,000)


(56,387,500 ) (16,592,500) (63,380,000)

Cum. trans. adj. (4,147,500 ) 160,000 (4,307,500 )

$0 $0 $92,727,500 $92,727,500 $0


d. Consolidated income statement and balance sheet—2011.

Parker, Inc.Consolidated Income Statement

For the year ended December 31, 2011

Sales $ 116,480,000 Cost of goods sold (60,560,000)Depreciation (23,320,000)Other expenses (15,960,000)Net income $ 16,640,000

Parker, Inc.Consolidated Balance Sheet

December 31, 2011

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AssetsCash $ 6,207,500Accounts receivable 18,736,000Inventory 60,240,000Property, plant & equipment (net) 168,840,000Total $254,023,500

Liabilities and Shareholders' EquityAccounts payable $ 27,936,000Long-term debt 58,400,000Common stock 100,000,000Retained earnings 63,380,000Accum. other comp. income 4,307,500Total $254,023,500


Part II—Stable Foreign Currency




December 31, 2011Exchange

Pounds Rate DollarsCash £ 1,500,000 $1.60 $ 2,400,000Accounts receivable 5,200,000 $1.60 8,320,000Inventory 18,000,000 $1.60 28,800,000Property, plant, & equipment (net) 36,000,000 $1.60 57,600,000Accounts payable (1,450,000) $1.60 (2,320,000)Long-term debt (5,000,000) $1.60 (8,000,000)Common stock (44,000,000) $1.60 (70,400,000)Retained earnings, 1/1/11 (8,000,000) Schedule A (12,800,000)Sales (28,000,000) $1.60 (44,800,000)Cost of goods sold 16,000,000 $1.60 25,600,000Depreciation 2,000,000 $1.60 3,200,000Other expenses 6,000,000 $1.60 9,600,000

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Dividends paid, 1/30/11 1,750,000 $1.60 2,800,000Cumulative translationadjustment 0





Determination of Cumulative Exchange ExchangeTranslation Adjustment Pounds Rate Rate DollarsNet assets, 1/1/10 £50,000,000 $1.60 $1.60 $0Net income, 2010 2,000,000 $1.60 $1.60 0Translation adjustment, 2010 $0Net assets, 1/1/11 £52,000,000 $1.60 $1.60 0Net income, 2011 4,000,000 $1.60 $1.60 0Dividends, 2011 (1,750,000 ) $1.60 $1.60 0Translation adjustment, 2011 0Net assets, 12/31/11 £ 54,250,000Cumulative Translation Adjustment, 12/31/11 $0

ExchangeCost Allocation Schedule Pounds Rate DollarsCost £52,000,000 $1.60 $83,200,000Book value 50,000,000 $1.60 80,000,000Excess of cost over book value £ 2,000,000 $ 3,200,000

Translation Adjustment Related to ExchangeExcess of Cost Over Book Value Pounds Rate DollarsExcess of cost over book value £2,000,000U.S. dollar value at 12/31/11 $1.60 $3,200,000U.S. dollar value at 1/1/10 $1.60 3,200,000Translation adjustment relatedto excess, 12/31/11 $0

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Sales ($70,000,000) ($44,800,000) ($114,800,000)


Depreciation 20,000,000 3,200,000 23,200,000

Other expenses 6,000,000 9,600,000 15,600,000

Dividend income (2,800,000 ) 2,800,000 0

Net income ($12,800,000 ) ($6,400,000 ) ($16,400,000 )

Ret. earnings, 1/1/11 ($48,000,000) ($12,800,000) 12,800,000 3,200,000 ($51,200,000)

Net income (12,800,000) (6,400,000) (16,400,000)

Dividends 4,500,000 2,800,000 2,800,000 4,500,000


($56,300,000 ) ($16,400,000 ) ($63,100,000 )

Cash $3,600,000 $2,400,000 $6,000,000


Inventory 30,000,000 28,800,000 58,800,000


3,200,000

Prop, plant & eq (net) 105,000,000 57,600,000 3,200,000 165,800,000

0


Long-term debt (50,000,000) (8,000,000) (58,000,000)

Common stock (100,000,000) (70,400,000) 70,400,000 (100,000,000)


(56,300,000 ) (16,400,000) (63,100,000)

Cum. Trans. adj. 0 0 0

$0 $0 $92,400,000 $92,400,000 $0



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Sales $114,800,000Cost of goods sold (59,600,000)Depreciation (23,200,000)Other expenses (15,600,000)Net income $ 16,400,000


December 31, 2011


Liabilities and Shareholders' EquityAccounts payable $ 27,820,000Long-term debt 58,000,000Common stock 100,000,000Retained earnings 63,100,000Accum. other comp. income 0Total $248,920,000


Part III—Depreciating Foreign Currency




December 31, 2011

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ExchangePounds Rate Dollars

Cash £ 1,500,000 $1.52 $ 2,280,000Accounts receivable 5,200,000 $1.52 7,904,000Inventory 18,000,000 $1.52 27,360,000Property, plant, & equipment (net) 36,000,000 $1.52 54,720,000Accounts payable (1,450,000) $1.52 (2,204,000)Long-term debt (5,000,000) $1.52 (7,600,000)Common stock (44,000,000) $1.60 (70,400,000)Retained earnings, 1/1/11 (8,000,000) Schedule A (12,760,000)Sales (28,000,000) $1.54 (43,120,000)Cost of goods sold 16,000,000 $1.54 24,640,000Depreciation 2,000,000 $1.54 3,080,000Other expenses 6,000,000 $1.54 9,240,000Dividends paid (1/30/11) 1,750,000 $1.55 2,712,500Cumulative translationadjustment—negative (debit balance) 4,147,500





Determination of Cumulative Exchange ExchangeTranslation Adjustment Pounds Rate Rate DollarsNet assets, 1/1/10 £50,000,000 $1.56 $1.60 $(2,000,000)Net income, 2010 2,000,000 $1.56 $1.58 (40,000)Translation adjustment, 2010 (negative)

$(2,040,000)Net assets, 1/1/11 £52,000,000 $1.52 $1.56 (2,080,000)Net income, 2011 4,000,000 $1.52 $1.54 (80,000)Dividends, 2011 (1,750,000 ) $1.52 $1.55 52,500Translation adjustment, 2011 (negative) (2,107,500 ) Net assets, 12/31/11 £ 54,250,000Cumulative Translation Adjustment, 12/31/11 (negative)

$(4,147,500)

ExchangeCost Allocation Schedule Pounds Rate Dollars

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Cost £52,000,000 $1.60 $83,200,000Book value 50,000,000 $1.60 80,000,000Excess of cost over book value £ 2,000,000 $ 3,200,000

Translation Adjustment Related to ExchangeExcess of Cost Over Book Value Pounds Rate DollarsExcess of cost over book value £2,000,000U.S. dollar value at 12/31/11 $1.52 $3,040,000U.S. dollar value at 1/1/10 $1.60 3,200,000Translation adjustment related to excess, 12/31/11—negative $(160,000)




Sales ($70,000,000) ($43,120,000) ($113,120,000)


Depreciation 20,000,000 3,080,000 23,080,000

Other expenses 6,000,000 9,240,000 15,240,000

Dividend income (2,712,500 ) 2,712,500 0

Net income ($12,712,500 ) ($6,160,000 ) ($16,160,000 )

Ret. earnings, 1/1/11 ($48,000,000) ($12,760,000) 12,760,000 3,160,000 ($51,160,000)

Net income (12,712,500) (6,160,000) (16,160,000)

Dividends 4,500,000 2,712,500 2,712,500 4,500,000


($56,212,500 ) ($16,207,500 ) ($62,820,000 )

Cash $3,512,500 $2,280,000 $5,792,500


Inventory 30,000,000 27,360,000 57,360,000


3,200,000

Prop, plant & eq (net) 105,000,000 54,720,000 3,200,000 162,760,000

160,000


Long-term debt (50,000,000) (7,600,000) (57,600,000)

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Common stock (100,000,000) (70,400,000) 70,400,000 (100,000,000)


(56,212,500 ) (16,207,500) (62,820,000)

Cum. Trans. adj. 4,147,500 160,000 4,307,500

$0 $0 $92,392,500 $92,392,500 $0





Sales $ 113,120,000 Cost of goods sold (58,640,000)Depreciation (23,080,000)Other expenses (15,240,000)Net income $ 16,160,000


December 31, 2011


Liabilities and Shareholders' EquityAccounts payable $ 27,704,000Long-term debt 57,600,000Common stock 100,000,000Retained earnings 62,820,000Accum. other comp. income (4,307,500)Total $243,816,500


Part IV—Risk Assessment Report and Financial Management Recommendations

December 31, 2011 Exchange Rate

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$1.68 $1.60 $1.52Consolidated net income $16,640,000 $16,400,000 $16,160,000Percentage difference 101.5% 100% 98.5%

+ 1.5% -- - 1.5%

Cash flow from dividends $2,887,500 $2,800,000 $2,712,500Percentage difference 103% 100% 97%

+ 3% -- - 3%

Total Liabilities $86,336,000 $85,820,000 $85,304,000Total Stockholders’ equity $167,687,500 $163,100,000 $158,512,500Debt-to-equity ratio 51.5% 52.6% 53.8%Percentage difference 98% 100% 102%

- 2% -- + 2%

Appreciation of the British pound from $1.60 to $1.68 results in consolidated net income being 1.5% higher, cash flow from dividends being 3% higher, and the debt-to-equity ratio being 2% lower than if there had been no change in exchange rates.

Depreciation of the British pound from $1.60 to $1.52 would have resulted in income being 1.5% lower, cash flow from dividends being 3% lower, and the debt-to-equity ratio being 2% higher than if there had been no change in exchange rates.

An increase in the dollar value of the British pound results in higher profitability, greater cash inflow, and an improved debt-to-equity ratio. The opposite is true for a decrease in the dollar value of the British pound.

If the British pound is expected to appreciate, Parker should not hedge its British pound exposure associated with its investment in Suffolk. However, if the British pound is expected to depreciate, Parker may wish to hedge its British pound net asset and cash flow exposure in some way. The decline in dollar value of future British pound dividend payments could be hedged by selling British pounds forward or by purchasing a British pound put option. The negative translation adjustment reported in accumulated other comprehensive income could be avoided using an option or forward contract, or by taking out a loan in British pounds.

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