Find more slides, ebooks, solution manual and testbank on www.downloadslide.com CHAPTER 10 TRANSLATION 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 Which method should be used? 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, costof-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 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) Reporting a translation loss when the foreign currency appreciates is thought to be inconsistent with economic reality McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 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 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 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) Appreciation in the foreign currency results in a positive translation adjustment (gain); depreciation results in a negative translation adjustment (loss) IV FASB Statement No 52 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 SFAS 52 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 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 SFAS 133 refers to this as a hedge of a net investment in a foreign operation and 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 McGraw-Hill/Irwin 10-2 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 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: Describe the procedures of the current rate and temporal methods of translation Understand the method by which the retained earnings balance of a foreign subsidiary is translated Discuss the theoretical underpinnings and limitations of the current rate and temporal methods Understand balance sheet exposure and explain how it differs from transaction exposure to foreign exchange risk Discuss SFAS 52 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 Translate a foreign subsidiary's financial statements into its parent's reporting currency using the guidelines of SFAS 52 Determine the amount and placement of the translation adjustment that is reported as a result of the translation process Remeasure a foreign subsidiary's financial statements using the guidelines of SFAS 52 and calculate the associated remeasurement gain or loss Explain the reason for using the temporal method to translate financial statements of operations in highly inflationary environments 10 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 11 Prepare a consolidation worksheet for a parent and its foreign subsidiary McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 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 force 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 McGraw-Hill/Irwin 10-4 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions 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 translation adjustment should be treated as a gain or loss in income, or should be deferred as a separate component of stockholders’ equity Balance sheet exposure arises when a foreign currency balance is translated at the current 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 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 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 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 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 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 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 was merely brought forward Thereafter, the ending balance translated each year for retained earnings becomes the beginning figure to be reported for the following year 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 average exchange rate for the current period 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 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 McGraw-Hill/Irwin 10-6 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 10 One theory mentioned by the FASB identifies 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 in Statement 52 that either theory is considered more appropriate 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 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Problems C C C B 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 A All asset accounts are translated at current rates A Because the foreign currency is the functional currency, a translation is required All assets accounts are translated at current rates C 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 B 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] C 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 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 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 12 C Beginning inventory Purchases Ending inventory Cost of goods sold McGraw-Hill/Irwin 10-8 FCU 200,000 x $1.00 = $ 200,000 10,300,000 x $0.80 = 8,240,000 (500,000) x $0.75 = (375,000) FCU 10,000,000 $8,065,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 13 C Beginning net assets, 1/1………… Increase in net assets: Income Ending net assets, 12/31 Ending net assets at current exchange rate Translation Adjustment (positive) P20,000 x $.15 = $ 3,000 10,000 P30,000 x $.19 = 1,900 $ 4,900 P30,000 x $.21 = $ 6,300 $(1,400) 14 C 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 Beginning net monetary assets, 1/1 Increases in net monetary assets: Sale of inventory Decreases in net monetary assets: Purchase of equipment Purchase of inventory Transfer to parent Ending net monetary assets, 12/31 Ending net monetary assets at the current exchange rate Remeasurement gain P100,000 x $.16 = $16,000 50,000 x $.20 = 10,000 (60,000) (30,000) (10,000) P 50,000 x $.16 = x $.18 = x $.21 = (9,600) (5,400) (2,100) $ 8,900 P 50,000 x $.22 = (11,000) $(2,100) 16 C Marketable equity securities are carried at market value and therefore translated at the current exchange rate under the temporal method 17 B 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 Wages payable is translated at the current exchange rate 19 C 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 Remeasurement gains are reported in the income statement as a part of income from continuing operations 21 (10 minutes) (Specify appropriate rates for a translation) 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 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 21 (continued) 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 exchange rate at the balance sheet date Common stock—as an equity account, use historic rate at time of recording, the date of issuance 22 (5 minutes) (Determine translated values) 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 = $10,000 Accounts payable LCU120,000 x 40% unpaid = LCU48,000 x 1/3.0 = $16,000 23 (10 minutes) (Determine translation and remeasurement rates) Accounts payable Accounts receivable Accumulated depreciation Advertising expense Amortization expense Buildings Cash Common stock Depreciation expense Dividends paid (10/1) Notes payable Patents (net) Salary expense Sales Translation $.16 C $.16 C $.16 C $.19 A $.19 A $.16 C $.16 C $.28 H $.19 A $.20 H $.16 C $.16 C $.19 A $.19 A Remeasurement $.16 C $.16 C $.26 H $.19 A $.25 H $.26 H $.16 C $.28 H $.26 H $.20 H $.16 C $.25 H $.19 A $.19 A * C = current rate, H = historical rate, A = average rate McGraw-Hill/Irwin 10-10 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 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 McGraw-Hill/Irwin 10-42 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 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 1/1/08 to $1.68 at 12/31/09 Under the second set of assumptions, the exchange rate remains $1.60 from 1/1/08 to 12/31/09 Under the third set of assumptions, the British pound depreciates steadily from $1.60 at 1/1/08 to $1.52 at 12/31/09 Part I—Appreciating Foreign Currency Relevant exchange rates: McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e January 1, 2008 2008 Average December 31, 2008 $1.64 January 30, 2009 2009 Average December 31, 2009 $1.68 $1.60 $1.62 $1.65 $1.66 © The McGraw-Hill Companies, Inc., 2009 10-43 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com a Translation of Suffolk’s December 31, 2009 trial balance from British pounds to U.S dollars Suffolk PLC Trial Balance December 31, 2009 Cash £ Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/09 Sales Cost of goods sold Depreciation Other expenses Dividends paid (1/30/09) Cumulative translation adjustment—positive (credit balance) Pounds 1,500,000 5,200,000 18,000,000 36,000,000 (1,450,000) (5,000,000) (44,000,000) (8,000,000) (28,000,000) 16,000,000 2,000,000 6,000,000 1,750,000 Exchange Rate Dollars $1.68 $ 2,520,000 $1.68 8,736,000 $1.68 30,240,000 $1.68 60,480,000 $1.68 (2,436,000) $1.68 (8,400,000) $1.60 (70,400,000) Schedule A (12,840,000) $1.66 (46,480,000) $1.66 26,560,000 $1.66 3,320,000 $1.66 9,960,000 $1.65 2,887,500 £ Note: Amounts in parentheses are credit balances Schedule A Retained earnings, 1/1/08 Net income, 2008 Retained earnings, 12/31/08 McGraw-Hill/Irwin 10-44 Pounds £(6,000,000) (2,000,000) £(8,000,000) $ Exchange Rate $1.60 $1.62 (4,147,500) Dollars $ (9,600,000) (3,240,000) $(12,840,000) © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com b Schedule detailing the change in Suffolk’s cumulative translation adjustment for 2008 and 2009 Determination of Cumulative Exchange Exchange Translation Adjustment Pounds Rate Rate Dollars Net assets, 1/1/08 £50,000,000 $1.64 $1.60 $2,000,000 Net income, 2008 2,000,000 $1.64 $1.62 40,000 Translation adjustment, 2008 (positive) $2,040,000 Net assets, 1/1/09 £52,000,000 $1.68 $1.64 2,080,000 Net income, 2009 4,000,000 $1.68 $1.66 80,000 Dividends, 2009 (1,750,000) $1.68 $1.65 (52,500) Translation adjustment, 2009 (positive) 2,107,500 Net assets, 12/31/09 £ 54,250,000 Cumulative Translation Adjustment, 12/31/09(positive) $4,147,500 Consideration Paid Allocation Schedule Consideration paid (equal to fair value) Book value Excess of fair value over book value Translation Adjustment Related to Excess of Fair Value Over Book Value Excess of fair value over book value U.S dollar value at 12/31/09 U.S dollar value at 1/1/08 Translation adjustment related to excess, 12/31/09—positive McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Pounds £52,000,000 50,000,000 £ 2,000,000 Pounds £2,000,000 Exchange Rate $1.60 $1.60 Exchange Rate $1.68 $1.60 Dollars $83,200,000 80,000,000 $ 3,200,000 Dollars $3,360,000 3,200,000 $ 160,000 © The McGraw-Hill Companies, Inc., 2009 10-45 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com c Consolidation Worksheet—December 31, 2009 Parker Suffolk ($70,000,000) ($46,480,000) 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) Sales ($12,887,500) ($6,640,000) Ret earnings, 1/1/09 ($48,000,000) ($12,840,000) (12,887,500) (6,640,000) 4,500,000 2,887,500 Dividends Consolidated ($116,480,000) 2,887,500 Net income Net income Adjustments & Eliminations ($16,640,000) 12,840,000 3,240,000 ($51,240,000) (16,640,000) 2,887,500 4,500,000 ($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 Ret earnings, 12/31/09 3,240,000 83,240,000 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) (56,387,500) (16,592,500) Ret earnings, 12/31/09 $0 $0 (100,000,000) (63,380,000) (4,147,500) Cum trans adj McGraw-Hill/Irwin 10-46 70,400,000 160,000 $92,727,500 $92,727,500 (4,307,500) $0 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com d Consolidated income statement and balance sheet—2009 Parker, Inc Consolidated Income Statement For the year ended December 31, 2009 Sales Cost of goods sold Depreciation Other expenses Net income $ 116,480,000 (60,560,000) (23,320,000) (15,960,000) $ 16,640,000 Parker, Inc Consolidated Balance Sheet December 31, 2009 Assets Cash Accounts receivable Inventory Property, plant & equipment (net) Total $ 6,207,500 18,736,000 60,240,000 168,840,000 $254,023,500 Liabilities and Shareholders' Equity Accounts payable $ 27,936,000 Long-term debt 58,400,000 Common stock 100,000,000 Retained earnings 63,380,000 Other comprehensive income 4,307,500 Total $254,023,500 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-47 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Part II—Stable Foreign Currency Relevant exchange rates: January 1, 2008 2008 Average December 31, 2008 $1.60 January 30, 2009 2009 Average December 31, 2009 $1.60 $1.60 $1.60 $1.60 $1.60 Translation of Suffolk’s December 31, 2009 trial balance from British pounds to U.S dollars Suffolk PLC Trial Balance December 31, 2009 Cash £ Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/09 Sales Cost of goods sold Depreciation Other expenses Dividends paid, 1/30/09 Cumulative translation adjustment Pounds 1,500,000 5,200,000 18,000,000 36,000,000 (1,450,000) (5,000,000) (44,000,000) (8,000,000) (28,000,000) 16,000,000 2,000,000 6,000,000 1,750,000 Exchange Rate $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 Schedule A $1.60 $1.60 $1.60 $1.60 $1.60 £ Note: Amounts in parentheses are credit balances Schedule A Retained earnings, 1/1/08 Net income, 2008 Retained earnings, 12/31/08 McGraw-Hill/Irwin 10-48 Pounds £(6,000,000) (2,000,000) £(8,000,000) Exchange Rate $1.60 $1.60 Dollars $ 2,400,000 8,320,000 28,800,000 57,600,000 (2,320,000) (8,000,000) (70,400,000) (12,800,000) (44,800,000) 25,600,000 3,200,000 9,600,000 2,800,000 $ Dollars $ (9,600,000) (3,200,000) $(12,800,000) © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Schedule detailing the change in Suffolk’s cumulative translation adjustment for 2008 and 2009 Determination of Cumulative Translation Adjustment Net assets, 1/1/08 Net income, 2008 Translation adjustment, 2008 Net assets, 1/1/09 Net income, 2009 Dividends, 2009 Translation adjustment, 2009 Net assets, 12/31/09 Cumulative Translation Adjustment, 12/31/09 Pounds £50,000,000 2,000,000 Exchange Exchange Rate Rate $1.60 $1.60 $1.60 $1.60 Dollars $0 $0 £52,000,000 4,000,000 (1,750,000) $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 0 0 £ 54,250,000 Consideration Paid Allocation Schedule Consideration paid (equals fair value) Book value Excess of fair value over book value $0 Pounds £52,000,000 50,000,000 £ 2,000,000 Translation Adjustment Related to Excess of Fair Value Over Book Value Pounds Excess of fair value over book value £2,000,000 U.S dollar value at 12/31/09 U.S dollar value at 1/1/08 Translation adjustment related to excess, 12/31/09 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Exchange Rate $1.60 $1.60 Exchange Rate $1.60 $1.60 Dollars $83,200,000 80,000,000 $ 3,200,000 Dollars $3,200,000 3,200,000 $0 © The McGraw-Hill Companies, Inc., 2009 10-49 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Consolidation Worksheet—December 31, 2009 Parker Suffolk Adjustments & Eliminations Consolidated ($70,000,000) ($44,800,000) Cost of goods sold 34,000,000 25,600,000 59,600,000 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) Sales 2,800,000 Net income ($12,800,000) ($6,400,000) Ret earnings, 1/1/09 ($48,000,000) ($12,800,000) (12,800,000) (6,400,000) 4,500,000 2,800,000 Net income Dividends ($114,800,000) ($16,400,000) 12,800,000 3,200,000 ($51,200,000) (16,400,000) 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 Accounts receivable 10,000,000 8,320,000 18,320,000 Inventory 30,000,000 28,800,000 58,800,000 Investment in Suffolk 83,200,000 Ret earnings, 12/31/09 3,200,000 83,200,000 3,200,000 Prop, plant & eq (net) 105,000,000 57,600,000 3,200,000 165,800,000 Accounts payable (25,500,000) (2,320,000) (27,820,000) Long-term debt (50,000,000) (8,000,000) (58,000,000) Common stock (100,000,000) (70,400,000) (56,300,000) (16,400,000) Ret earnings, 12/31/08 $0 $0 (100,000,000) (63,100,000) Cum Trans adj McGraw-Hill/Irwin 10-50 70,400,000 $92,400,000 0 $92,400,000 $0 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com d Consolidated income statement and balance sheet—2009 Parker, Inc Consolidated Income Statement For the year ended December 31, 2009 Sales Cost of goods sold Depreciation Other expenses Net income $114,800,000 (59,600,000) (23,200,000) (15,600,000) $ 16,400,000 Parker, Inc Consolidated Balance Sheet December 31, 2009 Assets Cash Accounts receivable Inventory Property, plant & equipment (net) Total $ 6,000,000 18,320,000 58,800,000 165,800,000 $248,920,000 Liabilities and Shareholders' Equity Accounts payable $ 27,820,000 Long-term debt 58,000,000 Common stock 100,000,000 Retained earnings 63,100,000 Other comprehensive income Total $248,920,000 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-51 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Part III—Depreciating Foreign Currency Relevant exchange rates: January 1, 2008 2008 Average December 31, 2008 $1.56 January 30, 2009 2009 Average December 31, 2009 $1.52 $1.60 $1.58 $1.55 $1.54 a Translation of Suffolk’s December 31, 2009 trial balance from British pounds to U.S dollars Suffolk PLC Trial Balance December 31, 2009 Cash £ Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/09 Sales Cost of goods sold Depreciation Other expenses Dividends paid (1/30/09) Cumulative translation adjustment—negative (debit balance) Pounds 1,500,000 5,200,000 18,000,000 36,000,000 (1,450,000) (5,000,000) (44,000,000) (8,000,000) (28,000,000) 16,000,000 2,000,000 6,000,000 1,750,000 Exchange Rate $1.52 $1.52 $1.52 $1.52 $1.52 $1.52 $1.60 Schedule A $1.54 $1.54 $1.54 $1.54 $1.55 £ Note: Amounts in parentheses are credit balances Schedule A Retained earnings, 1/1/08 Net income, 2008 Retained earnings, 12/31/08 McGraw-Hill/Irwin 10-52 Pounds £(6,000,000) (2,000,000) £(8,000,000) Dollars $ 2,280,000 7,904,000 27,360,000 54,720,000 (2,204,000) (7,600,000) (70,400,000) (12,760,000) (43,120,000) 24,640,000 3,080,000 9,240,000 2,712,500 $ Exchange Rate $1.60 $1.58 4,147,500 Dollars $ (9,600,000) (3,160,000) $(12,760,000) © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Schedule detailing the change in Suffolk’s cumulative translation adjustment for 2008 and 2009 Determination of Cumulative Exchange Exchange Translation Adjustment Pounds Rate Rate Dollars Net assets, 1/1/08 £50,000,000 $1.56 $1.60 $(2,000,000) Net income, 2008 2,000,000 $1.56 $1.58 (40,000) Translation adjustment, 2008 (negative) $(2,040,000) Net assets, 1/1/09 £52,000,000 $1.52 $1.56 (2,080,000) Net income, 2009 4,000,000 $1.52 $1.54 (80,000) Dividends, 2009 (1,750,000) $1.52 $1.55 52,500 Translation adjustment, 2009 (negative) (2,107,500) Net assets, 12/31/09 £ 54,250,000 Cumulative Translation Adjustment, 12/31/09 (negative) $(4,147,500) Consideration Paid Allocation Schedule Consideration paid (equal to fair value) Book value Excess of fair value over book value Translation Adjustment Related to Excess of Fair Value Over Book Value Excess of cost over book value U.S dollar value at 12/31/09 U.S dollar value at 1/1/08 Translation adjustment related to excess, 12/31/09—negative McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Pounds £52,000,000 50,000,000 £ 2,000,000 Pounds £2,000,000 Exchange Rate $1.60 $1.60 Exchange Rate $1.52 $1.60 Dollars $83,200,000 80,000,000 $ 3,200,000 Dollars $3,040,000 3,200,000 $(160,000) © The McGraw-Hill Companies, Inc., 2009 10-53 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com c Consolidation Worksheet—December 31, 2009 Parker Suffolk ($70,000,000) ($43,120,000) Cost of goods sold 34,000,000 24,640,000 58,640,000 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) Sales Adjustments & Eliminations ($12,712,500) ($6,160,000) Ret earnings, 1/1/09 ($48,000,000) ($12,760,000) (12,712,500) (6,160,000) 4,500,000 2,712,500 Net income Dividends ($113,120,000) 2,712,500 Net income Consolidated ($16,160,000) 12,760,000 3,160,000 ($51,160,000) (16,160,000) 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 Accounts receivable 10,000,000 7,904,000 17,904,000 Inventory 30,000,000 27,360,000 57,360,000 Investment in Suffolk 83,200,000 Ret earnings, 12/31/09 3,160,000 83,160,000 3,200,000 Prop, plant & eq (net) 105,000,000 54,720,000 3,200,000 162,760,000 160,000 Accounts payable (25,500,000) (2,204,000) (27,704,000) Long-term debt (50,000,000) (7,600,000) (57,600,000) Common stock (100,000,000) (70,400,000) (56,212,500) (16,207,500) Ret earnings, 12/31/09 Cum Trans adj $0 McGraw-Hill/Irwin 10-54 70,400,000 (100,000,000) (62,820,000) 4,147,500 160,000 $0 $92,392,500 4,307,500 $92,392,500 $0 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com d Consolidated income statement and balance sheet—2009 Parker, Inc Consolidated Income Statement For the year ended December 31, 2009 Sales Cost of goods sold Depreciation Other expenses Net income $ 113,120,000 (58,640,000) (23,080,000) (15,240,000) $ 16,160,000 Parker, Inc Consolidated Balance Sheet December 31, 2009 Assets Cash Accounts receivable Inventory Property, plant & equipment (net) Total $ 5,792,500 17,904,000 57,360,000 162,760,000 $243,816,500 Liabilities and Shareholders' Equity Accounts payable $ 27,704,000 Long-term debt 57,600,000 Common stock 100,000,000 Retained earnings 62,820,000 Other comprehensive income (4,307,500) Total $243,816,500 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-55 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Part IV—Risk Assessment Report and Financial Management Recommendations Consolidated net income Percentage difference Cash flow from dividends Percentage difference Total Liabilities Total Stockholders’ equity Debt-to-equity ratio Percentage difference December 31, 2009 Exchange Rate $1.68 $1.60 $1.52 $16,640,000 $16,400,000 $16,160,000 101.5% 100% 98.5% + 1.5% 1.5% $2,887,500 103% + 3% $2,800,000 100% $2,712,500 97% - 3% $86,336,000 $167,687,500 51.5% 98% - 2% $85,820,000 $163,100,000 52.6% 100% $85,304,000 $158,512,500 53.8% 102% + 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 other comprehensive income could be avoided using an option or forward contract, or by taking out a loan in British pounds McGraw-Hill/Irwin 10-56 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual ... thereby realizing a transaction loss of McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-11 Find more slides, ebooks, solution manual. .. gains and losses McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 10-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com... The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 10 One theory mentioned by the FASB identifies the translation