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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. 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.

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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). 1. Appreciation in the foreign currency results in a positive translation adjustment (gain); depreciation results in a negative translation adjustment (loss). IV. FASB Accounting Standards Codification Topic 830, Foreign Currency Matters, (FASB ASC 830) 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. U.S. GAAP 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. FASB Accounting Standards Codification Topic 815, Derivatives and Hedging (FASB ASC 815) 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.

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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.

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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 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 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 tot al 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.

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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 subsidiarys 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 subsidiarys 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 companys 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 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 average exchange rate for the current period. 8. The functional currency is the currency of the subsidiarys primary economic environment. It is usually identified as the currency in which the company generates and expends cash. FASB ASC 830 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 entitys functional currency. FASB ASC 830 does not provide any guidance as to how these factors are to be weighted (equally or otherwise) when identifying an entitys 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. Most companies include the cumulative translation adjustment on the U.S. dollar Balance Sheet in the Stockholders Equity Section under Accumulated Other Comprehensive Income.

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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 that either theory is considered more appropriate. 11. Translation is required when a foreign currency is the functional currency. 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. 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 entitys 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 entitys 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 inflation and then translated into the parents 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) 2. C (Comparison of current rate and temporal methods) 3. C (Translation process (current rate method)) 4. B (Determine appropriate translation method and resulting translation adjustment) 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) All asset accounts are translated at current rates. 6. A (Translation process (current rate method) assets) 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) 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) 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) 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 = $18,000]. 10. D (Translation process (current rate method) marketable securities and inventory) The foreign currency is the functional currency, so a translation is appropriate. All assets are translated at the current exchange rate of $.19.

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11. C (Remeasurement process (temporal method) marketable securities and inventory) 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 (Highly inflationary economy (temporal method) cost of goods sold) Beginning inventory Purchases Ending inventory Cost of goods sold 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

13. C (Calculation of translation adjustment) 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 10,000 P30,000 P30,000 x $.15 = x $.19 = x $.21 = $ 3,000 1,900 $ 4,900 $ 6,300 $(1,400)

14. C (Concepts underlying current rate and temporal methods) 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) 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 50,000 (60,000) (30,000) (10,000) P 50,000 P 50,000 x $.16 = x $.20 = x $.16 = x $.18 = x $.21 = x $.22 = $16,000 10,000 (9,600) (5,400) (2,100) $ 8,900 11,000 $(2,100)

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

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17. B (Determine appropriate translation method and treatment of translation adjustment) 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) 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) 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) Remeasurement gains are reported in the income statement as a part of income from continuing operations. 21. (10 minutes) (Specify appropriate exchange rates for the translation of foreign currency financial statements under the current rate method) Rent expenseuse 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 paiduse historical rate at time of recording, the date of declaration. Equipmentas an asset, use current rate at the balance sheet date. Notes payableas a liability, use current rate at the balance sheet date. Salesuse 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 expenseuse 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. Cashas an asset, use the current rate at the balance sheet date. Accumulated depreciationas a contra-asset account, use the current exchange rate at the balance sheet date. Common stockas an equity account, use historic rate at time of recording,
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the date of issuance. 22. (5 minutes) Determine Translated Values under the Current Rate Method 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 appropriate exchange rates under the current rate fethod [translation] and temporal method [remeasurement]) 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

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24. (20 minutes) (Calculate translation adjustment and remeasurement gain/loss and explain their economic relevance) 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 375,000 Inventory .................... 1,000,000 $.75 C 750,000 $.70 H 700,000 Fixed assets............... 3,000,000 $.75 C 2,250,000 $.70 H 2,100,000 Total assets .............. 4,500,000 3,375,000 3,175,000 Notes payable ............ 800,000 $.75 C 600,000 $.75 C 600,000 Owners equity ........... 3,700,000 $.70 H 2,590,000 $.70 H 2,590,000 Translation adjustment 185,000 Retained earnings (remeasurement loss) (15,000) Total ......................... 4,500,000 3,375,000 3,175,000 Alternatively, the translation adjustment and remeasurement loss can be calculated by analyzing the subsidiarys balance sheet exposure: Translation Beginning net assets, 12/1 Ending net assets, 12/31 at current exchange rate Translation adjustment (positive) Remeasurement Beginning net monetary liability position, 12/1 Ending net monetary liability position, 12/31 at current exchange rate Remeasurement loss CHF3,700,000 CHF3,700,000 x $.70 = $2,590,000 x $.75 = (2,775,000) $( 185,000)

CHF(300,000) CHF(300,000)

x $.70 = $(210,000) x $.75 = (225,000) $ 15,000

Economic Relevance of Translation Adjustment The 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 Loss The 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].)
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25. (30 minutes) (Prepare financial statements for a foreign subsidiary and then translate them into U.S. dollars) Fenwicke Company Subsidiary Income Statement LCU Rent revenue 60,000 x $1.90 A Interest expense (10,000) x $1.90 A Depreciation expense (14,000) x $1.90 A Repair expense (4,000) x $1.85*H Net income 32,000

= = = =

U.S. Dollars $114,000 (19,000) (26,600) (7,400) $ 61,000

* Repair expense is the only expense not incurred evenly throughout the year. Statement of Retained Earnings LCU Retained earnings, 1/1 -0Net income 32,000 (above) Dividends paid (5,000) x $1.80 H Retained earnings, 12/31 27,000 Balance Sheet LCU 41,000 x 10,000 x 140,000 x (14,000) x 177,000 10,000 x 100,000 x 40,000 x 27,000 177,000 U.S. Dollars -0$61,000 = (9,000) $52,000 U.S. Dollars $ 73,800 18,000 252,000 (25,200) $318,600 = $ 18,000 = 180,000 = 80,000 52,000 (11,400) $318,600 = = = = -0x $2.00 (above) x $1.80 x $1.80 = = = $ 80,000 61,000 (9,000) $132,000 120,600 $ 11,400

Cash Accounts receivable Building Accumulated depreciation Total assets Interest payable Note payable Common stock Retained earnings Translation adjustment Total liabilities and equities

$1.80 C $1.80 C $1.80 C $1.80 C $1.80 C $1.80 C $2.00 H (above) (below)

Computation of Translation Adjustment Beginning net assets -0Increase in net assets: Issued common stock 40,000 Net income 32,000 Decrease in net assets: Dividends paid (5,000) Ending net assets 67,000 Ending net assets at current exchange rate 67,000 Translation adjustment (negative)

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26. (30 minutes) (Prepare a statement of cash flows for a foreign subsidiary and then translate it into U.S. dollars) Fenwicke Company Subsidiary Statement of Cash Flows
LCU U.S. Dollars

Operating Activities: Net income 32,000 (from prob 25) $ 61,000 plus: depreciation 14,000 x $1.9 A = 26,600 less: increase in accounts receivable (10,000) x $1.9 A = (19,000) plus: increase in interest payable 10,000 x $1.9 A = 19,000 Cash 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 = 80,000 Borrowing on note 100,000 x $2.0 H = 200,000 Dividends paid (5,000) x $1.8 H = (9,000) 135,000 271,000 Increase in cash 41,000 78,600 Effect of exchange rate change on cash (4,800) Cash, 1/1 -0-0Cash, 12/31 41,000 x $1.80 C = $ 73,800

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27. (25 minutes) (Compute translation adjustment and remeasurement gain/loss) a. Translationonly changes in net assets have an impact on the computation of the translation adjustment. Net asset balance 1/1 Increases in net assets (income): Sold inventory at a profit 5/1 Sold land at a gain 6/1 Decreases in net assets: Paid a dividend 12/1 Depreciation recorded Net asset balance 12/31 Net asset balance 12/31 at current exchange rate Translation adjustmentpositive KM30,000 5,000 1,000 (3,000) (2,000) KM31,000 KM31,000 x $.32 = x $.34 = x $.35 = x $.41 = x $.37 = x $.42 = $ 9,600 1,700 350 (1,230) ( 740) $ 9,680 (13,020) $(3,340)

b. Remeasurementonly changes in net monetary assets and liabilities have an impact on the computation of the remeasurement gain. Beginning net monetary liability position KM (3,000) Increases in monetary assets: Sold inventory 5/1 15,000 Sold land 6/1 5,000 Decreases in monetary assets: Bought inventory 10/1 (12,000) Bought land 11/1 (4,000) Paid a dividend 12/1 (3,000) Ending net monetary liability position KM(2,000) Ending net monetary liability position at current exchange rate KM(2,000) Remeasurement gain x $.32 = x $.34 = x $.35 = x $.39 = x $.40 = x $.41 = $ ( 960) 5,100 1,750 (4,680) (1,600) (1,230) $(1,620) x $.42 = (840) $ (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.

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28. (20 minutes) (Compute translation adjustment and remeasurement gain/loss) a. The translation adjustment is based on changes in the net assets of the subsidiary. Net assets, 1/1 Changes in net assets Rendered services Incurred expense Net assets, 12/31 Net assets, 12/31 at current exchange rate Translation adjustment (positive) 82,000 LCU x $.24 = 30,000 LCU x $.25 = (18,000) LCU x $.26 = 94,000 LCU 94,000 LCU x $.29 = $19,680 7,500 (4,680) 22,500 27,260 $(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 Changes in net monetary assets Rendered services Incurred expense Net monetary assets, 12/31 Net monetary assets, 12/31 at current exchange rate Remeasurement gain c. Translated value of land Remeasured value of land 22,000 LCU x $.24 = 30,000 LCU x $.25 = (18,000) LCU x $.26 = 34,000 LCU 34,000 LCU x $.29 = 60,000 LCU 60,000 LCU x $.29 = x $.23 = $ 5,280 7,500 (4,680) $ 8,100 9,860 $(1,760) $17,400 $13,800

29. (10 minutes) (Determine the appropriate exchange rate under the current rate method [translation] and temporal method [remeasurement]) (a) Current Rate Method Account Translation Sales 20 A Inventory 22 C Equipment 22 C Rent expense 20 A Dividends 21 H Notes receivable 22 C Accumulated depreciation--equipment 22 C Salary payable 22 C Depreciation expense 20 A (b) Temporal Method Remeasurement 20 A 19 H 13 H 20 A 21 H 22 C 13 H 22 C 13 H

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

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30. (30 minutes) (Determine translation adjustment; prepare journal entries for forward contract hedge of balance sheet exposure; determine amount to be reported in accumulated other comprehensive income) a. Net assets, 1/1 (132,000 54,000) Change in net assets: Net income Dividends, 3/1 Dividends, 10/1 Net assets, 12/31 Net assets at current exchange rate, 12/31 Translation adjustment (negative) b. Forward contract journal entries 10/1 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) ................. 150,000 Forward Contract ............................ 2,000 (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). 78,000 kites 26,000 kites (5,000) kites (5,000) kites 94,000 kites 94,000 kites x $0.80 = x $0.77 = x $0.78 = x $0.76 = x $0.75 = $62,400 20,020 (3,900) (3,800) $74,720 70,500 $ 4,220

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31. (45 minutes) (Translation and remeasurement of foreign subsidiary trial balance) a. Translation of Subsidiary Trial Balance Debits Credits 8,000 KQ x 1.62 $12,960 9,000 KQ x 1.62 14,580 3,000 KQ x 1.62 4,860 600 KQ x 1.62 $ 972 5,000 KQ x 1.62 8,100 3,000 KQ x 1.62 4,860 5,000 KQ x 1.62 8,100 10,000 KQ x 1.71 17,100 4,000 KQ x 1.66 6,640 25,000 KQ x 1.64 41,000 5,000 KQ x 1.64 8,200 600 KQ x 1.64 984 9,000 KQ x 1.64 14,760 $71,084 Translation Adjustment (negative) 948 $72,032 $72,032 Calculation of Translation Adjustment Net assets, 1/1.. -0-0Increase in net assets: Common stock issued. 10,000 KQ x 1.71 $17,100 Sales. 25,000 KQ x 1.64 41,000 Decrease 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) Cash. Accounts Receivable.. Equipment.. Accumulated Depreciation Land Accounts Payable Notes Payable.. Common Stock Dividends Paid. Sales Salary Expense Depreciation Expense Miscellaneous Expense. Net assets, 12/31. Net assets, 12/31 at current exchange rate. Translation adjustment (negative) 16,400* KQ 16,400 KQ x 1.62 $27,516 26,568 $ 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.

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31. (continued) b. Remeasurement of Subsidiary Trial Balance Cash Accounts Receivable Equipment Accumulated Depreciation Land Accounts Payable Notes Payable Common Stock Dividends Paid Sales Salary Expense Depreciation Expense Miscellaneous Expense Remeasurement loss (debit) Calculation of Remeasurement Loss Net monetary assets, 1/1 -0Increase in net monetary assets: Common stock issued 10,000 Sales 25,000 Decrease in net monetary assets: Acquired equipment (3,000) Acquired land (5,000) Dividends paid (4,000) Salary expense (5,000) Miscellaneous expense (9,000) Net monetary assets, 12/31 Net monetary assets, 12/31 at current exchange rate Remeasurement loss (debit) 8,000 9,000 3,000 600 5,000 3,000 5,000 10,000 4,000 25,000 5,000 600 9,000 KQ x 1.62 KQ x 1.62 KQ x 1.71 KQ x 1.71 KQ x 1.59 KQ x 1.62 KQ x 1.62 KQ x 1.71 KQ x 1.66 KQ x 1.64 KQ x 1.64 KQ x 1.71 KQ x 1.64 Debits $12,960 14,580 5,130 7,950 4,860 8,100 17,100 6,640 41,000 8,200 1,026 14,760 $71,246 840 $72,086 -0KQ x 1.71 $17,100 KQ x 1.64 41,000 KQ KQ KQ KQ KQ x 1.71 x 1.59 x 1.66 x 1.64 x 1.64 (5,130) (7,950) (6,640) (8,200) (14,760) $15,420 14,580 $ 840 Credits

$ 1,026

$72,086

9,000* KQ 9,000 KQ x 1.62

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

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32. (30 minutes) (Translate financial statements of a foreign subsidiary) LIVINGSTON COMPANY Income Statement For Year Ending December 31, 2013 Goghs U.S. Dollars Sales 270,000 x 1/.63 = 428,571 Cost of Goods Sold (155,000) x 1/.63 = (246,032) Gross Profit 115,000 182,539 Operating Expenses (54,000) x 1/.63 = (85,714) Gain on Sale of Equipment 10,000 x 1/.58 = 17,241 Net Income 71,000 114,066 Statement of Retained Earnings For Year Ending December 31, 2013 Goghs U.S. Dollars Retained Earnings, 1/1/13 216,000 given 395,000 Net Income 71,000 above 114,066 Dividends Paid (26,000) x 1/.62 = (41,935) Retained Earnings, 12/31/13 261,000 467,131 Balance Sheet December 31, 2013 Goghs 44,000 x 1/.65 = 116,000 x 1/.65 = 58,000 x 1/.65 = 339,000 x 1/.65 = 557,000

Cash Receivables Inventory Fixed Assets (net) Total Liabilities Common Stock Retained Earnings Translation Adjustment Total

U.S. Dollars 67,692 178,462 89,231 521,538 856,923

176,000 x 1/.65 = 270,769 120,000 x 1/.48 = 250,000 261,000 above 467,131 (130,977) 557,000 856,923 U.S. Dollars x 1/.60 = 560,000 above 114,066 above (41,935) 632,131 x 1/.65 = 586,154 45,977 85,000 130,977

Translation Adjustment Goghs Net assets, 1/1/13 336,000 Net income, 2013 71,000 Dividends paid (26,000) Net assets, 12/31/13 381,000 Net assets at current exchange rate, 12/31/13 381,000

Translation adjustment, 2013 (negative) Cumulative translation adjustment, 1/1/13 (negative) Cumulative translation adjustment, 12/31/13 (negative)

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33. (35 minutes) (Compute remeasurement gain/loss and translation adjustment) a. Remeasurement Gain or Loss Net monetary assets, 1/1/13* Increases in net monetary assets: Issued Common Stock (4/1/13) Sold Building** (7/1/13) Sales (2013) Decreases in net monetary assets: Purchased Equipment (4/1/13) Paid Dividends (10/1/13) Rent Expense (2013) Salary Expense (2013) Utilities Expense (2013) Net monetary assets, 12/31/13 Net monetary assets, 12/31/13 at current exchange rate Remeasurement gain (credit) 2,000 10,000 22,000 80,000 (30,000) (32,000) (14,000) (20,000) ( 5,000) 13,000 13,000 KR x 2.50 = $ 5,000 KR x 2.60 = 26,000 KR x 2.80 = 61,600 KR x 2.70 = 216,000 KR x 2.60 = (78,000) KR x 2.90 = (92,800) KR x 2.70 = (37,800) KR x 2.70 = (54,000) KR x 2.70 = (13,500) KR $ 32,500 KR x 3.00 = 39,000 $ (6,500)

* Net monetary assets: (Cash + Accounts Receivable) - (Account Payable + Bonds Payable) ** 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 DepreciationEquipment increases by KR 5,000), KR 10,000 is depreciation of buildings. Accumulated Depreciation Buildings increases by only KR 5,000 during 2013, 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.

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33. (continued) b. Translation Adjustment Net assets, 1/1/13* 100,000 KR x 2.50 Increases in net assets Issued Common Stock (4/1/13) 10,000 KR x 2.60 Gain on Sale of Building** (7/1/13) 6,000 KR x 2.80 Sales (2013) 80,000 KR x 2.70 Decreases in net assets Paid Dividends (10/1/13) (32,000) KR x 2.90 Depreciation Expense (2013) (15,000) KR x 2.70 Rent Expense (2013) (14,000) KR x 2.70 Salary Expense (2013) (20,000) KR x 2.70 Utilities Expense (2013) ( 5,000) KR x 2.70 Net assets, 12/31/13 110,000 KR Net monetary assets, 12/31/13 at current exchange rate 110,000 KR x 3.00 Translation adjustment (positive) = $250,000 = = = = = = = = = 26,000 16,800 216,000 (92,800) (40,500) (37,800) (54,000) (13,500) $270,200 330,000 $(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, 2013 can be computed by translating the January 1 accounts and assuming that the translation adjustment is the balancing figure: Common Stock, 1/1/13 70,000 KR x 2.40 = $168,000 Retained Earnings, 1/1/13 30,000 KR given 62,319 Net assets, 1/1/13 100,000 KR $230,319 Net assets, 1/1/13 at current exchange rate 100,000 KR x 2.50 = 250,000 Cumulative translation adjustment (positive), 1/1/13 $ (19,681) Translation adjustment (positive), 2013 (59,800) Cumulative translation adjustment (positive), 12/31/13 $ (79,481)

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34. (90 minutes) (Remeasure non-functional currency accounts into foreign functional currency and then translate foreign functional currency financial statements into U.S. dollars) a. Remeasurement of Mexican Operations Accounts payable Accumulated depreciation Building and equipment Cash Depreciation expense Inventory (beginning income statement) Inventory (ending income statement) Inventory (endingbalance sheet) Purchases Receivables Salary expense Sales Main office Remeasurement loss Total Pesos 49,000 19,000 40,000 59,000 2,000 23,000 28,000 28,000 68,000 21,000 9,000 124,000 30,000 x .35 C x .25 H x .25 H x .35 C x .25 H x .30 A (12) x .34 A(13) x .34 A(13) x .34 A(13) x .35 C x .34 A x .34 A given Canadian Dollars Debit Credit 17,150 4,750 10,000 20,650 500 6,900 9,520 9,520 23,120 7,350 3,060 42,160 7,530 10 81,110 81,110

Schedule One

Schedule OneRemeasurement Loss Pesos Net monetary liabilities, 1/1/13* (16,000) x Increases in net monetary assets Sales 124,000 x Decreases in net monetary assets Purchases (68,000) x Salary Expense ( 9,000) x Net monetary assets, 12/31/13** 31,000 Net monetary assets, 12/31/13 at current exchange rate 31,000 x Remeasurement loss

.32 .34 .34 .34 .35

Canadian Dollars (5,120) 42,160 (23,120) ( 3,060) 10,860 10,850 10

* Net monetary liabilities, 1/1/13, can be determined by first determining the net monetary assets at 12/31/13 and then backing out the changes in monetary assets and liabilities during 2013sales, purchases, and salary expense. ** Net monetary assets, 12/31/13: Cash + Receivables Accounts Payable

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34. (continued) b. and c. 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$. Income Statement c. Translation into U.S. dollars For the Year Ended December 31, 2013 Current Rate Method Sales Cost of goods sold Gross profit Depreciation expense Salary expense Utility expense Gain on sale of equipment Remeasurement loss Net income C$ 354,160 (223,500) 130,660 (8,500) (29,060) (9,000) 5,000 (10) C$ 89,090 x .67 A = x .67 A = x x x x x .67 A .67 A .67 A .68 H .67 A = = = = = $ 237,287.20 (149,745.00) 87,542.20 (5,695.00) (19,470.20) (6,030.00) 3,400.00 (6.70) $ 59,740.30

Statement of Retained Earnings For the Year Ended December 31, 2013 Retained earnings, 1/1/13 Net income (above) Dividends paid Retained earnings, 12/31/13 C$ C$ 135,530 89,090 ( 28,000) 196,620 Given Above x .69 H = $ 70,421.00 59,740.30 (19,320.00) $110,841.30

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34. (continued) b. and c. Balance Sheet December 31, 2013 Cash Receivables Inventory Buildings and equipment Accumulated depreciation Total C$ 46,650 75,350 107,520 177,000 (31,750) 374,770 52,150 76,000 50,000 196,620 374,770 x x x x x .65 C .65 C .65 C .65 C .65 C = $ 30,322.50 = 48,977.50 = 69,888.00 = 115,050.00 = (20,637.50) $243,600.50

C$

Accounts payable C$ Notes payable Common stock Retained earnings Cumulative translation adjustment Total C$

x .65 C = $ 33,897.50 x .65 C = 49,400.00 x .45 H = 22,500.00 Above 110,841.30 Schedule Two 26,961.70 $ 243,600.50 $129,871.00 59,740.30 (19,320.00) $170,291.30 $ 160,303.00 9,988.30 (36,950.00) $(26,961.70)

Schedule TwoTranslation Adjustment Net assets, 1/1/13 C$ 185,530 x .70 = Changes in net assets Net income 89,090 Above Dividends (28,000) x .69 = Net assets, 12/31/13 C$ 246,620 Net assets, 12/31/13 at current exchange rate C$ 246,620 x .65 = Translation adjustment, 2013 (negative) Cumulative translation adjustment, 1/1/13 (positive) Cumulative translation adjustment, 12/31/13 (positive)

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35. (90 minutes) (Translate foreign currency financial statements and prepare consolidation worksheet) Step One 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 Dollars Sales (800,000) 0.274 (219,200) Cost of goods sold 420,000 0.274 115,080 Salary expense 74,000 0.274 20,276 Rent expense (adjusted) 36,000 0.274 9,864 Other expenses 59,000 0.274 16,166 Gain on sale of fixed assets, 10/1/13 (30,000) 0.273 (8,190) Net income (241,000) (66,004) R/E, 1/1/13 Net income Dividends paid R/E,12/31/13 Cash and receivables Inventory Prepaid rent (adjusted) Fixed assets Total Accounts payable Notes payable Common stock Addl paid-in capital Retained earnings, 12/31/13 Subtotal Cumulative translation adjustment (negative) Total (133,000) (241,000) 50,000 (324,000) 146,000 297,000 10,000 455,000 908,000 (54,000) (140,000) (240,000) (150,000) (324,000) Schedule 1 (38,244) Above (66,004) 0.275 13,750 (90,498) 0.270 0.270 0.270 0.270 0.270 0.270 0.300 0.300 Above Schedule 2 (908,000) 39,420 80,190 2,700 122,850 245,160 (14,580) (37,800) (72,000) (45,000) (90,498) (259,878) 14,718 (245,160)

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35. (continued) Schedule 1Translation of 1/1/13 Retained Earnings Retained earnings, 1/1/12 Net income, 2012 Dividends, 6/1/12 Retained earnings, 1/1/13 Pounds -0(163,000) 30,000 (133,000) Dollars -0(46,944) 8,700 (38,244)

0.288 0.290

Schedule 2Calculation of Cumulative Translation Adjustment at 12/31/13 Pounds Net assets, 1/1/12 (390,000) 0.300 Net income, 2012 (163,000) 0.288 Dividends, 6/1/12 30,000 0.290 Net assets, 12/3/12 (523,000) Net assets, 12/31/12 at current exchange rate (523,000) 0.280 Translation adjustment, 2012 (negative) Net assets, 1/1/13 (523,000) 0.280 Net income, 2013 (241,000) Above Dividends, 6/1/13 50,000 0.275 Net assets, 12/31/13 (714,000) Net assets, 12/31/13 at current exchange rate (714,000) 0.270 Translation adjustment, 2013 (negative) Cumulative translation adjustment, 12/31/13 (negative) Dollars (117,000) (46,944) 8,700 (155,244) (146,440) (8,804) (146,440) (66,004) 13,750 (198,694) (192,780) (5,914) (14,718)

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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 Balances Dollars Dollars Debit Credit Dollars (200,000) (219,200) (419,200) 93,800 115,080 208,880 19,000 20,276 39,276 7,000 9,864 16,864 21,000 16,166 37,166 (13,750) -0(I) 13,750 -0-0(8,190) (8,190) (72,950) (66,004) (125,204) (318,000) (72,950) 24,000 (366,950) 110,750 98,000 30,000 126,000 398,000 762,750 (60,800) (132,000) (120,000) (83,000) (366,950) (38,244) (S) 38,244 (*C) (38,244) (356,244) (66,004) (125,204) 13,750 (I) (13,750) 24,000 (90,498) (457,448) 39,420 80,190 2,700 -0- (*C) 38,244 (S)(164,244) 122,850 (S) 9,000 (E) (900) 245,160 150,170 178,190 32,700 -0528,950 890,010 (75,380) (169,800) (120,000) (83,000) (457,448) (905,628) 15,618 (890,010)

Account Sales Cost of goods sold Salary expense Rent expense Other expenses Dividend income Gain, 10/1/13 Net income Ret earn, 1/1/13 Net income Dividends paid Ret earn, 12/31/13 Cash and receivables Inventory Prepaid rent Investment Fixed assets Total Accounts payable Notes payable Common stock Additional PIC Ret earn, 12/31/13 Subtotal Cum trans adjust Total

(14,580) (37,800) (72,000) (S) 72,000 (45,000) (S) 45,000 (90,498) (259,878) 14,718 (E) 900 (762,750) (245,160) 217,138

217,138

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35. (continued) Explanation of Adjustment and Elimination Entries Entry *C Investment in Simbel ................................................... 38,244 Retained earnings, 1/1/13 ....................................... 38,244 To accrue 2013 increase in subsidiary book value (see Schedule 1). Entry is needed because parent is using the cost method. Entry S Common stock (Simbel) .......................................... 72,000 Add'l paid-in-capital (Simbel) ...................................... 45,000 Retained earnings, 1/1/13 (Simbel) ............................. 38,244 Fixed assets (revaluation) .......................................... 9,000 Investment in Simbel .......................................... 164,244 To eliminate subsidiary's stockholders' equity accounts and allocate the excess of acquisition consideration over book value to land (fixed assets). The excess of acquisition consideration over book value is calculated as follows: Acquisition consideration ...................................................... $126,000 Book value, 1/1/13 ................................................................... Common stock ...................................................................... (72,000) Addl paid-in capital .............................................................. (45,000) Excess of acquisition consideration over book value $ 9,000 The excess of acquisition consideration over book value is 30,000 pounds. The U.S. dollar equivalent at 1/1/13, the date of acquisition, is $9,000 (E30,000 x $.30). Entry I Dividend income .......................................................... 13,750 Dividends paid ......................................................... 13,750 To eliminate intra-entity dividend payments recorded by parent as income. Entry E Cumulative translation adjustment............................. 900 Fixed assets (revaluation) ..................................... 900 To revalue (write-down) the excess of acquisition consideration 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 acquisition consideration over book value U.S. dollar equivalent at 12/31/13 E30,000 x $.27 = $8,100 U.S. dollar equivalent at 1/1/13 E30,000 x $.30 = 9,000 Cumulative translation adjustment related to excess, 12/31/13 (negative) $( 900)

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36. (90 minutes) Translate [remeasure] foreign currency financial statements using U.S. GAAP and explain sign of translation adjustment [remeasurement gain/loss]) Part I (a). Czech koruna is the functional currencycurrent rate method KS Sales 25,000,000 Cost of goods sold (12,000,000) Depreciation expenseequipment (2,500,000) Depreciation expensebuilding (1,800,000) Research and development expense (1,200,000) Other expenses (1,000,000) Net income 6,500,000 Retained earnings, 1/1/13 500,000 Dividends paid, 12/15/13 (1,500,000) Retained earnings, 12/31/13 5,500,000 Cash Accounts receivable Inventory Equipment Accum. deprec.equipment Building Accum. deprec.equipment Land Total assets Accounts payable Long-term debt Common stock Additional paid-in capital Retained earnings, 12/31/13 Translation adjustment Total liabilities and equities 2,000,000 3,300,000 8,500,000 25,000,000 (8,500,000) 72,000,000 (30,300,000) 6,000,000 78,000,000 2,500,000 50,000,000 5,000,000 15,000,000 5,500,000 78,000,000 Exchange Rate US$ 0.035 875,000 0.035 (420,000) 0.035 (87,500) 0.035 (63,000) 0.035 (42,000) 0.035 (35,000) 227,500 given 22,500 0.031 (46,500) 203,500 0.030 0.030 0.030 0.030 0.030 0.030 0.030 0.030 60,000 99,000 255,000 750,000 (255,000) 2,160,000 (909,000) 180,000 2,340,000

0.030 75,000 0.030 1,500,000 0.050 250,000 0.050 750,000 above 203,500 to balance (438,500) 2,340,000

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36.

(continued) Calculation of Translation Adjustment Translation adjustment, 2013 (negative) Net assets, 1/1/13 20,500,000 0.040 Net income, 2013 6,500,000 0.035 Dividends, 12/15/13 (1,500,000) 0.031 Net assets, 12/31/13 25,500,000 Net assets, 12/31/13 at current exchange rate 25,500,000 0.030 Translation adjustment, 2013 (negative) Cumulative translation adjustment, 12/31/13 (negative) 202,500 820,000 227,500 (46,500) 1,001,000 765,000 236,000 438,500

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36. (continued) Part I (b). U.S. dollar is the functional currencytemporal method KS Sales 25,000,000 Cost of goods sold (12,000,000) Depreciation expenseequipment (2,500,000) Depreciation expensebuilding (1,800,000) Research and development expense (1,200,000) Other expenses (1,000,000) Income before remeasurement gain 6,500,000 Remeasurement gain, 2013 Net income 6,500,000 Retained earnings, 1/1/13 500,000 Dividends paid, 12/15/13 (1,500,000) Retained earnings, 12/31/13 5,500,000 Cash Accounts receivable Inventory Equipment Accum. deprec.equipment Building Accum. deprec.equipment Land Total assets Accounts payable Long-term debt Common stock Additional paid-in capital Retained earnings, 12/31/13 Total liabilities and equities Schedule ACost of goods sold Beginning inventory Purchases Ending inventory Cost of goods sold KS 6,000,000 14,500,000 (8,500,000) 12,000,000 ER 0.043 0.035 0.032 US$ 258,000 507,500 (272,000) 493,500 2,000,000 3,300,000 8,500,000 25,000,000 (8,500,000) 72,000,000 (30,300,000) 6,000,000 78,000,000 2,500,000 50,000,000 5,000,000 15,000,000 5,500,000 78,000,000 Rate 0.035 Sched.A Sched.B Sched.C 0.035 0.035 Exchange US$ 875,000 (493,500) (118,000) (85,200) (42,000) (35,000) 101,300 408,000 509,300 given 353,000 0.031 (46,500) 815,800

0.030 60,000 0.030 99,000 0.032 272,000 Sched.B 1,180,000 Sched.B (418,000) Sched.C 3,408,000 Sched.C (1,510,200) 0.050 300,000 3,390,800 0.030 0.030 0.050 0.050 above 75,000 1,500,000 250,000 750,000 815,800 3,390,800

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36. (continued) Schedule BEquipment KS ER US$ Old Equipmentat 1/1/13 20,000,000 0.050 1,000,000 New Equipmentacquired 1/3/13 5,000,000 0.036 180,000 Total 25,000,000 1,180,000 Accum. Depr.Old Equipment Accum. Depr.New Equipment Total Deprec expenseOld Equipment Deprec expenseNew Equipment Total Schedule CBuilding Old Buildingat 1/1/13 New Buildingacquired 3/5/13 Total Accum. Depr.Old Building Accum. Depr.New Building Total Deprec. expenseOld Building Deprec. expenseNew Building Total Calculation of Remeasurement Gain Net mon. liab., 1/1/13 Increase in mon. assets: Sales Decrease in mon. assets: Purchase of inventory Research and development Other expenses Dividends paid, 12/15/13 Purchase of equipment, 1/3/13 Purchase of buildings, 3/5/13 Net mon liab, 12/31/13 Net mon liab, 12/31/13 at current exchange rate Remeasurement gain2013 8,000,000 500,000 8,500,000 2,000,000 500,000 2,500,000 KS 60,000,000 12,000,000 72,000,000 30,000,000 300,000 30,300,000 1,500,000 300,000 1,800,000 KS (37,000,000) 25,000,000 (14,500,000) (1,200,000) (1,000,000) (1,500,000) (5,000,000) (12,000,000) (47,200,000) (47,200,000) 0.050 0.036 0.050 0.036 400,000 18,000 418,000 100,000 18,000 118,000 US$ 3,000,000 408,000 3,408,000 1,500,000 10,200 1,510,200 75,000 10,200 85,200

ER 0.050 0.034 0.050 0.034 0.050 0.034

ER US$ 0.040 (1,480,000) 0.035 0.035 0.035 0.035 0.031 0.036 0.034 875,000 (507,500) (42,000) (35,000) (46,500) (180,000) (408,000) (1,824,000)

0.030 (1,416,000) (408,000)

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36. (continued) Part I (c). U.S. dollar is the functional currencytemporal method (no longterm debt) Exchange KS Rate US$ Sales 25,000,000 0.035 875,000 Cost of goods sold (12,000,000) Sched.A (493,500) Depreciation expenseequipment (2,500,000) Sched.B (118,000) Depreciation expensebuilding (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 loss 6,500,000 101,300 Remeasurement loss, 2013 (92,000) Net income 6,500,000 9,300 Retained earnings, 1/1/13 500,000 given (147,000) Dividends paid, 12/15/13 (1,500,000) 0.031 (46,500) Retained earnings, 12/31/13 5,500,000 (184,200) Cash Accounts receivable Inventory Equipment Accum. deprec.equipment Building Accum. deprec.equipment Land Total assets Accounts payable Long-term debt Common stock Additional paid in capital Retained earnings, 12/31/13 Total liabilities and equities 2,000,000 3,300,000 8,500,000 25,000,000 (8,500,000) 72,000,000 (30,300,000) 6,000,000 78,000,000 2,500,000 0 20,000,000 50,000,000 5,500,000 78,000,000 0.030 60,000 0.030 99,000 0.032 272,000 Sched.B 1,180,000 Sched.B (418,000) Sched.C 3,408,000 Sched.C(1,510,200) 0.050 300,000 3,390,800 0.030 75,000 0.030 0 0.050 1,000,000 0.050 2,500,000 above (184,200) 3,390,800

Schedule ACost of goods sold - same as in Part I (b) Schedule BEquipment - same as in Part I (b) Schedule CBuilding - same as in Part I (b)

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36. (continued) Calculation of Remeasurement Loss Net monetary assets, 1/1/13 Increase in monetary assets: Sales Decrease in monetary assets: Purchase of inventory Research and development Other expenses Dividends paid, 12/15/13 Purchase of equipment, 1/3/13 Purchase of buildings, 3/5/13 Net monetary assets, 12/31/13 Net monetary assets, 12/31/13 at current exchange rate Remeasurement loss2013 KS 13,000,000 25,000,000 (14,500,000) (1,200,000) (1,000,000) (1,500,000) (5,000,000) (12,000,000) 2,800,000 2,800,000 ER 0.040 0.035 0.035 0.035 0.035 0.031 0.036 0.034 US$ 520,000 875,000 (507,500) (42,000) (35,000) (46,500) (180,000) (408,000) 176,000 84,000 92,000

0.030

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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 2013 (from $.040 at 1/1/13 to $.030 at 12/31/13). 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 KS 5,300,000). Accounts Payable and Long-term Debt are also translated at the current exchange rate (total KS 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 2013. Cash and Accounts Receivable are the only assets translated at the current exchange rate (total KS 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 KS 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.

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Chapter 10 Develop Your Skills Research Case 1Foreign 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 2Foreign Currency Translation Disclosures in the Computer Industry a. In 2010, in addition to providing information related to foreign currency translation and hedging activities in its Form 10-K under 1A. Risk Factors, p. 14, IBM also provided information in its Annual Report on these activities in the following locations: i. Management Discussion, under Currency Rate Fluctuations, p. 53. ii. Note A. Significant Accounting Policies, under Translation of Non-U.S Currency Amounts and Derivatives, p. 75. iii. Note L. Derivatives Financial Instruments, p. 96. In its Form 10-K for the year ended January 28, 2011 (Fiscal 2011), Dell provided information related to foreign currency translation and hedging activities in the following locations: i. Item 1A. Risk Factors, p. 17. ii. Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations, under Market Risk, p. 43. iii. Note 1. Description of Business and Summary of Significant Accounting Policies, under Foreign Currency Translation and Hedging Instruments, p. 63. iv. Note 6. Derivative Instruments and Hedging Activities, p. 81. b. IBMs foreign operations do not have a predominant functional currency. The company indicates that it operates in multiple functional currencies (AR, p. 96). The majority of Dells foreign operations have the U.S. dollar as their functional currency (10-K, p. 63). Most of IBMs 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. Dells 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.
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c. From the Consolidated Statement of Changes in Equity (AR, p. 65), it can be seen that IBM reported translation adjustments as follows over the period 2008-2010: 2008: negative $3,552 million 2009: positive $1,732 million 2010: positive $643 million The negative signs of the translation adjustments in 2008 and 2009 indicate that, on average, the foreign currency functional currencies of IBMs foreign operations decreased in value against the U.S. dollar in those years. The positive sign of the translation adjustment in 2010 indicates that, on average, the foreign currency functional currencies of IBMs foreign operations increased in value against the U.S. dollar in that year. Dell reported foreign currency translation adjustments in total comprehensive income (Consolidated Statements of Stockholders Equity) as follows: Fiscal 2009: positive $5 million Fiscal 2010: negative $29 million Fiscal 2011: positive $79 million On average, the foreign currency functional currencies of Dells foreign operations increased in value against the U.S. dollar in Fiscal 2009 and Fiscal 2011, and decreased in value in Fiscal 2010. 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. d. In Note L. Derivatives and Hedging Transactions, IBM indicates that a significant portion of the companys foreign currency denominated debt is designated as a hedge of its foreign currency balance sheet exposures (p. 97). The company also uses foreign currency forward contracts and cross-currency swaps 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.

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Accounting Standards Case 1More than One Functional Currency This case requires students to search the authoritative literature to determine how the functional currency should be determined for a foreign entity that has more than one distinct and separable operation. Source of guidance: FASB ASC 830-10-55-6 Foreign Currency Matters; Overall; Implementation Guidance and Illustrations: The Functional Currency ASC 830-10-55-6 states: 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. This guidance indicates that the functional currency should be determined separately for each distinct and separable operation of a single foreign entity. Within its Mexican subsidiary, Lynch should designate the Mexican peso as the functional currency for the Small Appliance division and the U.S. dollar as the functional currency for the Electronics division. Accounting Standards Case 2Change in Functional Currency This case requires students to search the authoritative literature to determine how an entity should handle a change in foreign currency from the foreign currency to the U.S. dollar. Specific questions are: Should the change in functional currency be treated as a change in accounting principle with retrospective restatement of the carrying values of nonmonetary assets? Should the cumulative translation adjustment be removed from equity and, if so, where should it go? Source of guidance: FASB ASC 830-10-45-10 Foreign Currency Matters; General; Other Presentation Matters; Functional Currency Changes from Foreign Currency to Reporting Currency ASC 830-10-45-10 states: 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.
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In essence, the authoritative guidance indicates that the change in functional currency from the Canadian dollar to the U.S. dollar should not be treated as a change in accounting principle with retrospective adjustments. Instead, the change should be handled prospectively with no adjustments made to the carrying amounts of nonmonetary assets or to the accumulated translation adjustment related to the Canadian subsidiary carried in AOCI.

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Excel CaseTranslating 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 Companys foreign subsidiary.
December 31, 2013 Sales Cost of goods sold Gross profit Selling expense Depreciation expense Remeasurement gain/loss Income before tax Income taxes Net income Retained earnings, 1/1/13 Ret. earnings, 12/31/13 Cash Inventory Fixed assets Less: accum/deprec Total assets Current liabilities Long-term debt Contributed capital Cum. trans. adjust. Retained earnings Total liab and stock equity Exchange Rates January 1-31, 2013 Average 2013 December 31, 2013 Inventory purchases Key: Average Exchange Rate Current Exchange Rate Historical Exchange Rate FC 5,000 (3,000) 2,000 (400) (600) 0 1,000 (300) 700 0 700 1,000 2,000 6,000 (600) 8,400 1,500 3,000 3,200 0 700 8,400 Current Rate Method Rate USD $0.45 $0.45 subtotal $0.45 $0.45 n/a subtotal $0.45 subtotal total $0.38 $0.38 $0.38 $0.38 total A $2,250 A (1,350) 900 A (180) A (270) 0 450 A (135) 315 0 315 C C C C 380 760 2,280 (228) 3,192 570 1,140 1,600 (433)* 315 3,192 Temporal Method Rate USD $0.45 calculation subtotal $0.45 $0.50 to balance subtotal $0.45 subtotal from B/S $0.38 $0.43 $0.50 $0.50 total C H H H A $2,250 (1,360) 890 (180) (300) 355 765 (135) 630 0 630 380 860 3,000 (300) 3,940 570 1,140 1,600 0 630 3,940

A H

$0.38 C $0.38 C $0.50 H to balance from I/S A=L+SE

$0.38 C $0.38 C $0.50 H n/a to balance A=L+SE

Temporal methodCOGS (on a FIFO basis) $0.50 BI 1,000 $0.50 H $500 $0.45 P 4,000 $0.43 H 1,720 $0.38 EI (2,000) $0.43 H (860) $0.43 COGS 3,000 $1,360 A C H

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Excel Case (continued) *Computation of Translation Adjustment Net assets, 1/1/13 Net income, 2013 Net assets, 12/31/13 Net assets, 12/31/13 at current exchange rate Translation adjustment (negative) FC 3,200 700 3,900 3,900 $0.50 $0.45 USD 1,600 315 1,915 1,482 433

$0.38

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.

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Excel Case (continued) FC Current ratio CA CL 3,000 1,500 2.0 Current Rate 1,140 570 2.0 Temporal 1,240 570 2.1754

Debt to equity ratio Total liabilities Total stockholders equity

4,500 3,900 1.15385

1,710 1,482 1.15385

1,710 2,230 0.76682

Profit margin NI Sales

700 5,000 0.14

315 2,250 0.14

630 2,250 0.28

Return on equity NI Average TSE

700 3,550 0.19718

315 1,541 0.20441

630 1,915 0.32898

Inventory turnover COGS Average Inventory

3,000 1,000 3

1,350 380 3.55263

1,360 430 3.16279

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.
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Excel Case (continued) 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.

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Excel and Analysis CaseParker 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 1/1/12 to $1.68 at 12/31/13. Under the second set of assumptions, the exchange rate remains $1.60 from 1/1/12 to 12/31/13. Under the third set of assumptions, the British pound depreciates steadily from $1.60 at 1/1/12 to $1.52 at 12/31/13. Part IAppreciating Foreign Currency Relevant exchange rates: January 1, 2012 2012 Average December 31, 2012 January 30, 2013 2013 Average December 31, 2013 $1.60 $1.62 $1.64 $1.65 $1.66 $1.68

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Excel and Analysis Case (continued) a. Translation of Suffolks December 31, 2013 trial balance from British pounds to U.S. dollars. Suffolk PLC Trial Balance December 31, 2013 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 (4,147,500) 0

Cash Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/13 Sales Cost of goods sold Depreciation Other expenses Dividends paid (1/30/13) Cumulative translation adjustmentpositive (credit balance)

0 Note: Amounts in parentheses are credit balances. Exchange Rate $1.60 $1.62

Schedule A Retained earnings, 1/1/12 Net income, 2012 Retained earnings, 12/31/12

Pounds (6,000,000) (2,000,000) (8,000,000)

Dollars $ (9,600,000) (3,240,000) $(12,840,000)

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Excel and Analysis Case (continued) b. Schedule detailing the change in Suffolks cumulative translation adjustment for 2012 and 2013.
Determination of Cumulative Exchange Exchange Translation Adjustment Pounds Rate Rate Dollars Net assets, 1/1/12 50,000,000 $1.64 $1.60 $2,000,000 Net income, 2012 2,000,000 $1.64 $1.62 40,000 Translation adjustment, 2012 (positive) $2,040,000 Net assets, 1/1/13 52,000,000 $1.68 $1.64 2,080,000 Net income, 2013 4,000,000 $1.68 $1.66 80,000 Dividends, 2013 (1,750,000) $1.68 $1.65 (52,500) Translation adjustment, 2013 (positive) 2,107,500 Net assets, 12/31/13 54,250,000 Cumulative Translation Adjustment, 12/31/13 (positive) $4,147,500 Exchange Rate $1.60 $1.60

Cost Allocation Schedule Cost Book value Excess of cost over book value Translation Adjustment Related to Excess of Cost Over Book Value Excess of cost over book value U.S. dollar value at 12/31/13 U.S. dollar value at 1/1/12 Translation adjustment related to excess, 12/31/13positive

Pounds 52,000,000 50,000,000 2,000,000

Dollars $83,200,000 80,000,000 $ 3,200,000

Pounds 2,000,000

Exchange Rate $1.68 $1.60

Dollars $3,360,000 3,200,000 $ 160,000

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Excel and Analysis Case (continued) c. Consolidation WorksheetDecember 31, 2013


Parker Suffolk ($46,480,000) 26,560,000 3,320,000 9,960,000 2,887,500 ($6,640,000) Adjustments & Eliminations Consolidated ($116,480,000) 60,560,000 23,320,000 15,960,000 0 ($16,640,000)

Sales Cost of goods sold Depreciation Other expenses Dividend income Net income Ret. earnings, 1/1/13 Net income Dividends Ret. earnings, 12/31/13 Cash Accounts receivable Inventory Investment in Suffolk

($70,000,000) 34,000,000 20,000,000 6,000,000 (2,887,500) ($12,887,500)

($48,000,000) (12,887,500) 4,500,000 ($56,387,500)

($12,840,000) (6,640,000) 2,887,500 ($16,592,500)

12,840,000

3,240,000

($51,240,000) (16,640,000)

2,887,500

4,500,000 ($63,380,000)

$3,687,500 10,000,000 30,000,000 83,200,000

$2,520,000 8,736,000 30,240,000 3,240,000 83,240,000 3,200,000

$6,207,500 18,736,000 60,240,000 0

Prop, plant & eq (net)

105,000,000

60,480,000

3,200,000 160,000

168,840,000

Accounts payable Long-term debt Common stock Ret. earnings, 12/31/13 Cum. trans. adj.

(25,500,000) (50,000,000) (100,000,000) (56,387,500)

(2,436,000) (8,400,000) (70,400,000) (16,592,500) 70,400,000

(27,936,000) (58,400,000) (100,000,000) (63,380,000)

(4,147,500) $0 $0 $92,727,500

160,000 $92,727,500

(4,307,500) $0

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Excel and Analysis Case (continued) d. Consolidated income statement and balance sheet2013. Parker, Inc. Consolidated Income Statement For the year ended December 31, 2013 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, 2013 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 Accum. other comp. income 4,307,500 Total $254,023,500

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Excel and Analysis Case (continued) Part IIStable Foreign Currency Relevant exchange rates: January 1, 2012 2012 Average December 31, 2012 January 30, 2013 2013 Average December 31, 2013 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60

a. Translation of Suffolks December 31, 2013 trial balance from British pounds to U.S. dollars. Suffolk PLC Trial Balance December 31, 2013 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 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 0 0

Cash Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/13 Sales Cost of goods sold Depreciation Other expenses Dividends paid, 1/30/13 Cumulative translation adjustment

0 Note: Amounts in parentheses are credit balances. Exchange Rate $1.60 $1.60

Schedule A Retained earnings, 1/1/12 Net income, 2012 Retained earnings, 12/31/12

Pounds (6,000,000) (2,000,000) (8,000,000)

Dollars $ (9,600,000) (3,200,000) $(12,800,000)

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Excel and Analysis Case (continued) b. Schedule detailing the change in Suffolks cumulative translation adjustment for 2012 and 2013.
Determination of Cumulative Translation Adjustment Net assets, 1/1/12 Net income, 2012 Translation adjustment, 2012 Net assets, 1/1/13 Net income, 2013 Dividends, 2013 Translation adjustment, 2013 Net assets, 12/31/13 Cumulative Translation Adjustment, 12/31/13 Pounds 50,000,000 2,000,000 52,000,000 4,000,000 (1,750,000) 54,250,000 $0 Exchange Exchange Rate Rate $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 Dollars $0 0 $0 0 0 0 0

Cost Allocation Schedule Cost Book value Excess of cost over book value Translation Adjustment Related to Excess of Cost Over Book Value Excess of cost over book value U.S. dollar value at 12/31/13 U.S. dollar value at 1/1/12 Translation adjustment related to excess, 12/31/13

Pounds 52,000,000 50,000,000 2,000,000

Exchange Rate $1.60 $1.60

Dollars $83,200,000 80,000,000 $ 3,200,000

Pounds 2,000,000

Exchange Rate $1.60 $1.60

Dollars $3,200,000 3,200,000 $0

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Excel and Analysis Case (continued) c. Consolidation WorksheetDecember 31, 2013


Parker Suffolk ($44,800,000) 25,600,000 3,200,000 9,600,000 2,800,000 ($6,400,000) Adjustments & Eliminations Consolidated ($114,800,000) 59,600,000 23,200,000 15,600,000 0 ($16,400,000)

Sales Cost of goods sold Depreciation Other expenses Dividend income Net income Ret. earnings, 1/1/13 Net income Dividends Ret. earnings, 12/31/13 Cash Accounts receivable Inventory Investment in Suffolk

($70,000,000) 34,000,000 20,000,000 6,000,000 (2,800,000) ($12,800,000)

($48,000,000) (12,800,000) 4,500,000 ($56,300,000)

($12,800,000) (6,400,000) 2,800,000 ($16,400,000)

12,800,000

3,200,000

($51,200,000) (16,400,000)

2,800,000

4,500,000 ($63,100,000)

$3,600,000 10,000,000 30,000,000 83,200,000

$2,400,000 8,320,000 28,800,000 3,200,000 83,200,000 3,200,000

$6,000,000 18,320,000 58,800,000 0

Prop, plant & eq (net)

105,000,000

57,600,000

3,200,000 0

165,800,000

Accounts payable Long-term debt Common stock Ret. earnings, 12/31/13 Cum. Trans. adj.

(25,500,000) (50,000,000) (100,000,000) (56,300,000)

(2,320,000) (8,000,000) (70,400,000) (16,400,000) 70,400,000

(27,820,000) (58,000,000) (100,000,000) (63,100,000)

0 $0 $0 $92,400,000

0 $92,400,000

0 $0

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2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Excel and Analysis Case (continued) d. Consolidated income statement and balance sheet2013. Parker, Inc. Consolidated Income Statement For the year ended December 31, 2013 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, 2013 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 Accum. other comp. income 0 Total $248,920,000

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Excel and Analysis Case (continued) Part IIIDepreciating Foreign Currency Relevant exchange rates: January 1, 2012 2012 Average December 31, 2012 January 30, 2013 2013 Average December 31, 2013 $1.60 $1.58 $1.56 $1.55 $1.54 $1.52

a. Translation of Suffolks December 31, 2013 trial balance from British pounds to U.S. dollars. Suffolk PLC Trial Balance December 31, 2013 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 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 4,147,500 0

Cash Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/13 Sales Cost of goods sold Depreciation Other expenses Dividends paid (1/30/13) Cumulative translation adjustmentnegative (debit balance)

0 Note: Amounts in parentheses are credit balances. Exchange Rate $1.60 $1.58

Schedule A Retained earnings, 1/1/12 Net income, 2012 Retained earnings, 12/31/12

Pounds (6,000,000) (2,000,000) (8,000,000)

Dollars $ (9,600,000) (3,160,000) $(12,760,000)

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Excel and Analysis Case (continued) b. Schedule detailing the change in Suffolks cumulative translation adjustment for 2012 and 2013.
Determination of Cumulative Exchange Exchange Translation Adjustment Pounds Rate Rate Dollars Net assets, 1/1/12 50,000,000 $1.56 $1.60 $(2,000,000) Net income, 2012 2,000,000 $1.56 $1.58 (40,000) Translation adjustment, 2012 (negative) $(2,040,000) Net assets, 1/1/13 52,000,000 $1.52 $1.56 (2,080,000) Net income, 2013 4,000,000 $1.52 $1.54 (80,000) Dividends, 2013 (1,750,000) $1.52 $1.55 52,500 Translation adjustment, 2013 (negative) (2,107,500) Net assets, 12/31/13 54,250,000 Cumulative Translation Adjustment, 12/31/13 (negative) $(4,147,500) Exchange Rate $1.60 $1.60

Cost Allocation Schedule Cost Book value Excess of cost over book value Translation Adjustment Related to Excess of Cost Over Book Value Excess of cost over book value U.S. dollar value at 12/31/13 U.S. dollar value at 1/1/12 Translation adjustment related to excess, 12/31/13negative

Pounds 52,000,000 50,000,000 2,000,000

Dollars $83,200,000 80,000,000 $ 3,200,000

Pounds 2,000,000

Exchange Rate $1.52 $1.60

Dollars $3,040,000 3,200,000 $(160,000)

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Excel and Analysis Case (continued) c. Consolidation WorksheetDecember 31, 2013


Parker Suffolk ($43,120,000) 24,640,000 3,080,000 9,240,000 2,712,500 ($6,160,000) Adjustments & Eliminations Consolidated ($113,120,000) 58,640,000 23,080,000 15,240,000 0 ($16,160,000)

Sales Cost of goods sold Depreciation Other expenses Dividend income Net income Ret. earnings, 1/1/13 Net income Dividends Ret. earnings, 12/31/13 Cash Accounts receivable Inventory Investment in Suffolk

($70,000,000) 34,000,000 20,000,000 6,000,000 (2,712,500) ($12,712,500)

($48,000,000) (12,712,500) 4,500,000 ($56,212,500)

($12,760,000) (6,160,000) 2,712,500 ($16,207,500)

12,760,000

3,160,000

($51,160,000) (16,160,000)

2,712,500

4,500,000 ($62,820,000)

$3,512,500 10,000,000 30,000,000 83,200,000

$2,280,000 7,904,000 27,360,000 3,160,000 83,160,000 3,200,000

$5,792,500 17,904,000 57,360,000 0

Prop, plant & eq (net)

105,000,000

54,720,000

3,200,000 160,000

162,760,000

Accounts payable Long-term debt Common stock Ret. earnings, 12/31/13 Cum. Trans. adj.

(25,500,000) (50,000,000) (100,000,000) (56,212,500)

(2,204,000) (7,600,000) (70,400,000) (16,207,500) 70,400,000

(27,704,000) (57,600,000) (100,000,000) (62,820,000)

4,147,500 $0 $0

160,000 $92,392,500 $92,392,500

4,307,500 $0

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Excel and Analysis Case (continued) d. Consolidated income statement and balance sheet2013. Parker, Inc. Consolidated Income Statement For the year ended December 31, 2013 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, 2013 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 Accum. other comp. income (4,307,500) Total $243,816,500

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Excel and Analysis Case (continued) Part IVRisk Assessment Report and Financial Management Recommendations
December 31, 2013 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% $86,336,000 $167,687,500 51.5% 98% - 2% $2,800,000 100% -$85,820,000 $163,100,000 52.6% 100% -$2,712,500 97% - 3% $85,304,000 $158,512,500 53.8% 102% + 2%

Consolidated net income Percentage difference

Cash flow from dividends Percentage difference

Total Liabilities Total Stockholders equity Debt-to-equity ratio Percentage difference

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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