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Translation of Foreign Currency Financial Statements: Chapter Outline
Translation of Foreign Currency Financial Statements: Chapter Outline
TRANSLATION OF FOREIGN
CURRENCY FINANCIAL STATEMENTS
Chapter Outline
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.
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.
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.
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.
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 total stockholders’
equity, there is an adverse (inflationary) impact on the debt to equity ratio. Companies with
restrictive debt covenants requiring them to stay below a maximum debt to equity ratio, may
find it necessary to hedge their balance sheet exposure so as to avoid negative translation
adjustments being reported. If the U.S. dollar is the functional currency or an operation is
located in a high inflation country, remeasurement gains and losses are reported in income.
Companies might want to hedge their balance sheet exposure in this situation to avoid the
adverse impact remeasurement losses can have on consolidated income and earnings per
share.
The paradox in hedging balance sheet exposure is that, by agreeing to receive or deliver
foreign currency in the future under a forward contract, a transaction exposure is created.
This transaction exposure is speculative in nature, given that there is no underlying inflow or
outflow of foreign currency that can be used to satisfy the forward contract. By hedging
balance sheet exposure, a company might incur a realized foreign exchange loss to avoid
an unrealized negative translation adjustment or unrealized remeasurement loss.
4. The gains and losses arising from financial instruments used to hedge balance sheet
exposure are treated in a similar manner as the item the hedge is intended to cover. If the
foreign currency is the functional currency, gains and losses on hedging instruments will be
taken to accumulated other comprehensive income. If the U.S. dollar is the functional
currency, gains and losses on the hedging instruments will be offset against the related
remeasurement gains and losses.
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.
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 subsidiary’s 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 entity’s 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 entity’s functional currency.
9. The foreign subsidiary's net asset position in foreign currency at the beginning of the period
is first determined. Changes in net assets are determined to explain the net asset balance
in foreign currency at the end of the period. The beginning net asset position and changes
in net assets are translated at appropriate exchange rates and the ending net asset position
in dollars is determined.
The ending net asset balance in foreign currency is then translated at the current rate and
this result is subtracted from the ending net asset position in dollars (already calculated).
The difference is the translation adjustment. It is positive if the actual dollar net asset
position is less than the net asset position based on the current exchange rate. The
translation adjustment is negative if the actual dollar net asset position is greater than if
translated at the current rate.
Most companies include the cumulative translation adjustment on the U.S. dollar Balance
Sheet in the Stockholders’ Equity Section under Accumulated Other Comprehensive
Income.
11. Translation is required when a foreign currency is the functional currency. Remeasurement
is required in two situations:
Remeasurement is carried out using the temporal method, with remeasurement gains and
losses reported in consolidated income. Translation is done using the current rate method
and the resulting translation adjustment is carried as a separate component of stockholders’
equity.
12. The temporal method must be used to remeasure the financial statements of operations in
highly inflationary countries. One reason for mandating the use of the temporal method is
that it avoids the disappearing plant problem that exists when the current rate method is
used. Under the current rate method, fixed assets are translated at current exchange rates.
With high rates of inflation, the foreign currency will depreciate significantly. When the
historical cost of fixed assets is translated at a significantly lower current exchange rate, the
dollar value of fixed assets “disappears.” This problem is avoided by translating at the
historical exchange rate as is done under the temporal method.
13. Differences exist between IFRS and U.S. GAAP with regard to (a) the hierarchy of factors
used to determine the functional currency and (b) the method used to translate the financial
statements of a subsidiary located in a hyperinflationary country.
IAS 21 establishes primary factors and other factors to be considered in determining an
entity’s functional currency. When the indicators are mixed and the functional currency is
not obvious, the parent must give priority to the primary indicators in determining the foreign
entity’s functional currency. U.S. GAAP does not have a similar hierarchy.
In translating the foreign currency financial statements of a subsidiary located in a highly
inflationary economy, IAS 21 requires financial statements to first be restated for local
inflation and then translated into the parent’s currency using the current exchange rate for all
financial statement items. In contrast, U.S. GAAP requires use of the temporal method with
no adjustment for inflation in this situation.
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.
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].
18. B (Translation process (current rate method) – wages expense and wages
payable)
21. (10 minutes) (Specify appropriate exchange rates for the translation of
foreign currency financial statements under the current rate method)
Notes payable—as a liability, use current rate at the balance sheet date.
Cash—as an asset, use the current rate at the balance sheet date.
22. (5 minutes) Determine Translated Values under the Current Rate Method
23. (10 minutes) (Determine appropriate exchange rates under the current rate
fethod [translation] and temporal method [remeasurement])
Translation Remeasurement
Accounts payable $.16 C $.16 C
Accounts receivable $.16 C $.16 C
Accumulated depreciation $.16 C $.26 H
Advertising expense $.19 A $.19 A
Amortization expense $.19 A $.25 H
Buildings $.16 C $.26 H
Cash $.16 C $.16 C
Common stock $.28 H $.28 H
Depreciation expense $.19 A $.26 H
Dividends paid (10/1) $.20 H $.20 H
Notes payable $.16 C $.16 C
Patents (net) $.16 C $.25 H
Salary expense $.19 A $.19 A
Sales $.19 A $.19 A
Translation
Beginning net assets, 12/1 CHF3,700,000 x $.70 = $2,590,000
Ending net assets, 12/31 at
current exchange rate CHF3,700,000 x $.75 = (2,775,000)
Translation adjustment (positive) $( 185,000)
Remeasurement
Beginning net monetary
liability position, 12/1 CHF(300,000) x $.70 = $(210,000)
Ending net monetary liability
position, 12/31 at current
exchange rate CHF(300,000) x $.75 = (225,000)
Remeasurement loss $ 15,000
* Repair expense is the only expense not incurred evenly throughout the
year.
Balance Sheet
LCU U.S. Dollars
Cash 41,000 x $1.80 C = $ 73,800
Accounts receivable 10,000 x $1.80 C = 18,000
Building 140,000 x $1.80 C = 252,000
Accumulated depreciation (14,000) x $1.80 C = (25,200)
Total assets 177,000 $318,600
Interest payable 10,000 x $1.80 C = $ 18,000
Note payable 100,000 x $1.80 C = 180,000
Common stock 40,000 x $2.00 H = 80,000
Retained earnings 27,000 (above) 52,000
Translation adjustment (below) (11,400)
Total liabilities and equities 177,000 $318,600
29. (10 minutes) (Determine the appropriate exchange rate under the current rate
method [translation] and temporal method [remeasurement])
* This amount can be verified as ending assets (24,400 KQ) minus ending
liabilities (8,000 KQ) – net assets, 12/31 = 16,400 KQ.
* This amount can be verified as ending assets (17,000 KQ) minus ending
liabilities (8,000 KQ) – net assets, 12/31 = 9,000 KQ.
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
Balance Sheet
December 31, 2013
Goghs U.S. Dollars
Cash 44,000 x 1/.65 = 67,692
Receivables 116,000 x 1/.65 = 178,462
Inventory 58,000 x 1/.65 = 89,231
Fixed Assets (net) 339,000 x 1/.65 = 521,538
Total 557,000 856,923
** To determine cash proceeds from the sale of the building, changes in the
Accumulated Depreciation and Buildings accounts must be analyzed
along with Depreciation Expense and Gain on Sale of Building.
Depreciation expense is KR 15,000; KR 5,000 is attributable to equipment
(Accumulated Depreciation—Equipment increases by KR 5,000), KR
10,000 is depreciation of buildings. Accumulated Depreciation—
Buildings increases by only KR 5,000 during 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.
b. Translation Adjustment
b. and c.
b. and c.
Balance Sheet
December 31, 2013
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)
Pounds Dollars
Retained earnings, 1/1/12 -0- -0-
Net income, 2012 (163,000) 0.288 (46,944)
Dividends, 6/1/12 30,000 0.290 8,700
Retained earnings, 1/1/13 (133,000) (38,244)
Pounds Dollars
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
Account Dollars Dollars Debit Credit Dollars
Sales (200,000) (219,200) (419,200)
Cost of goods sold 93,800 115,080 208,880
Salary expense 19,000 20,276 39,276
Rent expense 7,000 9,864 16,864
Other expenses 21,000 16,166 37,166
Dividend income (13,750) -0- (I) 13,750 -0-
Gain, 10/1/13 -0- (8,190) (8,190)
Net income (72,950) (66,004) (125,204)
Ret earn, 1/1/13 (318,000) (38,244) (S) 38,244 (*C) (38,244) (356,244)
Net income (72,950) (66,004) (125,204)
Dividends paid 24,000 13,750 (I) (13,750) 24,000
Ret earn, 12/31/13 (366,950) (90,498) (457,448)
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)
Add’l 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) $( 900)
Exchange
KčS Rate US$
Sales 25,000,000 0.035 875,000
Cost of goods sold (12,000,000) Sched.A (493,500)
Depreciation expense—equipment (2,500,000) Sched.B (118,000)
Depreciation expense—building (1,800,000) Sched.C (85,200)
Research and development expense (1,200,000) 0.035 (42,000)
Other expenses (1,000,000) 0.035 (35,000)
Income before remeasurement gain 6,500,000 101,300
Remeasurement gain, 2013 - 408,000
Net income 6,500,000 509,300
Retained earnings, 1/1/13 500,000 given 353,000
Dividends paid, 12/15/13 (1,500,000) 0.031 (46,500)
Retained earnings, 12/31/13 5,500,000 815,800
KčS ER US$
Beginning inventory 6,000,000 0.043 258,000
Purchases 14,500,000 0.035 507,500
Ending inventory (8,500,000) 0.032 (272,000)
Cost of goods sold 12,000,000 493,500
Schedule B—Equipment
KčS ER US$
Old Equipment—at 1/1/13 20,000,000 0.050 1,000,000
New Equipment—acquired 1/3/13 5,000,000 0.036 180,000
Total 25,000,000 1,180,000
Schedule C—Building
KčS ER US$
Old Building—at 1/1/13 60,000,000 0.050 3,000,000
New Building—acquired 3/5/13 12,000,000 0.034 408,000
Total 72,000,000 3,408,000
Accum. Depr.—Old Building 30,000,000 0.050 1,500,000
Accum. Depr.—New Building 300,000 0.034 10,200
Total 30,300,000 1,510,200
Deprec. expense—Old Building 1,500,000 0.050 75,000
Deprec. expense—New Building 300,000 0.034 10,200
Total 1,800,000 85,200
Part I (c). U.S. dollar is the functional currency—temporal method (no long-
term debt)
Exchange
KčS Rate US$
Sales 25,000,000 0.035 875,000
Cost of goods sold (12,000,000) Sched.A (493,500)
Depreciation expense—equipment (2,500,000) Sched.B (118,000)
Depreciation expense—building (1,800,000) Sched.C (85,200)
Research and development expense (1,200,000) 0.035 (42,000)
Other expenses (1,000,000) 0.035 (35,000)
Income before remeasurement 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)
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.
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.
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.
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.‖
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.‖
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2013
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e 10-38
© 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.
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.
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.
Profit margin
NI 700 315 630
Sales 5,000 2,250 2,250
0.14 0.14 0.28
Return on equity
NI 700 315 630
Average TSE 3,550 1,541 1,915
0.19718 0.20441 0.32898
Inventory turnover
COGS 3,000 1,350 1,360
Average Inventory 1,000 380 430
3 3.55263 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.
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.
a. Translation of Suffolk’s December 31, 2013 trial balance from British pounds
to U.S. dollars.
Suffolk PLC
Trial Balance
December 31, 2013
Exchange
Pounds Rate Dollars
Cash £ 1,500,000 $1.68 $ 2,520,000
Accounts receivable 5,200,000 $1.68 8,736,000
Inventory 18,000,000 $1.68 30,240,000
Property, plant, & equipment (net) 36,000,000 $1.68 60,480,000
Accounts payable (1,450,000) $1.68 (2,436,000)
Long-term debt (5,000,000) $1.68 (8,400,000)
Common stock (44,000,000) $1.60 (70,400,000)
Retained earnings, 1/1/13 (8,000,000) Schedule A (12,840,000)
Sales (28,000,000) $1.66 (46,480,000)
Cost of goods sold 16,000,000 $1.66 26,560,000
Depreciation 2,000,000 $1.66 3,320,000
Other expenses 6,000,000 $1.66 9,960,000
Dividends paid (1/30/13) 1,750,000 $1.65 2,887,500
Cumulative translation
adjustment—positive (credit balance) (4,147,500)
£ 0 $ 0
Note: Amounts in parentheses are credit balances.
Exchange
Schedule A Pounds Rate Dollars
Retained earnings, 1/1/12 £(6,000,000) $1.60 $ (9,600,000)
Net income, 2012 (2,000,000) $1.62 (3,240,000)
Retained earnings, 12/31/12 £(8,000,000) $(12,840,000)
Exchange
Cost Allocation Schedule Pounds Rate Dollars
Cost £52,000,000 $1.60 $83,200,000
Book value 50,000,000 $1.60 80,000,000
Excess of cost over book value £ 2,000,000 $ 3,200,000
3,200,000
160,000
$0 $0 $92,727,500 $92,727,500 $0
Parker, Inc.
Consolidated Income Statement
For the year ended December 31, 2013
Sales $ 116,480,000
Cost of goods sold (60,560,000)
Depreciation (23,320,000)
Other expenses (15,960,000)
Net income $ 16,640,000
Parker, Inc.
Consolidated Balance Sheet
December 31, 2013
Assets
Cash $ 6,207,500
Accounts receivable 18,736,000
Inventory 60,240,000
Property, plant & equipment (net) 168,840,000
Total $254,023,500
a. Translation of Suffolk’s December 31, 2013 trial balance from British pounds
to U.S. dollars.
Suffolk PLC
Trial Balance
December 31, 2013
Exchange
Pounds Rate Dollars
Cash £ 1,500,000 $1.60 $ 2,400,000
Accounts receivable 5,200,000 $1.60 8,320,000
Inventory 18,000,000 $1.60 28,800,000
Property, plant, & equipment (net) 36,000,000 $1.60 57,600,000
Accounts payable (1,450,000) $1.60 (2,320,000)
Long-term debt (5,000,000) $1.60 (8,000,000)
Common stock (44,000,000) $1.60 (70,400,000)
Retained earnings, 1/1/13 (8,000,000) Schedule A (12,800,000)
Sales (28,000,000) $1.60 (44,800,000)
Cost of goods sold 16,000,000 $1.60 25,600,000
Depreciation 2,000,000 $1.60 3,200,000
Other expenses 6,000,000 $1.60 9,600,000
Dividends paid, 1/30/13 1,750,000 $1.60 2,800,000
Cumulative translation
adjustment 0
£ 0 $ 0
Note: Amounts in parentheses are credit balances.
Exchange
Schedule A Pounds Rate Dollars
Retained earnings, 1/1/12 £(6,000,000) $1.60 $ (9,600,000)
Net income, 2012 (2,000,000) $1.60 (3,200,000)
Retained earnings, 12/31/12 £(8,000,000) $(12,800,000)
Exchange
Cost Allocation Schedule Pounds Rate Dollars
Cost £52,000,000 $1.60 $83,200,000
Book value 50,000,000 $1.60 80,000,000
Excess of cost over book value £ 2,000,000 $ 3,200,000
3,200,000
$0 $0 $92,400,000 $92,400,000 $0
Parker, Inc.
Consolidated Income Statement
For the year ended December 31, 2013
Sales $114,800,000
Cost of goods sold (59,600,000)
Depreciation (23,200,000)
Other expenses (15,600,000)
Net income $ 16,400,000
Parker, Inc.
Consolidated Balance Sheet
December 31, 2013
Assets
Cash $ 6,000,000
Accounts receivable 18,320,000
Inventory 58,800,000
Property, plant & equipment (net) 165,800,000
Total $248,920,000
a. Translation of Suffolk’s December 31, 2013 trial balance from British pounds to
U.S. dollars.
Suffolk PLC
Trial Balance
December 31, 2013
Exchange
Pounds Rate Dollars
Cash £ 1,500,000 $1.52 $ 2,280,000
Accounts receivable 5,200,000 $1.52 7,904,000
Inventory 18,000,000 $1.52 27,360,000
Property, plant, & equipment (net) 36,000,000 $1.52 54,720,000
Accounts payable (1,450,000) $1.52 (2,204,000)
Long-term debt (5,000,000) $1.52 (7,600,000)
Common stock (44,000,000) $1.60 (70,400,000)
Retained earnings, 1/1/13 (8,000,000) Schedule A (12,760,000)
Sales (28,000,000) $1.54 (43,120,000)
Cost of goods sold 16,000,000 $1.54 24,640,000
Depreciation 2,000,000 $1.54 3,080,000
Other expenses 6,000,000 $1.54 9,240,000
Dividends paid (1/30/13) 1,750,000 $1.55 2,712,500
Cumulative translation
adjustment—negative (debit balance) 4,147,500
£ 0 $ 0
Note: Amounts in parentheses are credit balances.
Exchange
Schedule A Pounds Rate Dollars
Retained earnings, 1/1/12 £(6,000,000) $1.60 $ (9,600,000)
Net income, 2012 (2,000,000) $1.58 (3,160,000)
Retained earnings, 12/31/12 £(8,000,000) $(12,760,000)
Exchange
Cost Allocation Schedule Pounds Rate Dollars
Cost £52,000,000 $1.60 $83,200,000
Book value 50,000,000 $1.60 80,000,000
Excess of cost over book value £ 2,000,000 $ 3,200,000
3,200,000
160,000
$0 $0 $92,392,500 $92,392,500 $0
Parker, Inc.
Consolidated Income Statement
For the year ended December 31, 2013
Sales $ 113,120,000
Cost of goods sold (58,640,000)
Depreciation (23,080,000)
Other expenses (15,240,000)
Net income $ 16,160,000
Parker, Inc.
Consolidated Balance Sheet
December 31, 2013
Assets
Cash $ 5,792,500
Accounts receivable 17,904,000
Inventory 57,360,000
Property, plant & equipment (net) 162,760,000
Total $243,816,500
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.
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.