11/17/2020 In-class practice question

1. Award: 10.00 points Problems? Adjust credit for all students.

On December 31, Year 1, Precision Manufacturing Inc. (PMI) of Edmonton purchased 100% of the outstanding
ordinary shares of Sandora Corp. of Flint, Michigan.

Sandora’s comparative statement of financial position and Year 2 income statement are as follows:

STATEMENT OF FINANCIAL POSITION

At December 31
Year 2 Year 1
Plant and equipment (net) US$ 6,600,000 US$ 7,300,000
Inventory 5,700,000 6,300,000
Accounts receivable 6,100,000 4,700,000
Cash 780,000 900,000
US$ 19,180,000 US$ 19,200,000
Ordinary shares US$ 5,000,000 US$ 5,000,000
Retained earnings 7,480,000 7,000,000
Bonds payable—due Dec. 31, Year 6 4,800,000 4,800,000
Current liabilities 1,900,000 2,400,000
US$ 19,180,000 US$ 19,200,000

INCOME STATEMENT
For the year ended December 31, Year 2
Sales US$ 30,000,000
Cost of purchases 23,400,000
Change in inventory 600,000
Depreciation expense 700,000
Other expenses 3,800,000
28,500,000
Profit US$ 1,500,000

Additional Information

Exchange rates

Dec. 31, Year 1 US$1= C$1.10

Sep. 30, Year 2 US$1= C$1.07
Dec. 31, Year 2 US$1= C$1.05
Average for Year 2 US$1= C$1.08

Sandora declared and paid dividends on September 30, Year 2.

The inventories on hand on December 31, Year 2, were purchased when the exchange rate was US$1 =
C$1.06.

Required:
(a) Assume that Sandora's functional currency is the Canadian dollar:

(i) Calculate the Year 2 exchange gain (loss) that would result from the translation of Sandora's financial statements.
(Input all amounts as positive value. Omit currency symbol in your response.)

Exchange gain C$ 16,400

(ii) Translate the Year 2 financial statements into Canadian dollars. (Round the values in the "Rate" column to 2
decimal places. Exchange gain, if any, should be entered as positive value, and Exchange loss, if any, should
be entered with a minus sign. Input all other amounts as positive values. Omit currency symbol in your
response.)
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11/17/2020 In-class practice question

Income Statement-Year 2
US$ Rate C$
Sales 30,000,000 × 1.08 32,400,000
Cost of purchases 23,400,000 × 1.08 25,272,000
Change in inventory 600,000 888,000
Depreciation expense 700,000 × 1.10 770,000
Other expenses 3,800,000 × 1.08 4,104,000
Exchange gain 16,400
28,500,000 31,017,600
Profit 1,500,000 1,382,400

Retained Earnings Statement-Year 2

US$ Rate C$
Bal. Jan 1 7,000,000 × 1.10 7,700,000
Profit 1,500,000 1,382,400
8,500,000 9,082,400
Dividends 1,020,000 × 1.07 1,091,400
Bal. Dec 31 7,480,000 7,991,000

Statement of Financial Position - December 31, Year 2

US$ Rate C$
Plant and equipment (net) 6,600,000 × 1.10 7,260,000 non-monetary items
Inventory 5,700,000 × 1.06 6,042,000
Accounts receivable 6,100,000 × 1.05 6,405,000
Cash 780,000 × 1.05 819,000
19,180,000 20,526,000
Ordinary shares 5,000,000 × 1.10 5,500,000
Retained earnings 7,480,000 7,991,000
Bonds payable 4,800,000 × 1.05 5,040,000
Current liabilities 1,900,000 × 1.05 1,995,000
19,180,000 20,526,000

(b) Assume that Sandora's functional currency is the U.S. dollar:

(i) Calculate the Year 2 exchange gain (loss) that would result from the translation of Sandora's financial statements
and would be reported in other comprehensive income. (Input all amounts as positive value. Omit currency symbol
in your response.)

Exchange loss C$ 624,600

(ii) Translate the Year 2 financial statements into Canadian dollars. (Round the values in the "Rate" column to 2
decimal places. Loss amounts should be indicated with a minus sign. Input all other amounts as positive
values. Omit currency symbol in your response.)

Income Statement - Year 2

US$ Rate C$
Sales 30,000,000 × 1.08 32,400,000
Cost of purchases 23,400,000 × 1.08 25,272,000
Change in inventory 600,000 × 1.08 648,000
Depreciation expense 700,000 × 1.08 756,000
Other expenses 3,800,000 × 1.08 4,104,000
Total 28,500,000
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11/17/2020 In-class practice question

30,780,000
Profit 1,500,000 × 1.08 1,620,000
Other comprehensive loss − unrealized exchange loss -624,600
Comprehensive income 995,400

Retained Earnings Statement - Year 2

US$ Rate C$
Bal. Jan 1 7,000,000 × 1.10 7,700,000
Profit 1,500,000 × 1.08 1,620,000
8,500,000 9,320,000
Dividends 1,020,000 × 1.07 1,091,400
Bal. Dec 31 7,480,000 8,228,600

Statement of Financial Position - December 31, Year 2

US$ Rate C$
Plant and equipment (net) 6,600,000 × 1.05 6,930,000
Inventory 5,700,000 × 1.05 5,985,000
Accounts receivable 6,100,000 × 1.05 6,405,000
Cash 780,000 × 1.05 819,000
19,180,000 20,139,000
Ordinary shares 5,000,000 × 1.10 5,500,000
Retained earnings 7,480,000 8,228,600
Accumulated foreign exchange adjustments -624,600
Bonds payable 4,800,000 × 1.05 5,040,000
Current liabilities 1,900,000 × 1.05 1,995,000
19,180,000 20,139,000

(c) Which functional currency would Sandora prefer to use if it wants to show the following?

(i) The strongest solvency position for the company.

Functional currency is Canadian dollar.

Functional currency is U.S. dollar and accumulated foreign exchange adjustments (AFEA) are included in equity.
Functional currency is U.S. dollar and accumulated foreign exchange adjustments (AFEA) are excluded from equity.

(ii) The best return on shareholders' equity.

Functional currency is Canadian dollar.

Functional currency is U.S. dollar and other comprehensive income (OCI) is included in income.
Functional currency is U.S. dollar and other comprehensive income (OCI) is excluded income.

Explanation:

(a-i)
Sandora’s functional currency is the Canadian dollar i.e. Sandora is an integrated foreign subsidiary

Retained earnings Dec. 31, Year 1 US$7,000,000

Profit – Year 2 1,500,000
8,500,000
Retained earnings Dec. 31, Year 2 7,480,000
Dividends Year 2 US$1,020,000

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11/17/2020 In-class practice question

Net monetary position US$ C$

Balance Jan 1, Year 2 (US$4,700,000 +
US$900,000 − US$4,800,000 − US$2,400,000) (1,600,000) × 1.10 (1,760,000)
Changes − Year 2
Sales 30,000,000 × 1.08 32,400,000
Purchases (23,400,000) × 1.08 (25,272,000)
Other expenses (3,800,000) × 1.08 (4,104,000)
Dividends (1,020,000) × 1.07 (1,091,400)
Calculated monetary position 172,600
Actual monetary position (US$6,100,000 +
US$780,000 − US$4,800,000 − US$1,900,000) 180,000 × 1.05 189,000
Exchange gain − Year 2 16,400

(a-ii)
Translation of Sandora's financial statements

Calculation of change in inventory US$ C$

Inventory – Year 1 6,300,000 × 1.10 6,930,000
Inventory – Year 2 5,700,000 × 1.06 6,042,000
600,000 888,000

(b-i)
Sandora’s functional currency is the US dollar i.e. Sandora is a self-sustaining foreign subsidiary

US$ C$
Net assets Year 1 12,000,000 × 1.10 13,200,000
Profit – Year 2 1,500,000 × 1.08 1,620,000
Dividends – Year 2 (1,020,000) × 1.07 (1,091,400)
Calculated net assets 13,728,600
Actual net assets – Year 2 12,480,000 × 1.05 13,104,000
Exchange loss – Year 2 (to be reported in other comprehensive income) 624,600

(c)
The answer to both of these questions depends on whether other comprehensive income (OCI) and accumulated
foreign exchange adjustments (AFEA) are included (B1 below) or excluded (B2 below) from the calculations as
indicated by the following:

A B1 B2
Total debt 7,035 7,035 7,035
Total equity including AFEA 13,491 13,104
Total equity excluding AFEA 13,729
Debt to equity ratio 0.52 0.54 0.51
Profit 1,382 1,620
Comprehensive income 995
Total equity including AFEA 13,491 13,104
Total equity excluding AFEA 13,729
Return on shareholders’ equity 10.2% 7.6% 11.8%

(i) The strongest solvency position is shown under B2 where the functional currency is the US dollar and shareholders’
equity excludes the accumulated foreign exchange losses.
(ii) The best return on shareholders’ equity is shown under B2 where the functional currency is the US dollar but the
profit rather than comprehensive income is used as the numerator.

References

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11/17/2020 In-class practice question

Worksheet Learning Objective: 11-

04 Prepare translated
financial statements for
foreign operations using
the presentation
currency translation
method.

Learning Learning Objective: 11-

Objective: 11-03 06 Analyze and interpret
Prepare translated financial statements
financial involving foreign
statements for operations.
foreign operations
using the
functional
currency
translation
method.

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