Now assume that a careful examination of the functional currency indicators in Exhibit 10.2 leads USCO’s management to conclude that SWISSCO’s functional currency is the U.S.
dollar. In that case, the Swiss franc financial statements must be remeasured into U.S. dollars using the temporal method and the remeasurement gain or loss reported in income. To ensure that the remeasurement gain or loss is reported in income, it is easiest to remeasure the bal- ance sheet first (as shown in Exhibit 10.7).
According to the procedures outlined in Exhibit 10.1, the temporal method remeasures cash, receivables, and liabilities into U.S. dollars using the current exchange rate of $0.70. In- ventory (carried at FIFO cost), property and equipment, patents, and the contributed capital accounts (Common Stock and Additional Paid-In Capital) are remeasured at historical rates.
These procedures result in total assets of $1,076,800 and liabilities and contributed capital of
$895,000. To balance the balance sheet, Retained Earnings must total $181,800. We verify the accuracy of this amount later.
Remeasurement of the Income Statement
Exhibit 10.8 shows the remeasurement of SWISSCO’s income statement and statement of retained earnings. Revenues and expenses incurred evenly throughout the year (sales, other expenses, and income taxes) are remeasured at the average exchange rate of $0.65. Expenses related to assets remeasured at historical exchange rates (depreciation expense and amortiza- tion expense) are remeasured at relevant historical rates.
452 Chapter 10
EXHIBIT 10.6 Translated Statement of Cash Flows—Current Rate Method
SWISSCO Statement of Cash Flows For Year Ending December 31, 2011
Translation
CHF Rate US$
Operating activities:
Net income . . . . CHF 470,000 0.65 A $ 305,500
Add: Depreciation . . . . 100,000 0.65 A 65,000
Amortization . . . . 10,000 0.65 A 6,500
Increase in accounts receivable . . . . (200,000) 0.65 A (130,000) Increase in inventory . . . . (250,000) 0.65 A (162,500)
Increase in accounts payable . . . . 600,000 0.65 A 390,000
Net cash from operations . . . . 730,000 474,500
Investing activities:
Purchase of property and equipment . . . . (1,000,000) 0.61 H (610,000)
Acquisition of patent . . . . (50,000) 0.62 H (31,000)
Net cash from investing activities . . . . . (1,050,000) (641,000)
Financing activities:
Proceeds from long-term debt . . . . 250,000 0.61 H 152,500
Payment of dividends . . . . (150,000) 0.67 H (100,500)
Net cash from financing activities . . . . 100,000 52,000
Decrease in cash . . . . (220,000) (114,500) Effect of exchange
rate change on cash . . . . To balance (4,500)
Cash at December 31, 2010 . . . . CHF 350,000 0.60 H 210,000 Cash at December 31, 2011 . . . . CHF 130,000 0.70 C $ 91,000
LO4
Remeasure a foreign subsidiary’s financial statements using the temporal method and calculate the associated remeasurement gain or loss.
hoy36628_ch10_435-488.qxd 1/7/10 6:42 PM Page 452
to download more slides, ebooks, and solution manual visit http://downloadslide.blogspot.com
Translation of Foreign Currency Financial Statements 453
EXHIBIT 10.7
Remeasurement of Balance Sheet—Temporal Method
SWISSCO Balance Sheet December 31, 2011
Remeasurement
CHF Rate US$
Assets
Cash . . . CHF 130,000 0.70 C $ 91,000
Accounts receivable . . . . 200,000 0.70 C 140,000
Inventory . . . . 400,000 0.68 H 272,000
Total current assets . . . . 730,000 503,000
Property and equipment . . . . 1,000,000 0.61 H 610,000
Less: Accumulated depreciation . . . . (100,000) 0.61 H (61,000)
Patents, net . . . . 40,000 0.62 H 24,800 Total assets . . . CHF 1,670,000 $1,076,800 Liabilities and Equities
Accounts payable . . . CHF 600,000 0.70 C $ 420,000
Total current liabilities . . . . 600,000 420,000
Long-term debt . . . . 250,000 0.70 C 175,000
Total liabilities . . . . 850,000 595,000
Common stock . . . . 100,000 0.60 H 60,000
Additional paid-in capital . . . . 400,000 0.60 H 240,000
Retained earnings . . . . 320,000 To balance 181,800
Total equity . . . . 820,000 481,800
Total liabilities and equity . . . CHF 1,670,000 $1,076,800
EXHIBIT 10.8
Remeasurement of Income Statement and Statement of Retained Earnings—
Temporal Method
SWISSCO Income Statement For Year Ending December 31, 2011
Remeasurement
CHF Rate US$
Sales . . . . CHF 4,000,000 0.65 A $ 2,600,000 Cost of goods sold . . . . (3,000,000) Calculation (1,930,500)
Gross profit . . . . 1,000,000 669,500
Depreciation expense . . . . (100,000) 0.61 H (61,000)
Amortization expense . . . . (10,000) 0.62 H (6,200)
Other expenses . . . . (220,000) 0.65 A (143,000)
Income before income taxes . . . . 670,000 459,300
Income taxes . . . . (200,000) 0.65 A (130,000) Remeasurement Loss . . . . To balance (47,000) Net income . . . . CHF 470,000 Below $ 282,300
Statement of Retained Earnings For Year Ending December 31, 2011
Remeasurement
CHF Rate US$
Retained earnings, 1/1/11 . . . . CHF –0– $ –0–
Net income, 2011 . . . . 470,000 To balance 282,300 Dividends . . . . (150,000) 0.67 H (100,500)
Retained earnings, 12/31/11 . . . . CHF 320,000 Above $ 181,800
hoy36628_ch10_435-488.qxd 1/23/10 7:30 PM Page 453
to download more slides, ebooks, and solution manual visit http://downloadslide.blogspot.com
The following procedure remeasures cost of goods sold at historical exchange rates. Be- ginning inventory acquired on January 1 is remeasured at the exchange rate on that date ($0.60). Purchases made evenly throughout the year are remeasured at the average rate for the year ($0.65). Ending inventory (at FIFO cost) is purchased evenly throughout the fourth quar- ter of 2011 and the average exchange rate for the quarter ($0.68) is used to remeasure that component of cost of goods sold. These procedures result in Cost of Goods Sold of
$1,930,500, calculated as follows:
Beginning inventory, 1/1/11 . . . CHF 150,000 0.60 $ 90,000 Plus: Purchases, 2011 . . . 3,250,000 0.65 2,112,500 Less: Ending inventory, 12/31/11 . . . (400,000) 0.68 (272,000)
Cost of goods sold, 2011 . . . CHF 3,000,000 $1,930,500 The ending balances in Retained Earnings on the balance sheet and on the statement of re- tained earnings must reconcile with one another. Because dividends are remeasured into a U.S.
dollar equivalent of $100,500 and the ending balance in Retained Earnings on the balance sheet is $181,800, net income must be $282,300.
Reconciling the amount of income reported in the statement of retained earnings and in the income statement requires a remeasurement loss of $47,000 in calculating net income. With- out this remeasurement loss, the income statement, statement of retained earnings, and bal- ance sheet are not consistent with one another.
The remeasurement loss can be calculated by considering the impact of exchange rate changes on the subsidiary’s balance sheet exposure. Under the temporal method, SWISSCO’s balance sheet exposure is defined by its net monetary asset or net monetary liability position.
SWISSCO began 2011 with net monetary assets (cash) of CHF 350,000. During the year, however, expenditures of cash and the incurrence of liabilities caused monetary liabilities (accounts payable long-term debt CHF 850,000) to exceed monetary assets (cash accounts receivable CHF 330,000). A net monetary liability position of CHF 520,000 ex- ists at December 31, 2011. The remeasurement loss is computed by translating the beginning net monetary asset position and subsequent changes in monetary items at appropriate ex- change rates and then comparing this with the dollar value of net monetary liabilities at year- end based on the current exchange rate:
Computation of Remeasurement Loss
Net monetary assets, 1/1/11 . . . CHF 350,000 0.60 $ 210,000 Increase in monetary assets:
Sales, 2011 . . . 4,000,000 0.65 2,600,000 Decreases in monetary assets and increases
in monetary liabilities:
Purchases, 2011 . . . (3,250,000) 0.65 (2,112,500) Other expenses, 2011 . . . (220,000) 0.65 (143,000) Income taxes, 2011 . . . (200,000) 0.65 (130,000) Purchase of property and equipment, 3/15/11 . . . (1,000,000) 0.61 (610,000) Acquisition of patent, 4/10/11 . . . (50,000) 0.62 (31,000) Dividends, 10/1/11 . . . (150,000) 0.67 (100,500) Net monetary liabilities, 12/31/11 . . . CHF (520,000) $ (317,000) Net monetary liabilities, 12/31/11
at the current exchange rate . . . CHF (520,000) 0.70 (364,000) Remeasurement loss . . . $ 47,000
Had SWISSCO maintained its net monetary asset position of CHF 350,000 for the entire year, a $35,000 remeasurement gain would have resulted. The CHF held in cash was worth
$210,000 (CHF 350,000 $0.60) at the beginning of the year and $245,000 (CHF 350,000
$0.70) at year-end. However, the net monetary asset position is not maintained because of changes during the year in monetary items other than the original cash balance. Indeed, a net
454 Chapter 10
hoy36628_ch10_435-488.qxd 1/23/10 7:30 PM Page 454
to download more slides, ebooks, and solution manual visit http://downloadslide.blogspot.com
Translation of Foreign Currency Financial Statements 455
monetary liability position arises. The foreign currency appreciationcoupled with an increase in net monetary liabilitiesgenerates a remeasurement lossfor the year.
Remeasurement of the Statement of Cash Flows
In remeasuring the statement of cash flows (shown in Exhibit 10.9), the U.S. dollar value for net income comes directly from the remeasured income statement. Depreciation and amorti- zation are remeasured at the rates used in the income statement, and the remeasurement loss is added back to net income because it is a noncash item. The increases in accounts receivable and accounts payable relate to sales and purchases and therefore are remeasured at the average rate. The U.S. dollar value for the increase in inventory is determined by referring to the re- measurement of the cost of goods sold.
The resulting U.S. dollar amount of “net cash from operations” ($474,500) is exactly the same as when the current rate method was used in translation. In addition, the investing and financing activities are translated in the same manner under both methods. This makes sense;
the amount of cash inflows and outflows is a matter of fact and is not affected by the particu- lar translation methodology employed.
Nonlocal Currency Balances
One additional issue related to the translation of foreign currency financial statements needs to be considered. If any of the accounts of the Swiss subsidiary are denominated in a currency other than the Swiss franc, those balances would first have to be restated into francs in accor- dance with the rules discussed in Chapter 9. Both the foreign currency balance and any related foreign exchange gain or loss would then be translated (or remeasured) into U.S. dollars. For example, a note payable of 10,000 British pounds first would be remeasured into Swiss francs before the translation process could commence.
EXHIBIT 10.9 Remeasurement of Statement of Cash Flows—
Temporal Method
SWISSCO Statement of Cash Flows For Year Ending December 31, 2011
Remeasurement
CHF Rate US$
Operating activities:
Net income . . . CHF 470,000 From I/S $ 282,300
Add: Depreciation expense . . . . 100,000 0.61 H 61,000
Amortization expense . . . . 10,000 0.62 H 6,200
Remeasurement loss . . . . From I/S 47,000
Increase in accounts receivable . . . . (200,000) 0.65 A (130,000)
Increase in inventory . . . . (250,000) * (182,000)
Increase in accounts payable . . . . 600,000 0.65 A 390,000
Net cash from operations . . . . 730,000 474,500
Investing activities:
Purchase of property and equipment . . (1,000,000) 0.61 H (610,000)
Acquisition of patent . . . . (50,000) 0.62 H (31,000)
Net cash from investing activities . . (1,050,000) (641,000)
Financing activities:
Proceeds from long-term debt . . . . 250,000 0.61 H 152,500
Payment of dividends . . . . (150,000) 0.67 H (100,500)
Net cash from financing activities . . 100,000 52,000
Decrease in cash . . . . (220,000) (114,500)
Effect of exchange rate changes on cash To balance (4,500)
Cash at December 31, 2010 . . . CHF 350,000 0.6 H $ 210,000 Cash at December 31, 2011 . . . CHF 130,000 0.7 C $ 91,000
*In remeasuring cost of goods sold earlier, beginning inventory was remeasured as $90,000 and ending inventory was remeasured as $272,000:
an increase of $182,000.
hoy36628_ch10_435-488.qxd 1/23/10 7:30 PM Page 455
to download more slides, ebooks, and solution manual visit http://downloadslide.blogspot.com