Solution manual advanced accounting 10e by beams ch13

Other factors that are considered in determining the functional currency include whether its sales prices are determined primarily by local competition or local government regulation ins

FOREIGN CURRENCY FINANCIAL STATEMENTS

Answers to Questions

1 A company’s functional currency is the currency of the primary economic environment in which it

operates It is normally the currency in which it receives most of its payments from customers and in which it pays most of its liabilities Other factors that are considered in determining the functional currency include whether its sales prices are determined primarily by local competition or local

government regulation instead of short-run exchange rate changes or worldwide markets

The functional currency determination (local currency or parent currency or some other currency) is critical in determining what approach to converting financial statements to the ultimate reporting currency is used: the current rate or the temporal method If the functional currency is the local currency, the current rate method is used If it is the parent currency, the temporal method is used If it

is some other currency, then both approaches may need to be used

2 A highly inflationary economy under Statement 52 is one that has cumulative inflation of approximately

100 percent or more over a three-year period The functional currency is assumed to be the reportingcurrency (for U.S companies, the dollar) which means that the foreign currency financial statementsmust be remeasured into the dollar using the temporal method The effect of the hyperinflation is thenreflected in the current year’s consolidated income statement which would not be the case if the currentrate method were used Judgment must be exercised in applying this rule to avoid changing functionalcurrencies frequently due to minor differences in the inflation rate

3 The functional currency of a foreign subsidiary does not affect the original recording of the business

combination This is because all assets, liabilities, and equities of the foreign subsidiary are convertedinto U.S dollars at the current exchange rate in effect on the date of consummation of the businesscombination As a result, no special procedure must be applied at the date of original recording of aforeign subsidiary

4 The current rate method is used when the foreign subsidiary’s currency is determined to be the

subsidiary’s functional currency The subsidiary’s financial statements must be translated using thecurrent rate method into the reporting entity’s currency (typically the parent’s currency)

5 The temporal method is used when the foreign subsidiary’s currency is determined to be the reporting

entity’s currency (typically the parent’s currency) The subsidiary’s financial statements must beremeasured using the temporal method into the reporting entity’s currency

6 Since the functional currency is not the parent’s, no direct impact on the reporting entity’s (parent’s)

cash flows is expected due to exchange rate changes The effects of exchange rate changes are reflected

in the consolidated statement’s accumulated comprehensive income account instead of being included inthe income statement

7 Since the functional currency is assumed to be the reporting entity’s (or parent’s), a direct impact on the

parent’s cash flows is expected due to exchange rate changes The effects of exchange rate changes arereflected in the consolidated income statement

8 A foreign subsidiary’s financial statements could be both translated and remeasured if the entity’s books

are maintained in a different currency than the functional currency and the functional currency is not the

a remeasurement gain or loss in income and the a translation adjustment included in accumulated othercomprehensive income.

9 No, it would not be appropriate to use the annual average exchange rate Theoretically, the exchange

rate at the date each transaction occurs should be used Given that this is not practical, reasonableassumptions are made concerning what exchange rate to use The use of an average exchange rate isappropriate when sales are earned evenly during the year and expenses are incurred evenly during theyear A reasonable assumption for a holiday tree grower would be to use the average exchange rateduring the quarter from October through December since those are the month’s that trees are typicallysold For expenses, examining the months that are the most labor intensive (such as planting, fertilizingand harvesting) and using a reasonable weighting of those months exchange rates would be a reasonableway of determining the rate for those costs

10 The parent purchased the subsidiary for an amount in excess of book value This excess was attributable

to an unrecorded patent Recall that the excess amount would not be included on the subsidiary’s books.The consolidated financial statements, however, would include both the amortization of the patent andthe patent Since the current rate method is being used, the impact of the change in exchange rates onthe patent and the amortization is included in the translation adjustment to be included in consolidatedcomprehensive income The subsidiary’s translation adjustment would not include this because thepatent was not included in the books Thus, the consolidated translation adjustment is larger than thesubsidiary’s translation adjustment

11 The temporal method requires remeasuring expenses of a foreign subsidiary Expenses related to

monetary items are remeasured at appropriately weighted average exchange rates for the period Thosetypes of expenses are either paid in cash or recorded as liabilities which will require the eventualpayment of cash Those that relate to nonmonetary items are remeasured at historical exchange rates

Expenses related to nonmonetary items would be those related to inventory and plant assets [See FASB Statement No 52, paragraph 48, for examples of nonmonetary items.] Under the current ratemethod, all accounts are translated at the weighted average rate

12 If the current rate method is used the gain or loss on the hedge of a net investment in a foreign

subsidiary is reported in other comprehensive income If the temporal method is used, the gain or loss

is included in current period income

13 [Appendix A] Under the current rate method, the noncontrolling interest’s balance includes its share of

the accumulated other comprehensive income translation adjustment, however, the noncontrollinginterest expense would not be affected This is logical since the translation adjustment bypasses theincome statement As one might expect, the remeasurement gain or loss from using the temporalmethod does affect the noncontrolling interest expense since the gain or loss is included in income

14 [Appendix B] The translation adjustment of cash is presented on a separate line in the consolidated

statement of cash flows immediately below the “cash flows from financing activities.” [See FASB Statement No 95, “Statement of Cash Flows,” Appendix C, paragraphs 144 and 146.]

15 [Appendix C] Special care must be exercised in applying the lower-of-cost-or-market rule to

inventories in remeasured statements because remeasured amounts are affected both by changes in exchange rates and changes in replacement costs Write-downs to market may be appropriate for both foreign currency statements and translated statements, foreign currency statements but not translated statements, or translated statements but not foreign currency statements

Paily Company and Subsidiary

Consolidated Balance Sheet

at January 1, 2006Current assets [$3,000,000 - $990,000 + (100,000£ × $1.65)] $2,175,000

Buildings — net [$1,200,000 + (250,000£ × $1.65)] 1,612,500Equipment — net [$1,000,000 + (100,000£ × $1.65)] 1,165,000Goodwill [$990,000 cost - (450,000£ fair value × $1.65)] 247,500

$6,330,000Current liabilities [$600,000 + (50,000£ × $1.65)] $ 682,500Notes payable [$1,000,000 + (150,000£ × $1.65)] 1,247,500

$6,330,000

Solution E13-4

Foreign currency statements

Inventory will be carried at the 10,000 euros historical cost

Remeasured statements (Temporal Method)

Inventory will be carried at cost of $5,300

Under translated statements (Current Rate Method)

Inventory will be carried at year-end current rate of $6,000

2 Patent amortization in dollars

Patent amortization in Euros (5,000,000/10 years)

= 500,000 Euros

Patent amortization in $ (500,000 Euros × $.032 average

3 Entry to record patent amortization

Solution E13-6

Preliminary computations

2 Equity adjustment from excess allocated to patent on December 31, 2006

Patent (must be carried in £) $4,440/$1.66 = 2,675 £ patent

Patent amortization is 2,675 £ / 10 years = 267 £Unamortized excess balance at year-end based on £

Add: Amortization of patent based on £

$ 4,390Less: Beginning patent based on U.S dollars $ 4,440Equity adjustment from translation of patent (loss) $ 50

Not required: The entry to record the decrease in the equity adjustment

related to equipment and patent would be as follows:

Equity adjustment from translation (equipment) 100

Equity adjustment from translation of patent 50

Solution E13-7

Preliminary computations

Book value acquired (1,400,000 Eu × $.75 exchange rate) 1,050,000

Excess allocated to undervalued land (400,000 Eu × $.75) $ 300,000

Equity adjustment from translation on excess allocated to land

Less: Excess on land at December 31, 2006

(400,000 Eu × $.77 current rate at year-end) 308,000Equity adjustment from translation - gain (credit) $ 8,000

Solution E13-8 [AICPA adapted]

Exchange loss of $15,000 less an exchange gain on the account payable of

$4,000 ($64,000 original payable - $60,000 year-end adjusted balance) =

Long-term receivables 1,500,000 LCU ÷ 1.5 = $1,000,000

Loan balance measured in pesos on December 31

($19,000/$.0016 current exchange rate) 11,875,000

Shinhan’s December 31, 2006 inventory

5,000,000 won ending inventory × $.00135 historical rate $ 6,750Shinhan’s cost of sales for 2006

In Won Exchange Rate In DollarsInventory January 1, 2006 9,000,000 $.0012 H $ 10,800

Less: Inventory December 31, 2006 (5,000,000) $.00135 H (6,750)

SOLUTIONS TO PROBLEMS

Solution P13-1

1 Parkway’s income from Scorpio for 2006

Investment cost of 40% interest in Scorpio $1,080,000

Less: Book value acquired ($2,400,000 × 40%) (960,000)

Patent in dollars at acquisition $ 120,000

Patent in euros at acquisition

$120,000/$.60 exchange rate = 200,000 eurosEquity in Scorpio’s income ($310,000 × 40%) $ 124,000

Patent amortization for 2006

200,000 euros/10 years × $.62 average rate (12,400)

Income from Scorpio for 2006 $ 111,600

2 Investment in Scorpio at December 31, 2006

3 Proof of investment balance

Net assets at December 31, 2006 of $2,730,000 × 40% $1,092,000Add: Unamortized patent (180,000 euros × $.65) 117,000

Excess Patent in LCUs $102,000/$.15 = 680,000 LCUs

2 Excess Patent amortization — 2006:

Excess Patent in LCUs 680,000/10 years × $.14 average

3 Unamortized Excess Patent at December 31, 2006:

(680,000 - 68,000 LCUs amortization) × $.13 current rate $ 79,560

4 Equity adjustment from Excess Patent:

Alternatively,

68,000 LCUs × ($.15 - $.14) = $ 680612,000 LCUs × ($.15 - $.13) = 12,240

$12,920

5 Income from Sorrier — 2006:

6 Investment in Sorrier balance at December 31, 2006:

Solution P13-3

Translation Worksheet for 2006

British Exchange Pounds Rate US Dollars

Equity adjustment from translation 25,500

To record income from Sooth and enter equity adjustment for currency fluctuations

Check:

Investment in Sooth 1/1 $800,000 Capital stock 400,000 £Dividends (48,600) Retained earnings 1/1 100,000 £

Equity adjustment 25,500 Less: Dividends (30,000)£Investment in Sooth 12/31 $891,000 Stockholders’ equity 540,000 £

$891,000

Solution P13-4

Preliminary computations

Less: Book value of interest acquired

(7,000,000 euros × $.50 exchange rate × 80% interest) 2,800,000

Patent in euros ($400,000/$.50 exchange rate) = 800,000 euros

Patent amortization based on euros 800,000 euros/10 years = 80,000 euros

Translation Worksheet

at and for the year ended December 31, 2006

Exchange Euros Rate U.S Dollars

2 Peter’s income from Schultz — 2006

Share of Schultz’s net income ($5,500,000 sales -

$2,200,000 cost of sales - $440,000 depreciation -

Less: Patent amortization (80,000 euros × $.55 average

Solution P13-4 (continued)

3 Investment in Schultz December 31, 2006

Add: Equity adjustment from translation ($795,000 × 80%) 636,000Add: Equity adjustment from Patent

[$400,000 Patent at beginning of the period - $44,000

Patent amortization — (720,000 euros unamortized Patent

Solution P13-6

Stuart Corporation

Remeasurement WorksheetDecember 31, 2006New Zealand Dollars Exchange Rate U.S Dollars

$.67) - ending inventory (30,000 NZ$ × $.66)Note 3 Depreciation on original equipment (50,000 NZ$ × 20% × $.70) +

depreciation on new equipment (10,000 NZ$ × 20% × $.68)Note 4 Other operating expenses consist of the prepaid supplies used

(8,000 NZ$ × $.70) + current year outlays (20,000 NZ$ × $.67)Note 5 Accumulated depreciation on the original equipment (20,000 NZ$ ×

$.70) + accumulated depreciation on the equipment purchased (2,000NZ$ × $.68)

Equity adjustment from translation 40,600

To record equity in Sapir

Equity adjustment from translation 3,840

To record equity adjustment from Patent amortization computed as follows:

Patent amortization 80,000 shekels/10 years × $.32 rate = $2,560Ending balance 72,000 shekels × $.30 rate = $21,600

$28,000 beginning balance - $21,600 ending balance = $6,400

Solution P13-8

Preliminary computations

Book value acquired (8,000,000 LCU × $.190) (1,520,000)

Amortization of Patent (1,000,000 LCU/10 years) 100,000 LCUPatent amortization for 2006 (100,000 LCU × $.185) $ 18,500Unamortized Patent at December 31, 2006

Equity adjustment for Patent for 2006:

Reconciliation of investment account:

Add: Income from SAA for 2006

($360,750 - $18,500 Patent amortization) 342,250Equity adjustment from translation ($84,750 × 100%) (84,750)

Equity adjustment from translation 84,750

To record equity in income of SAA

Equity adjustment from translation 9,500

Solution P13-8 (continued)

PWA Corporation and Subsidiary

Consolidation Working Papersfor the year ended December 31, 2006

PWA SAA Adjustments andEliminations ConsolidatedStatements

Retained earnings — SAA $ 570,000 b 570,000

Equity adjustment from translation 39,600

To record investment income from San of $49,500 computed as [$154,000 revenue – ($44,000 cost of sales + $22,000 depreciation expense + $26,400 other expenses + $6,600 exchange loss)] × 90% and to record equity adjustment from translation of $39,600 computed as $44,000 × 90%

Supporting computations

Less: Equity adjustment from translation (39,600)

Noncontrolling interest at January 1, 2006 date of

Solution P13-9 (continued)

Consolidation Working Papersfor the year ended December 31, 2006

Par San 90% Adjustments andEliminations Noncontrolling

Interest

Consolidated Statements

Income Statement

Income from San 49,500 a 49,500

Cost of sales (400,000) (44,000) (444,000) Depreciation expense (81,000) (22,000) (103,000) Other expenses (200,000) (26,400) (226,400)

Noncontrolling income $ 5,500 (5,500) Net income $ 168,500 $ 55,000 $ 168,500

December 31, 2006 $ 288,500 $ 82,000 $ 288,500

Balance Sheet

Accounts receivable 90,000 36,000 126,000 Loan to San 46,000 c 46,000

Inventories 110,000 46,000 156,000

Buildings — net 180,000 60,000 240,000 Equipment — net 160,000 80,000 240,000 Investment in San 207,000 a 30,600

b 176,400

$ 990,000 $ 302,000 $1,039,000

Accounts payable $ 241,100 $ 26,000 $ 267,100 Loan from Par 46,000 c 46,000

Capital stock 500,000 192,000 b 192,000 500,000 Retained earnings 288,500 82,000 288,500 Equity adjustment

Equity adjustment

— San (44,000) b 44,000