16.2 Flashcards
Boe Corp.’s equity balances, which include no accumulated other comprehensive income, were as follows at December 31:
6% noncumulative preferred stock, $100 par (liquidation value $105 per share): $100,000
Common stock, $10 par: 300,000
Retained earnings: 95,000
At December 31, Boe’s book value per common share was
$13
The preferred stock is noncumulative, so the equity of the preferred shareholders equals the liquidation value of $105,000 (1,000 shares × $105 per share). Given total equity of $495,000 ($100,000 + $300,000 + $95,000), common equity is $390,000 ($495,000 – $105,000). Therefore, book value per common share equals $13.00 ($390,000 ÷ 30,000 shares).
On October 1 of the current year, a U.S. company sold merchandise on account to a British company for 2,000 pounds (exchange rate, 1 pound = $1.43). At the company’s December 31 fiscal year end, the exchange rate was 1 pound = $1.45. The exchange rate was 1 pound = $1.50 on collection in January of the subsequent year. What amount would the company recognize as a gain (loss) from the foreign currency transaction when the receivable is collected?
$100
Gains and losses from foreign currency transactions are recognized in current earnings. Because the exchange rate (dollars per pound) increased, the U.S. entity’s receivable, which is denominated in pounds, increased in value. Thus, the result is a gain. At the time of collection in January, the gain is $100 [($1.50 – $1.45) × 2,000 pounds]. At December 31, the gain was $40 [($1.45 – $1.43) × 2,000 pounds].
The functional currency of Nash, Inc.’s subsidiary is the euro. Nash borrowed euros as a partial hedge of its investment in the subsidiary. In preparing consolidated financial statements, Nash’s translation loss on its investment in the subsidiary exceeded its transaction gain on the borrowing. How should the effects of the loss and gain be reported in Nash’s consolidated financial statements?
The translation loss less the transaction gain is reported in other comprehensive income.
Translation adjustments are gains and losses from translating financial statements from the functional to the reporting currency. They should be reported in other comprehensive income. They are not included in the determination of net income. A foreign currency transaction gain or loss ordinarily should be included as a component of income from continuing operations in the period in which the exchange rate changes. However, a gain or loss on a foreign currency transaction that hedges a net investment in a foreign entity is not included in the determination of net income but is reported in the same manner as a translation adjustment. Thus, the translation loss and the transaction gain should be reported in accumulated other comprehensive income.
Hunt Co. purchased merchandise for 300,000 British pounds from a vendor in London on November 30, Year 4. Payment in British pounds was due on January 30, Year 5. The exchange rates to purchase one pound were as follows:
November 30, Year 4
Spot-rate 1.65
30-day rate 1.64
60-day rate 1.63
December 31, Year 4
Spot-rate 1.62
30-day rate 1.59
60-day rate 1.56
In its December 31, Year 4, income statement, what amount should Hunt report as foreign currency transaction gain?
$9,000
In its December 31, Year 4, income statement, what amount should Hunt report as foreign currency transaction gain?
The following financial ratios and calculations were based on information from Kale Co.’s financial statements for the current year:
Accounts receivable turnover: Ten times during the year
Total assets turnover: Two times during the year
Average receivables during the year: $200,000
What was Kale’s average total assets for the year?
$1,000,000
The total assets turnover ratio (given as 2.0) equals net sales divided by average total assets. The accounts receivable turnover ratio (given as 10.0) equals net sales divided by average accounts receivable (it must be assumed that all sales are on credit). Given $200,000 of average accounts receivable, net sales must equal $2,000,000 ($200,000 × 10.0). Accordingly, average total assets equals $1,000,000 ($2,000,000 net revenue ÷ 2.0 total assets turnover).
When remeasuring foreign currency financial statements into the functional currency, which of the following items would be remeasured using historical exchange rates?
Inventories carried at cost.
The current rate of exchange is used for remeasuring certain balance sheet items and the historical rate for other balance sheet items. Nonmonetary balance sheet items and related revenue, expense, gain, and loss accounts are remeasured at the historical rate. Monetary accounts are remeasured at the current rate. Inventories valued at cost are nonmonetary items and are measured at historical rates.
Selected data pertaining to Lore Co. for the Year 4 calendar year is as follows:
Net cash sales: $3,000
Cost of goods sold: 18,000
Inventory at beginning of year: 6,000
Purchases: 24,000
Accounts receivable at beginning of year: 20,000
Accounts receivable at end of year: 22,000
What was Lore’s inventory turnover for Year 4?
2.0 times
Inventory turnover is equal to cost of goods sold divided by average inventory. Ending inventory equals beginning inventory, plus purchases, minus cost of goods sold, or $12,000 ($6,000 + $24,000 – $18,000). Average inventory is $9,000 [($6,000 + $12,000) ÷ 2]. Inventory turnover is 2.0 times ($18,000 cost of goods sold ÷ $9,000 average inventory).
The following is the equity section of Harbor Co.’s balance sheet at December 31:
Common stock $10 par, 100,000 shares authorized, 50,000 shares issued, of which 5,000 have been reacquired and are held in treasury: $450,000
Additional paid-in capital-common stock: 1,100,000
Retained earnings: 800,000
Subtotal: $2,350,000
Minus: treasury stock (at cost): (150,000)
Total stockholders’ equity: $2,200,000
Harbor has insignificant amounts of convertible securities, stock warrants, and stock options. What is the book value per share of Harbor’s common stock?
$49
The book value per share of common stock equals net assets available to common shareholders divided by ending common shares outstanding. Net assets available to common shareholders can also be stated as total equity minus liquidation value of preferred stock. Given no preferred shares, the numerator equals equity (assets minus liabilities). Thus, the book value per share of common stock is $49 [$2,200,000 equity ÷ (50,000 shares issued – 5,000 shares held in treasury)].
Toigo Co. purchased merchandise from a vendor in England on November 20 for 500,000 British pounds. Payment was due in British pounds on January 20. The spot rates to purchase 1 pound were as follows:
November 20: $1.25
December 31: 1.20
January 20: 1.17
How should the foreign currency transaction gain be reported on Toigo’s financial statements at December 31?
A gain of $25,000 in the income statement.
Foreign currency transactions are recorded at the spot rate in effect at the transaction date. Transaction gains and losses are included in the income statement in the period the exchange rate changes. On November 20, the entity made the following entry:
Inventory (500,000 pounds × $1.25): $625,000
Accounts payable: $625,000
On December 31, the entity made the following entry:
Accounts payable [500,000 pounds × ($1.25 – $1.20)]: $25,000
Foreign currency transaction gain: $25,000
In a comparison of the two most recent years, Neir Co.’s inventory turnover ratio increased substantially, although sales and inventory amounts were essentially unchanged. Which of the following statements explains the increased inventory turnover ratio?
Gross profit percentage decreased.
The inventory turnover ratio is equal to cost of goods sold divided by average inventory. If inventory is unchanged, an increase in cost of goods sold (the numerator) increases the ratio. A decrease in the gross profit percentage [(sales – cost of goods sold) ÷ sales] signifies an increase in cost of goods sold, given that the amount of sales is constant.
On October 1, Bordeaux, Inc., a calendar year-end firm, invested in a derivative designed to hedge the risk of changes in fair value of certain assets, currently valued at $1.5 million. The derivative is structured to result in an effective hedge. However, some ineffectiveness may result. On December 31, the fair value of the hedged assets has decreased by $350,000, and the fair value of the derivative has increased by $325,000. Bordeaux should recognize a net effect on earnings for the year of
$25,000
A hedge of an exposure to changes in the fair value of a recognized asset or liability is classified as a fair value hedge. Gains and losses arising from changes in fair value of a derivative classified as a fair value hedge are included in the determination of earnings in the period of change. They are offset by losses or gains on the hedged item attributable to the risk being hedged. Thus, earnings of the period of change are affected only by the net gain or loss attributable to the ineffective aspect of the hedge. The ineffective portion is equal to $25,000 ($350,000 – $325,000).
How is the average inventory used in the calculation of each of the following?
Acid Test (Quick) ratio: Inventory Turnover rate:
Not used
Denominator
Assets included in the numerator of the acid-test (quick) ratio include cash, short-term investment securities, and net accounts receivable. The inventory turnover rate is equal to cost of goods sold divided by average inventory. Thus, average inventory is included in the denominator of the inventory turnover rate but is not used in the acid-test ratio.
At the beginning of period 1, Forecast Corp. enters into a qualifying cash flow hedge of a transaction it expects to occur at the beginning of period 4. Forecast assesses hedge effectiveness by comparing the change in present value (PV) of the expected cash flows associated with the forecasted transaction with all of the hedging derivative’s gain or loss (change in fair value). The change in those cash flows that occurs for any reason has been designated as the hedged risk. The following information about the periodic changes in the hedging relationship is available:
Period 1
Change in FV of Derivative: $50,000
Change in PV of Expected Cash Flows from the Forecasted Transaction: $(48,000)
Period 2
Change in FV of Derivative: $47,000
Change in PV of Expected Cash Flows from the Forecasted Transaction: $(52,000)
Period 3
Change in FV of Derivative: $81,000
Change in PV of Expected Cash Flows from the Forecasted Transaction: $80,000
Given that the hedge is effective to the extent it offsets the change in the present value of the expected cash flows on the forecasted transaction, Forecast should
Report a balance in accumulated other comprehensive income (OCI) of $16,000 at the end of period 3.
The effective portion of a cash flow hedge of a forecasted transaction is included in accumulated OCI (an equity account to which periodic OCI is closed) until periods in which the forecasted transaction affects earnings. At the end of period 3, the net change in the hedging derivative’s fair value is $16,000 ($50,000 + $47,000 – $81,000), and the change in the PV of the expected cash flows on the forecasted transaction is –$20,000 ($80,000 – $48,000 – $52,000). Thus, the hedge is effective at the end of period 3 to the extent it offsets $16,000 of the net $20,000 decrease in the cash flows of the forecasted transaction that are expected to occur in period 4.
Which of the following is included in other comprehensive income?
Foreign currency translation adjustments.
Other comprehensive income (OCI) includes all items of comprehensive income not included in net income. Foreign currency translation adjustments for a foreign operation that is relatively self-contained and integrated within its environment do not affect cash flows of the reporting entity. Thus, they are excluded from earnings and reported in OCI.
The following information pertains to Ali Corp. as of and for the year ended December 31:
Liabilities: $60,000
Equity: $500,000
Shares of common stock issued and outstanding: 10,000
Net income: $30,000
During the year, Ali’s officers exercised share options for 1,000 shares of stock at an option price of $8 per share. What was the effect of exercising the share options?
Debt-to-equity ratio decreased to 12%.
Exercising share options improves (decreases) the debt-to-equity ratio because equity is increased with no effect on debt. When share options are exercised, common stock and additional paid-in capital are credited and cash is debited.
