16.4 Flashcards
Gains from remeasuring a foreign subsidiary’s financial statements from the local currency into its functional currency should be reported
In income from continuing operations.
If the books of record of a foreign entity are maintained in a currency other than the functional currency, the foreign currency amounts first must be remeasured into the functional currency using the temporal method and then translated using the current rate method into the reporting currency. The gain arising from remeasurement should be reported in current earnings as part of continuing operations.
The effective portion of a loss associated with a change in fair value of a derivative instrument should be reported as a component of other comprehensive income only if the derivative is appropriately designated as a
Cash flow hedge of the foreign currency exposure of a forecasted transaction.
The hedge of the foreign currency exposure of a forecasted transaction is designated as a cash flow hedge. The effective portion of gains and losses associated with changes in fair value of a derivative instrument designated and qualifying as a cash flow hedging instrument is reported as a component of other comprehensive income.
Park Co.’s wholly owned subsidiary, Schnell Corp., maintains its accounting records in euros. Because all of Schnell’s branch offices are in London, its functional currency is the British pound. Remeasurement of Schnell’s Year 4 financial statements resulted in a $7,600 gain, and translation of its financial statements resulted in an $8,100 gain. What amount should Park report as a foreign currency transaction gain in its income statement for the year ended December 31, Year 4?
$7,600
The financial statements must be remeasured into the functional currency using the temporal method and then translated into the reporting currency using the current rate method. The $7,600 gain arising from remeasurement should be reported in current income. The $8,100 translation gain should be reported in other comprehensive income and is not reflected in income.
On December 1 of the current year, Bann Co. entered into an option contract to purchase 2,000 shares of Norta Co. stock for $40 per share (the same as the current market price) by the end of the next 2 months. The time value of the option contract is $600. At the end of December, Norta’s stock was selling for $43, and the time value of the option is now $400. If Bann does not exercise its option until January of the subsequent year, which of the following changes would reflect the proper accounting treatment for this transaction on Bann’s December 31, year-end financial statements?
Net Income will decrease by $5,800.
The contract is a call option. A call option allows the purchaser to benefit from an increase in price of the underlying. The purchaser pays a premium for the opportunity to benefit from the appreciation in the underlying (in this case, stock). Thus, a call option is a derivative. A derivative is an investment transaction in which the buyer purchases the right to a potential gain with a commitment for a potential loss. The purpose is either to speculate (incur risk) or to hedge (avoid risk). A derivative is an unperformed contract that results in cash flow between two counterparties based on the change in some other indicator of value. The gains and losses from changes in the fair value of a derivative that is not a hedging instrument are included in earnings in the period of change. The change in fair value of the call option includes (1) a decrease of $200 ($600 – $400) in its time value (amount in excess of intrinsic value) and (2) an increase of $6,000 [2,000 × ($43 – $40)] in its intrinsic value (market price – exercise price). Thus, the total change in fair value recognized in earnings is an unrealized gain of $5,800 ($6,000 – $200).
TGR Enterprises provided the following information from its statement of financial position for the year ended December 31, Year 1:
January 1: Cash $10,000 Accounts receivable $120,000 Inventories $200,000 Prepaid expenses $20,000 Accounts payable $175,000 Accrued liabilities $25,000
December 31: Cash $50,000 Accounts receivable $100,000 Inventories $160,000 Prepaid expenses $10,000 Accounts payable $120,000 Accrued liabilities $30,000
TGR’s sales and cost of sales for Year 1 were $1,400,000 and $840,000, respectively. What is the accounts receivable turnover in days?
28.7 days
The accounts receivable turnover in days equals the number of days in the year divided by the accounts receivable turnover (sales ÷ average accounts receivable). Thus, using a 365-day year, the number of days in receivables is 28.7 [365 ÷ ($1,400,000 ÷ $110,000)].
Ball Corp. had the following foreign currency transactions during Year 4:
- Merchandise was purchased from a foreign supplier on January 20, Year 4, for the U.S. dollar equivalent of $90,000. The invoice was paid on March 20, Year 4, at the U.S. dollar equivalent of $96,000.
- On July 1, Year 4, Ball borrowed the U.S. dollar equivalent of $500,000 evidenced by a note that was payable in the lender’s local currency on July 1, Year 6. On December 31, Year 4, the U.S. dollar equivalents of the principal amount and accrued interest were $520,000 and $26,000, respectively. Interest on the note is 10% per annum.
In Ball’s Year 4 income statement, what amount should be included as a foreign currency transaction loss?
$27,000
When a foreign currency transaction gives rise to a receivable or a payable that is fixed in terms of the foreign currency, a change in the exchange rate between the functional currency and the currency in which the transaction is denominated is a gain or loss that ordinarily should be included as a component of income from continuing operations in the period in which the exchange rate changes. In the Year 4 income statement, the foreign currency transaction loss should include the $6,000 difference between the $90,000 initially recorded as a payable and the $96,000 payment amount, the $20,000 difference between the $500,000 equivalent amount of the principal of the note at December 31 and its $520,000 equivalent at July 1, and the $1,000 difference between the $26,000 equivalent of the interest accrued and the $25,000 [$500,000 × 10% × (6 ÷ 12 months)] interest on the initially recorded amount of the loan. The foreign currency transaction loss therefore equals $27,000 ($6,000 + $20,000 + $1,000).
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.
Stent Co. had total assets of $760,000, capital stock of $150,000, and retained earnings of $215,000. What was Stent’s debt-to-equity ratio?
1.08
The debt-to-equity ratio equals total liabilities divided by total equity. Total liabilities equal $395,000 ($760,000 total assets – $150,000 capital stock – $215,000 retained earnings). Consequently, the debt-to-equity ratio is 1.08 (rounded) [$395,000 ÷ ($150,000 + $215,000)].
Shore Co. records its transactions in U.S. dollars. A sale of goods resulted in a receivable denominated in Japanese yen, and a purchase of goods resulted in a payable denominated in euros. Shore recorded a foreign currency transaction gain on collection of the receivable and an exchange loss on settlement of the payable. The exchange rates are expressed as so many units of foreign currency to one dollar. Did the number of foreign currency units exchangeable for a dollar increase or decrease between the contract and settlement dates?
Yen Exchangeable for $1:
Euros Exchangeable for $1:
Decrease
Decrease
When a foreign currency transaction results in a receivable or a payable, fixed in terms of the amount of foreign currency, a change in the exchange rate between the functional currency and the currency in which the transaction is denominated is a gain or loss that ordinarily should be included as a component of income from continuing operations in the period in which the exchange rate changes. A gain on a receivable denominated in a foreign currency results when the fixed amount of the foreign currency can be exchanged for a greater number of dollars at the date of collection, that is, when the number of foreign currency units exchangeable for a dollar decreases. A loss on a payable denominated in a foreign currency results when the number of dollars needed to purchase the fixed amount of the foreign currency increases, that is, when the number of foreign currency units exchangeable for a dollar decreases.
A sale of goods was denominated in a currency other than the entity’s functional currency. The sale resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. The exchange rate between the functional currency and the currency in which the transaction was denominated changed. The effect of the change should be included as a(n)
Component of income whether the change results in a gain or a loss.
A foreign currency transaction is one whose terms are denominated in a currency other than the entity’s functional currency. When a foreign currency transaction gives rise to a receivable or a payable that is fixed in terms of the amount of foreign currency to be received or paid, a change in the exchange rate between the functional currency and the currency in which the transaction is denominated results in a gain or loss that ordinarily should be included as a component of income from continuing operations in the period in which the exchange rate changes.
A foreign subsidiary of a U.S. parent company should measure its assets, liabilities, and operations using
The subsidiary’s functional currency.
The functional currency is the currency of the primary economic environment in which the entity operates. Normally, that environment is the one in which it primarily generates and expends cash. The subsidiary’s functional currency is the currency that is used to measure its liabilities, assets, and operations. At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss resulting from the transaction must be measured in the functional currency of the recording entity. If an entity’s books of record are not maintained in its functional currency, remeasurement into the functional currency is required before translation into the reporting currency.
Fact Pattern:
As part of its risk management strategy, Copper Monkey Mining sells futures contracts to hedge changes in fair value of its inventory. On March 12, the commodity exchange spot price was $0.81/lb., and the futures price for mid-June was $0.83/lb. On that date, Copper Monkey, which has a March 31 fiscal year end, sold 200 futures contracts on the commodity exchange at $0.83/lb. for delivery in June. Each contract was for 25,000 lb. Copper Monkey designated these contracts as a fair value hedge of 5 million lb. of current inventory for which a mid-June sale is expected. The average cost of this inventory was $0.58/lb. Copper Monkey documented (1) the hedging relationship between the futures contracts and its inventory, (2) its objectives and strategy for undertaking the hedge, and (3) its conclusion that the hedging relationship will be highly effective. On March 31, the mid-June commodity exchange futures price was $0.85/lb.
In the March 31 statement of financial position, the company should record the futures contracts as a
$100,000 liability.
GAAP require that derivative instruments be recorded as assets and liabilities and measured at fair value. At the inception of the futures contracts, their fair value was $0 because the contracts were entered into at the futures price at that date. On March 31, the fair value of the futures contracts is equal to the change in the futures price between the inception price and the price on the balance sheet date. Given that the futures contracts created an obligation to deliver 5 million lb. (25,000 lb. × 200 contracts) of copper at $0.83/lb. and that the price had risen to $0.85/lb. at the date of the financial statements, Copper Monkey should record a loss and a liability of $100,000 [5 million lb. × ($0.83 – $0.85)].
The following data pertain to Ruhl Corp.’s operations for the year ended December 31:
Operating income: $800,000 Interest expense: (100,000) Income before income tax: $700,000 Income tax expense: (210,000) Net income: $490,000
The times-interest-earned ratio is
8.0 to 1.
The times-interest-earned ratio is a measure of the firm’s ability to pay interest on debt. It equals earnings before interest and taxes divided by interest expense. Thus, Ruhl’s times-interest-earned ratio is 8.0 to 1 ($800,000 ÷ $100,000).
The following information was taken from Baxter Department Store’s financial statements:
Inventory at January 1: $100,000
Inventory at December 31: 300,000
Net sales: 2,000,000
Net purchases: 700,000
What was Baxter’s inventory turnover for the year ending December 31?
2.5
Inventory turnover is equal to cost of goods sold divided by average inventory. Cost of goods sold is equal to net purchases minus the annual increase in inventory. Thus, it equals $500,000 [$700,000 net purchases – ($300,000 – $100,000)]. Average inventory is $200,000 [($100,000 + $300,000) ÷ 2]. Inventory turnover is therefore 2.5 ($500,000 ÷ $200,000).
Fact Pattern:
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).
