16.6 Flashcards
The following information is available from Timber Corp.’s financial records for the current year:
Sales
Net credit sales: $500,000
Net cash sales: 250,000
= $750,000
Accounts Receivable
Balance, January 1: $75,000
Balance, December 31: 50,000
How many times did Timber’s accounts receivable turn over during the year?
8.
The accounts receivable turnover is equal to net credit sales divided by the average accounts receivable. Net credit sales is $500,000 and average accounts receivable is $62,500 [($75,000 + $50,000) ÷ 2]. Accounts receivable turnover is thus 8 × ($500,000 ÷ $62,500).
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.
A company has a current ratio of 2 to 1. This ratio will decrease if the company
Borrows cash on a 6-month note.
If a ratio is greater than 1.0, an equal increase in the numerator (current assets) and denominator (current liabilities), like borrowing cash on a short-term basis, decreases the ratio.
If all assets and liabilities of a firm’s foreign subsidiary are translated into the parent’s currency at the current exchange rate (the rate in effect at the date of the balance sheet), the extent of the parent firm’s translation gain or loss is based on the subsidiary’s
Total assets minus total liabilities.
When the functional currency of a foreign subsidiary is the local (foreign) currency, translation of all assets and liabilities is required at the current rate as of the balance sheet date.
Smythe Co. invested $200 in a call option for 100 shares of Gin Co. $.50 par common stock when the market price was $10 per share. The option expired in 3 months and had an exercise price of $9 per share. What was the intrinsic value of the call option at the time of initial investment?
$100
The intrinsic value of an option is calculated as the market value of the underlying minus the exercise price of the option, calculated as follows: [100 shares × ($10 market price – $9 exercise price)].
Hoyt Corp.’s current balance sheet reports the following equity:
5% cumulative preferred stock, par value $100 per share; 2,500 shares issued and outstanding: $250,000
Common stock, par value $3.50 per share; 100,000 shares issued and outstanding: 350,000
Additional paid-in capital in excess of par value of common stock: 125,000
Retained earnings: 300,000
Accumulated other comprehensive income: 100,000
Dividends in arrears on the preferred stock amount to $25,000. If Hoyt were to be liquidated, the preferred shareholders would receive par value plus a premium of $50,000. The book value per share of common stock is
$8.00
Given that the preferred stock is cumulative, the liquidation value of the preferred stock equals the par value ($250,000), plus the premium ($50,000), plus the dividends in arrears ($25,000), or $325,000. Given total equity of $1,125,000 ($250,000 + $350,000 + $125,000 + $300,000 + $100,000), common equity is $800,000 ($1,125,000 – $325,000). Thus, book value per share of common stock equals $8.00 ($800,000 ÷ 100,000 shares outstanding).
On December 31, Northpark Co. collected a receivable due from a major customer. Which of the following ratios would be increased by this transaction?
Receivable turnover ratio.
The accounts receivable turnover is equal to net credit sales divided by the average accounts receivable. Collection of a receivable decreases the denominator and thus increases the ratio.
Fact Pattern:
On November 15, Year 7, Hector Corp., a calendar-year-end U.S. company, signed a legally binding contract to purchase equipment from Diego Corp., a foreign company. The negotiated price is 1,000,000 FCU. The scheduled delivery date is February 15, Year 8. Terms require payment by Hector Corp. upon delivery. The terms also impose a 10% penalty on Diego Corp. if the equipment is not delivered by February 15, Year 8.
To hedge its agreement to pay 1,000,000 FCU, Hector entered into a foreign currency forward contract on November 15, Year 7, to receive 1,000,000 FCU on February 15, Year 8, at an exchange rate of 1.00 FCU = U.S.$0.36. Additional exchange rate information:
11/15/Year 7
Spot rate: 1 FCU = $0.35 U.S.
Forward rates for 2/15/Year 8: 1 FCU = $0.36 U.S.
12/31/Year 7
Spot rate: 1 FCU = $0.36 U.S.
Forward rates for 2/15/Year 8: 1 FCU = $0.38 U.S.
2/15/Year 8
Spot rate: 1 FCU = $0.39 U.S.
Forward rates for 2/15/Year 8: 1 FCU = $0.39 U.S.
Quotes obtained from dealers indicate the following incremental changes in the fair values of the forward contract based on the changes in forward rates discounted on a net-present-value basis:
11/15/Year 7 Gain/Loss:$0
12/31/Year 7 Gain Loss: $19,600
2/15/Year 8 Gain/Loss: $10,400
Hector formally documented its objective and strategy for entering into this hedge. Hector also decided to assess hedge effectiveness based on an assessment of the difference between changes in value of the forward contract and the U.S.-dollar equivalent of the purchase agreement with Diego. Because both changes are based on changes in forward rates, Hector further determined that the hedge is 100% effective.
The contract signed by Hector Corp. to purchase the equipment from Diego Corp. meets the definition of a
Firm Commitment:
Forecasted Transaction:
Yes
No
A firm commitment is an agreement between unrelated parties, binding on both and usually legally enforceable, that specifies all significant terms and includes a disincentive for nonperformance. A forecasted transaction is a transaction that is expected to occur for which there is no firm commitment.
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).
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
$13.00
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).
A company’s foreign subsidiary operation maintains its financial statements in the local currency. The foreign operation’s capital accounts would be translated to the functional currency of the reporting entity using which of the following rates?
Historical exchange rate.
If the books of a foreign entity are maintained in a currency not the functional currency, foreign currency amounts must be remeasured into the functional currency using the temporal method. Under this method, nonmonetary balance sheet items such as capital accounts are remeasured at the historical exchange rate. Monetary items such as receivables are remeasured at the current exchange rate.
How should gains or losses from fair value hedges be recognized?
The gain or loss, along with the offsetting loss or gain attributable to the hedged risk, should be recognized currently in earnings in the same accounting period.
A fair value hedge mitigates the risk of changes in the fair value of a recognized asset or liability. These changes must relate to a specified risk. Gains or losses from changes in the fair value of the hedging instrument are recognized immediately in earnings. Also, gains or losses from changes in the fair value of the hedged item attributable to the hedged risk are recognized immediately in earnings. Thus, a fully effective hedge results in no net gain or loss. It occurs when the gain or loss on the hedging instrument exactly offsets the loss or gain on the hedged item.
On September 22, Year 2, Yumi Corp. purchased merchandise from an unaffiliated foreign company for 10,000 units of the foreign company’s local currency. On that date, the spot rate was $.55. Yumi paid the bill in full on March 20, Year 3, when the spot rate was $.65. The spot rate was $.70 on December 31, Year 2. What amount should Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, Year 2?
$1,500
A receivable or payable stated in a foreign currency is adjusted to its current exchange rate at each balance sheet date. The resulting gain or loss should ordinarily be included in determining net income. It is the difference between the spot rate on the date the transaction originates and the spot rate at year end. Thus, the Year 2 transaction loss for Yumi Corp. is $1,500 [10,000 units × ($0.55 – $0.70)].
On June 1, Year 1, ABC Co. issued a 200,000 euro purchase order for equipment to be supplied by a German company. ABC’s functional currency is the U.S. dollar. The equipment was delivered to ABC on November 1, Year 1, and ABC recorded a payable due to the German company. ABC paid for the equipment on January 31, Year 2. The following are the exchange rates in effect:
June 1, Year 1: 1 euro = 1.40 U.S. dollars
November 1, Year 1: 1 euro = 1.50 U.S. dollars
December 31, Year 1: 1 euro = 1.35 U.S. dollars
January 31, Year 2: 1 euro = 1.30 U.S. dollars
What is the foreign currency gain or loss that ABC should record for the year ended December 31, Year 1?
A gain of $30,000
The terms of a foreign currency transaction are stated in a currency different from the entity’s functional currency. The initial measurement of the transaction must be in ABC’s functional currency (U.S. dollar). The exchange rate used is the rate in effect on the date the transaction was initially recognized. On 11/1/Year 1, ABC initially recognized a payable to a German company of $300,000 (200,000 euros × 1.5 exchange rate on 11/1/Year 1) because the equipment was delivered on that date. A foreign currency transaction gain or loss is recognized in the period when the exchange rate changes, e.g., at a balance sheet date and at the settlement date. On 12/31/Year 1, a payable is reported at $270,000 (200,000 euros × 1.35 exchange rate on 12/31/Year 1). The decrease in the payable of $30,000 ($270,000 – $300,000) is recognized as a gain in the Year 1 income statement.
Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due 1 month after the goods were received at Fogg’s warehouse. Between the receipt of goods and the time of payment, the exchange rates changed in Fogg’s favor. The resulting gain should be included in Fogg’s financial statements as a(n)
Component of income from continuing operations.
This foreign currency transaction resulted in a payable stated in a foreign currency. The favorable change in the exchange rate between the functional currency and the currency in which the transaction was stated should be included in determining net income for the period in which the exchange rate changed. It should be classified as a component of income from continuing operations.
