Académique Documents
Professionnel Documents
Culture Documents
5-1
OUTLINE
Passive investments
Accounting for Investment Securities
Disclosure of Investment Securities
Analyzing Investment Securities
Business Combinations
Accounting Mechanics of Business Combinations
Analysis Implications of Business Combinations
Comparison of Pooling versus Purchase Accounting for Business
Combinations
Derivative Securities
Defining a Derivative
Classification and Accounting for Derivatives
Disclosure of Derivatives
Analysis of Derivatives
5-2
ANALYSIS OBJECTIVES
Analyze implications of both the purchase and pooling methods of accounting for
business combinations.
5-3
QUESTIONS
1. Long-term investments are usually investments in assets such as debt instruments,
equity securities, real estate, mineral deposits, or joint ventures acquired with longerterm goals. Such goals often include the acquisition of control or affiliation with other
companies, investment in suppliers, securing sources of supply, etc. The valuation and
presentation of noncurrent investments depends on the degree of influence that the
investor company has over the investee company. With no influence, debt investments
other than held-to-maturity bonds and equity investments are accounted for at market
value. Once influence is established, equity investments are accounted for under the
equity method or consolidated with the statements of the investor company.
a. In the absence of evidence to the contrary, an investment (direct or indirect) in 20%
or more of the voting stock of an investee carries the presumption of an ability to
exercise significant influence over the investee. Conversely, an investment of less
than 20% in the voting stock of the investee leads to the presumption of a lack of
such influence unless the ability to influence can be demonstrated. Accounting
requirements are: Held-to-maturity securities are reported at amortized cost.
Noncurrent available-for-sale securities are reported at fair value. Influential
securities are accounted for under the equity method.
b. Standards indicate that a position of more than 20% of the voting stock might give
the investor the ability to exercise significant influence over the operating and
financial policies of the investee. When such an ability to exercise influence is
evident, the investment should be accounted for under the equity method. Basically
this means at cost, plus the equity in the earnings or losses of the investee since
acquisition (with the addition of certain other adjustments). Evidence of an investor's
ability to exercise significant influence over operating and financial policies of the
investee is reflected in several ways such as management representation and
participation. While eligibility to use the equity method is based on the percent of
voting stock outstanding, that can include, for example, convertible preferred stock,
the percent of earnings that can be picked up under the equity method depends on
ownership of common stock only.
2. a. The accounting for investments in common stock representing over 20% of equity
requires the equity method. While use of the equity method is superior to reporting
cost, one must note that this is not equivalent to fair market valuewhich, depending
on the circumstances, can be significantly higher or lower than the carrying amount
under the equity method.
An analyst also must remember that the presumption that an investment holding of
20% or more of the voting securities of an investee results in significant influence
over that investee is arbitraryan assumption made in the interest of accounting
uniformity. If such influence is absent, then there is some question regarding the
investor's ability to realize the amount reported.
b. A loss in value of an investment that is other than a temporary decline should be
recognized the same as a loss in value for other long-term assets. This statement
suggests considerable judgment and interpretation and, in the past, has resulted in
companies being very slow to recognize losses in their investments. Since
5-4
5-5
11. A cash flow hedge is designed to hedge exposure to volatility in cash flows attributable
to a specific risk. An example of a cash flow hedge is a floating-for-fixed interest rate
swap. This swap hedges the cash flows related to an interest-bearing financial
instrument. An example of a fair value hedge is a fixed future commitment to sell a fixed
quantity of a commodity at a specified price. This transaction hedges the fair value of
the commodity against loss before the time that it is sold.
12. In fair value accounting, both the hedging instrument and the hedged asset or liability
are recorded at fair value in the balance sheet. All realized and unrealized gains and
losses on both the hedging instrument and the hedged asset or liability are immediately
recognized in income.
Unrealized gains and losses relating to the effective portion of a cash flow hedge are
immediately recorded as part of other comprehensive income up to the effective date of
the transaction. After the effective date of the transaction, the gains and losses are
transferred to income. The cash flow hedging instrument is recorded at fair value on the
balance sheet. However, there is no offsetting asset or liability as in the case of a fair
value hedge. Instead, the offset in the balance sheet occurs through accumulated
comprehensive income, which is part of equity.
13. Speculative derivatives are recorded at fair value on the balance sheet and any
unrealized or realized gains or losses are immediately recorded in net income.
14. From a strict legal viewpoint, the statement is basically correct. Still, we must remember
that consolidated financial statements are not prepared as legal documents.
Consolidated financial statements disregard legal technicalities in favor of economic
substance to reflect the economic reality of a business entity under centralized control.
From the analysts' viewpoint, consolidated statements are often more meaningful than
separate financial statements in providing a fair presentation of financial condition and
the results of operations.
15. The consolidated balance sheet obscures rather than clarifies the margin of safety
enjoyed by specific creditors. To gain full comprehension of the financial position of
each part of the consolidated group, an analyst needs to examine the individual financial
statements of each subsidiary. Specifically, liabilities shown in the consolidated financial
statements do not operate as a lien upon a common pool of assets. The creditors,
secured and unsecured, have recourse in the event of default only to assets owned by
the individual corporation that incurred the liability. If, on the other hand, a parent
company guarantees a specific liability of a subsidiary, then the creditor would have the
guarantee as additional security.
16. Consolidated financial statements generally provide the most meaningful presentation of
the financial condition and the results of operations of the combined entity. Still, they do
have certain limitations, including:
The financial statements of the individual companies in the group may not be
prepared on a comparable basis. Accounting principles applied, valuation bases, and
amortization rates used can differ. This can impair homogeneity and the validity of
ratios, trends, and key relations.
Companies in relatively poor financial condition may be combined with sound
companies, obscuring information necessary for effective analysis.
5-6
5-7
20. a. Goodwill represents the excess of the total cost over the fair value assigned to the
identifiable tangible and intangible assets acquired less the liabilities assumed.
b. It is possible that the market values of identifiable assets acquired less liabilities
assumed exceed the cost (purchase price) of the acquired company. In this case, the
values otherwise assignable to noncurrent assets (except for marketable securities)
acquired should be reduced by a proportionate part of the excess. Negative goodwill
should not be recorded unless the value assigned to such long-term assets is first
reduced to zero. If negative goodwill must be recorded, it is recorded as an
extraordinary gain (net of tax) below income from continuing operations
c. Marketable Securities are recorded at current net realizable values.
d. Receivables are recorded at the present value of amounts to be received, computed
at proper current interest rates, less allowances for uncollectibility and collection
costs.
e. Finished Goods are recorded at selling prices less cost of disposal and reasonable
profit allowance.
f.
Work-in-Process is recorded at the estimated selling price of the finished goods less
the sum of the costs to complete, costs of disposal, and a reasonable profit
allowance.
j.
k. The goodwill of the acquired company is not carried forward to the acquiring
company's accounting records.
21. A crude way of adjusting for omitted values in a pooling combination is to estimate the
difference between the market value and the recorded book value of the net assets
acquired, and then to amortize this difference on some reasonable basis. The result
would be approximately comparable to the net income reported using purchase
accounting. Admittedly, the information available for making such adjustments is limited.
22. Analysis should be alert to the appropriateness of the valuation of the net assets
acquired in the combination. In periods of high stock market price levels, purchase
accounting can introduce inflated values when net assets (particularly the intangibles) of
acquired companies are valued on the basis of the high market price of the stock issued.
Such values, while determined on the basis of temporarily inflated stock prices, remain
on a company's balance sheet and may require future write-downs if impaired. This
concern also extends to temporarily depressed stock prices and its related implications.
5-8
23. a. An acquisition program aimed at purchasing companies with lower PE ratios can, in
effect, "buy" earnings for the acquiring company. To illustrate, say that Company X
has earnings of $1 million, or $1 per share on 1 million shares outstanding, and that
its PE is 50. Now, lets assume it purchases Company Y at 10 times it earnings of
$5,000,000 ($50 million price) by issuing an additional 1,000,000 shares of X valued at
$50 per share. Then:
Earnings of Combined Entity are: X earnings .... $1,000,000
Y earnings .... 5,000,000
$6,000,000
The new number of shares outstanding is 2,000,000, providing an EPS of $3.00
(computed as $6 million divided by 2 million shares). Also, note that earnings per
share increases from $1 to $3 per share for Company X by means of this acquisition.
We should recognize the synergistic effect in this case. That is, two companies
combined can sometimes show results that are better than the total effect of each
separately. This can occur through combination of vertical, horizontal, or other basis
of company integration. Consider the following example:
Company S:
PE = 10
EPS = $1.00
Earnings = $1,000,000
Number of shares = 1,000,000
Company T:
PE = 10
Earnings = $1,000,000
Assume Company S buys Company T at a bargain of 10 times earnings and it
assumes $1,000,000 after-tax savings from efficiencies. Then:
Combined entity:
S earnings .................................. $1,000,000
T earnings .................................. 1,000,000
Savings from merger ................. 1,000,000
New earnings ............................. $3,000,000
New number of shares ..............
New EPS .....................................
2,000,000
$1.50
5-9
would look good in comparison with pooled years 1 and 2. An analysis of the
acquiring companys results alone versus the combined entity would reveal this trick.
24. The amount of goodwill that is carried on the acquirer's statement too often bears little
relation to its real value based on the demonstrated superior earning power of the
acquired company. Should the goodwill become impaired, the resulting write-down could
significantly impact earnings and the market value of the company.
25. All factors supporting the estimates of the benefit periods should be reexamined in the
light of current economic conditions. Some circumstances that can affect such estimates
are:
A new invention that renders a patented device obsolete.
Significant shifts in customer preferences.
Regulatory sanctions against a segment of the business.
Reduced market potential because of an increased number of competitors.
26.A
The major provisions of accounting for foreign currency translation (SFAS 52) are:
The translation process requires that the functional currency of the entity be
identified first. Ordinarily it will be the currency of the country where the entity is
located (or the U.S. dollar). All financial statement elements of the foreign entity must
then be measured in terms of the functional currency in conformity with GAAP.
Under the current rate method (most commonly used), translation from the functional
currency into the reporting currency, if they are different, is to be at the current
exchange rate, except that revenues and expenses are to be translated at the average
exchange rates prevailing during the period. The current method generally considers
the effect of exchange rate changes to be on the net investment in a foreign entity
rather than on its individual assets and liabilities (which was the focus of SFAS 8).
Translation adjustments are not included in net income but are disclosed and
accumulated as a separate component of stockholders' equity (Other Comprehensive
Income or Loss) until such time that the net investment in the foreign entity is sold or
liquidated. To the extent that the sale or liquidation represents realization, the
relevant amounts should be removed from the separate equity component and
included as a gain or loss in the determination of the net income of the period during
which the sale or liquidation occurs.
27. A The accounting standards for foreign currency translation have as its major
objectives: (1) to provide information that is generally compatible with the expected
economic effects of a change in exchange rate on an enterprise's cash flows and equity,
and (2) to reflect in consolidated statements the financial results and relations as
measured in the primary currency of the economic environment in which the entity
operates, which is referred to as its functional currency. Moreover, in adopting the
functional currency approach, the FASB had the following goals of foreign currency
translation in mind: (1) to present the consolidated financial statements of an enterprise
in conformity with U.S. GAAP, and (2) to reflect in consolidated financial statements the
financial results and relations of the individual consolidated entities as measured in their
functional currencies. The Board's approach is to report the adjustment resulting from
translation of foreign financial statements not as a gain or loss in the net income of the
period but as a separate accumulation as part of equity (in comprehensive income).
5-10
28. A Following are some analysis implications of the accounting for foreign currency
translation:
(a) The accounting insulates net income from balance sheet translation gains and
losses, but not transaction gains and losses and income statement translation
effects.
(b) Under current GAAP, all balance sheet items, except equity, are translated at the
current rate; thus, the translation exposure is measured by the size of equity or the
net investment.
(c) While net income is not affected by balance sheet translation, the equity capital is.
This affects the debt-to-equity ratio (the level of which may be specified by certain
debt covenants) and book value per share of the translated balance sheet, but not of
the foreign currency balance sheet. Since the entire equity capital is the measure of
exposure to balance sheet translation gain or loss, that exposure may be even more
substantial, particularly with regard to a subsidiary financed with low debt and high
equity. The analyst can estimate the translation adjustment impact by multiplying
year-end equity by the estimated change in the period to period rate of exchange.
(d) Under current GAAP, translated reported earnings will vary directly with changes in
exchange rates, and this makes estimation by the analyst of the "income statement
translation effect" less difficult.
(e) In addition to the above, income will also include the results of completed foreign
exchange transactions. Also, any gain or loss on the translation of a current payable
by the subsidiary to parent (which is not of a long-term capital nature) will pass
through consolidated net income.
5-11
EXERCISES
Exercise 5-1 (20 minutes)
a. Usual objectives underlying the holding of both current and noncurrent portfolios
of securities are:
Currentfor temporary investments of excess cash in highly liquid investments.
Noncurrentfor investment income, appreciation value, control purposes of
another entity, or to secure sources of supplies or avenues of sales.
b. Securities should be classified as follows: Trading securities are always
classified as current. Held-to-maturity securities are classified as noncurrent,
except for the reporting period immediately prior to maturity. Available-for-sale
securities are classified as current or noncurrent based on managements intent
regarding sale. Influential securities are noncurrent unless their sale is imminent.
Marketable securities that are temporary investments of cash specifically
designated for special purposes such as plant expansion or sinking fund
requirements are classified as noncurrent.
Unrealized losses on trading securities (which are classified as current assets)
are the only unrealized losses to flow through the income statement. Unrealized
losses on noncurrent investments (and current investments in available-for sale
securities) are included as a separate component of shareholders' equity. Some
analysts treat much if not all of these unrealized gains and losses as another
component of adjusted net income.
Exercise 5-2 (12 minutes)
a. When available-for-sale securities are marked to market, an asset account is
adjusted to market (either upward or downward) and an equity account is
increased when marked up or decreased when marked down.
b. If the investments being marked to market were trading securities instead of
available-for-sale securities, then an asset account would be adjusted to market.
In addition, a gain or loss account that flows through income would also be
included to reflect the change in market value (and equity would change
accordingly when income is closed to it).
c. Although under available-for-sale accounting unrealized gains are not recorded,
realized gains are reflected in reported income. Microsoft, therefore, can sell
securities with unrealized gains and increase its reported income.
5-12
5-13
5-14
e. 100 percent of C2's assets and liabilities are included in the consolidated balance
sheet. However, the stockholders' equity of C2 is split into two parts: 80 percent
is added to the stockholders' equity of Co. X and 20 percent is shown on a
separate line (above Co. X's stockholders' equity) as "minority ownership of C2"
(frequently just simply called "minority interest"). The portion of the 80 percent
representing the past purchase by Co. X would be eliminated (in consolidation)
against the "investment in subsidiary."
Exercise 5-5concluded
f. Co. X must purchase enough additional common stock from the other
stockholders in C3 or purchase enough new shares issued by C3 to increase its
ownership to more than 50 percent of C3's common stock. (Alternatively, C1 or
C2 could purchase the additional shares.)
g. There would be no intercompany investment or intercompany dividends. But any
other intercompany transactions must be eliminated (such as intercompany sales
and intercompany receivables and payables).
Exercise 5-6A (20 minutes)
a. The choice of the functional currency would make no difference for the reported
sales numbers. This is because sales are translated at rates on the transaction
date, or average rates, regardless of the choice of the functional currency.
b. When the U.S. dollar is the functional currency (Bethel Company), some assets
and liabilities (mainly inventory and fixed assets) are translated at historic rates.
The monetary assets and liabilities are translated at current exchange rates. This
means the translation gain or loss is based only on those assets and liabilities
that are translated at current rates. When the functional currency is the local
currency (Home Brite Company), all assets and liabilities are translated at current
exchange rates, and common and preferred stock are translated at historic rates.
The translation gain or loss is based on the net investment in each local currency.
c. When the U.S. dollar is the functional currency, all translation gains or losses are
included in reported net income. When the functional currency is the local
currency, the translation gain or loss appears on the balance sheet as a separate
component of shareholders' equity (in comprehensive income or loss), thus
bypassing the net income statement.
(CFA Adapted)
5-15
PROBLEMS
Problem 5-1 (20 minutes)
a. Investments Reported on the Balance Sheet:
Able Corp. bonds ............................
$ 330
Bryan Co. bonds ....................................................... 825
Caltran, Inc. bonds ................................................... 515
Available-for-sale equity securities ..................... 1,600
Trading equity securities ....................................
950
Total ....................................................................... $4,220
b. Reporting of Unrealized Value Fluctuations:
Unrealized price fluctuations on available-for-sale securities are reported in
comprehensive income (Bryan Co. bonds and available-for-sale equity
securities).
Unrealized price fluctuations on trading securities are reported in net income
(Caltran bonds and trading equity securities).
Problem 5-2 (30 minutes)
1. Since the aggregate market value of the portfolio exceeds cost, there is no write
down of the individual security whose market value declined to less than one-half
of its cost. Stockholders' equity will be increased (decreased) to the extent that
the excess of market over cost has increased (decreased) over the period. There
is no effect on the income statement.
2. This situation is similar to 1 above. The only difference is that the firm in question
does not use the classified balance sheet format. In this case, the analyst must be
sure to review note disclosures regarding the classification of investments (if not
provided on the face of the balance sheet).
3. This is not a reclassification between categories as the securities remain in the
available-for-sale category. However, the analyst should note that management is
contemplating a sale in the near future.
4. The increase in fair value of the security should be credited to shareholders'
equity. (Since the security is classified as noncurrent, it cannot be a trading
security).
5-16
$ 110,000
3,190,000
660,000
(360,000)
$3,600,000
c. Accounting method for 2006. For 2006, with ownership in excess of 50% (in this
case, 100%) and Simpson in control of BC, the consolidation method is used to
combine BCs financial statements with those of Simpson. In a consolidation,
only the purchase method is available to account for the investmentpooling of
interest is not allowed.
5-17
Investment
$40,000
1,600 [1]
(800) [2]
(480) [3]
(640) [4]
$39,680
Notes ($000s):
[1] 80% of $2,000 net income
[2] 80% of $1,000 dividends
[3] 80% of $(600) net loss
[4] 80% of $800 dividends
b. The strengths associated with use of the equity method in this case include:
It reduces the balance in the investment account in Year 7 due to the net loss.
Note: Just recording dividend income would obscure the loss.
It recognizes goodwill on the balance sheet (via inclusion in the investment
balance) and, therefore, it reflects the full cost of the investment in Bowman
Co.
The possible weaknesses with use of the equity method in this case include:
Lack of detailed information (one-line consolidation).
Dollar earned by Bowman may not be equivalent to dollar earned by Burry.
5-18
5-19
$135
70
130
130
35 *
$500
$140
180
180
$500
*Goodwill computation:
Cash payment .............................................................. $180
Fair value of net assets acquired ($165 - $20) .......... 145
$ 35
b. The basic difference between pooling and purchase accounting for business
combinations is that in the pooling case there is a high likelihood of not recording
all assets acquired and paid for by the acquiring company. This results in an
understatement of assets and, consequently, an overstatement of current and
future net income. This is because pooling accounting is limited to recording only
book values of the acquired companys net assets, which do not necessarily
reflect current fair values of net assets. Given the inflationary tendencies of most
economies, pooling tends to understate asset values. The understatement of
assets under pooling leads to an understatement of expenses (from lack of cost
allocations) and to an overstatement of gains realized on the disposition of these
assets.
5-20
180.1
e. (1) The change in the cumulative translation adjustment accounts [101] for
Europe is most likely due to significant translation losses in Year 11.
(2) In the case of Australia, the decrease in the credit balance of the account may
be due to sales of businesses by Arnotts Ltd. [169A], which may have
involved the removal of a proportionate part of the account as well as gains or
losses on translation in Year 11. This is corroborated by item [93] that shows a
reduction in the cumulative translation account due to sales of foreign
operations.
5-21
CASES
Case 5-1 (45 minutes)
a. (1) Pooling Accounting:
Investment in Wheal ..........................................
Capital StockAxel .....................................
110,000
110,000
350,000
110,000
240,000
100,000
10,000
110,000
25,000
100,000
30,000
40,000
2,000
5,000
2,000
190,000
100,000
25,000
35,000
160,000
5-22
Pooling
$150,000
35,000
$185,000
Purchase
$150,000
$150,000
5-23
Case 5-2continued
f. Focusing on earnings before special items can be a useful tool when attempting
to measure earnings that is more reflective of the permanent earnings stream
and, consequently, more reflective of future earnings. However, several
companies record repeated special item charges. These companies are
essentially overstating earnings for several periods (not including those with
special charges) and then catching up by recording the huge charge. Analysts
must be careful to identify such companies so that they are not relying on
overstated earnings of the company in predicting future performance. For such
companies, it is prudent to assign a portion of the charges to several periods to
develop an approximation of the ongoing earnings of the company.
5-24
Accounting
Treatment by
Newmont
(pre-SFAS 133)
Forward Sales of
No unrealized gain or
125,000 ounces
of future gold
from Indonesian
sales. Hedge.
and liability (as the case may be) in the balance sheet until the
ounce
when sold.
Transaction
To provide an
No unrealized gain or
on 50,000 ounces
item for this instrument. The call is recorded at fair value. The
sales in case of
net income effect is the difference between the value of the call
forward sale.
when sold.
Prepaid Sale in
To raise immediate
No unrealized gains
cash to service
Note the fair value of the instrument is non-zero only when the
ounces at various
debt. Secondary
recognized. Realized
objective, to hedge
price recorded on
of $300 and
downside risk
date of sale.
ceiling of $380.
Prepaid amount
upside potential up
to $380. A hedge
is adjusted when
unchanged.
upside potential
within a range.
5-25
Transaction
Newmonts
Strategy
Accounting
Treatment by
Newmont
(pre-SFAS 133)
Prepaid Sales in
To raise immediate
No unrealized gains
cash to service
and losses
per annum at
recognized on either
mine).
instrument locks-in
security. Realized
(no information
(fixed) price on
second instrument
price).
by the value of
objective is clearly
forward purchase
not hedging
related.
Forward purchase
to actual realization.
in July 1999 of
identical
Treated as deferred
quantities at
revenue that is
prices ranging
sales occur.
Purchased Put
To provide
No unrealized gains
Option in August
downside risk
and losses
recognized. Cost of
million ounces.
over term.
potential.
Written Call
Options in August
purchase.
in net income.
income.
5-26
Case 5-3continued
c. Forward sales: Economically, this agreement locks in the cash flows associated
with sales. There is no potential for gain or loss on this sales price. As a result,
risk is removed. The accounting treatment does reflect the economics of this
transaction as there is no impact until the date of sale.
Purchased calls: Economically this agreement makes the lock in of $454 on 40%
of the forward sales a floor sales price, with no economic impact until the date of
sale. Earlier method does reflect the economics. SFAS 133 treatment recognizes
the change in value over time even though no cash will change hands until the
date of sale.
Prepaid sale: Economically, this agreement locks the cash flows associated with
the sales into a specified range. The deferred revenue treatment is consistent
with the economics. Hedge accounting treatment, both before SFAS 133 and
under SFAS 133, is consistent with the economics as there is no income
statement impact until the date of sale.
Prepaid sale (35,900 ounces) and forward purchase (35,900 ounces): Considered
simultaneously, the economic impact of these transactions is a wash and the
accounting treatment reflects this offsetting effect.
Purchased put option: Economically, this option sets a floor on the sales price of
2.85 million ounces of product. The accounting treatment, both before SFAS 133
and under SFAS 133 should be a good reflection of the economic reality.
Written call option: Economically, this option exposes the company to lower
sales prices in the future. The value of this option will change over time. Thus, the
accounting treatment is an adequate reflection of the economics.
d. The justification for not allowing the hedging treatment comes from the fact that
the written calls are not hedging a specific transaction or event. SFAS 133
requires that the derivative be tied to a specific transaction, not just an overall
business risk.
e. Newmonts criticism is valid if hedging is defined in terms of firm-wide risk, rather
than in terms of transaction risk. From the firm-wide perspective, Newmont is
correct in describing the economic impact as only being the opportunity cost of
selling at a higher price in the future.
f. The economic reality is that Newmont was unable to benefit fully from the sudden
increase in gold prices because of its various hedging arrangements. The
financial statements exaggerate the opportunity costs of the hedging program,
primarily because the loss recognized on the written options is not offset by an
increase in the value of the gold reserves.
5-27
2,000,000A
10,000
80,000
20,000
100,000
190,000
________
2,400,000
.37
C
C.
C
H
[3]
740,000
.38
3,800
.38
30,400
.38
7,600
.30
30,000
[2]
61,000
25,900
898,700
Rate
$
Inventory, 1/1/Year 8
150,000
56,700 To Balance
A
.37
370,000
Purchases
1,000,000
Goods available for sale
1,150,000
426,700
C
.38
45,600
Inventory, 12/31/Year 8
120,000
A
.37
381,100
Cost of goods sold
1,030,000
[2] Dollar balance at Dec. 31, Year 7
[3] Amount to balance.
5-28
Case 5-4Acontinued
b.
SWISSCO
Income Statement (In Dollars)
For the Year Ended Dec. 31, Year 8
Sales ..................................................................
Beginning inventory ........................................ $ 56,700 [1]
Purchases .........................................................
370,000
Goods available................................................
426,700
Ending inventory ( 120,000 x $0.38) .............
(45,600) [1]
Cost of goods sold...........................................
Gross profit.......................................................
Depreciation expense ......................................
37,000
Other expenses (including taxes)...................
74,000
Net income ........................................................
$740,000
381,100
358,900
111,000
$247,900
SWISSCO
Balance Sheet (In Dollars)
At December 31, Year 8
ASSETS
Cash ........................................................................
Accounts receivable ..............................................
Less: Allowances for doubtful accounts .............
Inventory .................................................................
Property, plant, and equipment, net .....................
Total assets ............................................................
LIABILITIES AND EQUITY
Accounts payable ..................................................
Note payable ...........................................................
Total liabilities ........................................................
Capital stock ...........................................................
Retained earnings: 1/1/Year 8 ...............................
Add: Income for Year 8 ..........................................
Equity Adjustment from translation of
foreign currency statements ................................
Stockholders' equity ..............................................
Total liabilities and equity .....................................
5-29
$ 19,000
$38,000
3,800
34,200
45,600 [A]
304,000
$402,800
$30,400
7,600
38,000
30,000
61,000
247,900
308,900
25,900 [B]
364,800
$402,800
185,925
185,925
Note: While not specifically required by the problem, the parent would also pick
up the translation adjustment as follows:
Investment in SwissCo Corporation ..........................
Equity adjustment from translation of
foreign currency statements (75% x $25,900) ...
5-30
19,425
19,425
ASSETS
Cash ................................................
Accounts receivable .......................
Inventory..........................................
Fixed assets (net) ..........................
Total assets .....................................
LIABILITIES AND EQUITY
Accounts payable ..........................
Capital stock ..................................
Retained earnings ..........................
Translation adjustment .................
Total liabilities and equity ..............
Exchange Rate
Ponts/$
82
700
455
360
1,597
4.0
4.0
4.0
4.0
20.50
175.00
113.75
90.00
399.25
532
600
465
4.0
3.0
133.00
200.00
132.86
(66.61)*
399.25
1,597
5-31
Dollars
(millions)
Case 5-5continued
FUNI, INC.
Income Statement
For Year Ended Dec. 31, Year 9
Ponts
(millions)
Sales ...............................................
Cost of sales ..................................
Depreciation expense.....................
Selling expense ..............................
Net income ......................................
b. (1) Dollar:
Pont:
(2) Dollar:
Pont:
(3) Dollar:
Pont:
3,500
(2,345)
(60)
(630)
465
Exchange Rate
Ponts/$
3.5
3.5
3.5
3.5
Dollars
(millions)
1,000.00
(670.00)
(17.14)
(180.00)
132.86
5-32