Analysis and Use of Financial Statements w solutionsch15.docx
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AnalysisandUseofFinancialStatementswsolutionsch15
Chapter15-Solutions
Overview:
ProblemLengthProblem#’s
{S}4,5,7,12
{M}1-3,6,9,10,13-15
{L}8,11
1.{M}a.BecausethefunctionalcurrencyofNipponMTistheyen,thecurrentratemethodshouldbeusedtotranslatetheyenfinancialstatementsintoUSdollars,thereportingcurrency.
b.SeeExhibit15S-1(page2)forincomestatementandbalancesheettranslation.
c.ThelowervalueoftheyenrelativetotheUSdollarreducedtheearningsofNipponMTaftertranslationintodollarsasthe(average)currentexchangerateisusedtotranslateallincomestatementcomponents.
d.Thealternativemethodisthetemporalmethod,whichwouldberequiredifNipponMT
∙Operatedinahighlyinflationaryeconomy,or
∙WashighlyintegratedwithMasterToy,requiringtheuseoftheUSdollarasitsfunctionalcurrency
e.Underthetemporalmethod,nonmonetaryassetsandliabilities(suchasinventoriesandfixedassets)aretranslatedatthehistoricalrate.Monetaryassetsandliabilitiesaretranslatedatthecurrentrate.Incomestatementitemsrelatedtononmonetaryassetsandliabilities(suchasCOGSanddepreciationexpense)aretranslatedusinghistoricalrateswhilethoserelatedtomonetaryassetsandliabilitiesaretranslatedattheaverageratefortheperiod.
Thetemporalandcurrentratemethodsalsodifferinthedefinitionofthecurrencyexposure:
thenetmonetarypositionoftheforeignunitisthemeasureofriskunderthetemporalmethodwhereasthenetassets(thatis,thestockholders’equity)delineatetheexposurewhenthecurrentratemethodisused.
Thedifferentdefinitionofexposureandthedissimilarexchangeratesusedtotranslatevariousassetsandliabilitiesgeneratedisparateamountsoftranslationgainorloss.Theseamountsarealsodisplayedindifferentfinancialstatements;thetemporalmethodreportstranslationgainorlossintheincomestatementwhereasthecurrentratemethodreportsthegainorlossisacomponentofothercomprehensiveincome.
Exhibit15S-1.NipponMT
(thousands)
Exchangerate
StatementofIncomeandRetainedEarnings
Yen
Dollars
Rate
Explanation
Sales
700,000
$5,000
140
Averagerate
Expenses
Costofsales
280,000
2,000
140
Averagerate
Depreciation
126,000
900
140
Averagerate
Selling,general,andadministrative
77,000
550
140
Averagerate
Totalexpenses
483,000
$3,450
Incomebeforetaxes
217,000
$1,550
Incometaxes
(98,000)
(700)
140
Averagerate
Netincome
119,000
$850
RetainedearningsDecember31,1997
250,000
2,000
Given
369,000
$2,850
Dividends
(58,000)
(400)
145
Ratewhenpaid
RetainedearningsDecember31,1998
311,000
$2,450
BalanceSheet
Assets
Cashandreceivables
60,000
$400
150
Year-endrate
Inventory
180,000
1,200
150
Year-endrate
Land
200,000
1,333
150
Year-endrate
Fixedassets
346,000
2,307
150
Year-endrate
Totalassets
786,000
$5,240
150
Year-endrate
Liabilitiesandstockholdersequity
Liabilities
300,000
2,000
150
Year-endrate
Capitalstock
175,000
1,750
100
Given
Retainedearnings
311,000
2,450
Computedabove
Cumulativetranslationadjustment
(960)
Plug
Totalliabilitiesandstockholders'equity
786,000
$5,240
2.{M}a.
Fuente,Ltd.
BalanceSheet,December31,1999
Exchangerate
LC
Dollars
Rate
Explanation
Cash
15.2
$17.5
0.87
Year-endrate
Accountsreceivable
3.8
4.4
0.87
Year-endrate
Inventories
7.7
8.9
0.87
Year-endrate
Fixedassets(net)
35.6
40.9
0.87
Year-endrate
Other
12.1
13.9
0.87
Year-endrate
Totalassets
74.4
$85.5
Currentliabilities
13.3
15.3
0.87
Year-endrate
Longtermdebt
19.6
22.5
0.87
Year-endrate
Totalliabilities
32.9
$37.8
Stockholders'equity
41.5
47.7
0.87
Year-endrate
Totalliabilitiesandequity
74.4
$85.5
IncomeStatement,YearEndedDecember31,1999
Exchangerate
LC
Dollars
Rate
Explanation
Revenue
47.1
$49.6
0.95
Averagerate
Costofgoodssold
(16.9)
(17.8)
0.95
Averagerate
Depreciation
(3.2)
(3.4)
0.95
Averagerate
Otheroperatingcosts
(14.8)
(15.6)
0.95
Averagerate
Operatingprofit
12.2
$12.8
Interestexpense
(3.4)
(3.6)
0.95
Averagerate
Pretaxincome
8.8
$9.3
Incometaxexpense
(3.2)
(3.4)
0.95
Averagerate
Netincome
5.6
$5.9
b.Undertheall-currentmethod,theincomestatementistranslatedattheaverageratewhilethebalancesheetistranslatedattheyear-endexchangerate.Thereforeratiosthatuseonlyincomestatementdataoronlybalancesheetdataareunchanged;ratiosthatmixincomestatementandbalancesheetdataaredifferent,assumingthattheaverageandyear-endratesdiffer.
(i)Different:
earningsattheaveragerate,equityattheclosingrate.
(ii)Same:
debtandassetsbothattheclosingrate.
(iii)Same:
netincomeandrevenuesbothattheaveragerate.
(iv)Different:
receivablesattheclosingrate,revenueattheaveragerate.
c.Underthetemporalmethod,monetaryassetsandliabilitiesaretranslatedatthecurrentrate;otherassets(mainlyinventoriesandfixedassets)andliabilitiesaretranslatedatthehistoricalrate.Intheincomestatement,COGSanddepreciationaretranslatedatthehistoricalrate.Thesedifferencesfromtheall-currentmethodaffectratiosasfollows:
(i)Different:
bothnetincomeandassetsaredifferentunderthetemporalmethod.
(ii)Different:
debtisthesamebutassetsdifferent.
(iii)Different:
revenueisthesamebutnetincomeisdifferent.
(iv)Same:
bothaccountsreceivableandrevenuearethesameunderthetwomethods.
(v)Same:
asthequickratiocomparescashandaccountsreceivabletocurrentliabilities,itisthesameunderbothmethods.
3.{M}a.Withdollarasthefunctionalcurrency,FIistranslatedusingthetemporalmethod.
Yearended
December31,2001
Ponts
(Millions)
ExchangeRate
(Ponts/$)
Dollars
(Millions)
BalanceSheet:
Cash
Accountsreceivable
Inventory
Fixedassets(net)
Totalassets
Accountspayable
Capitalstock
Retainedearnings
Translationadjustment
Totalliabilities
andequities
82
700
455
360
1,597
532
600
465
---
1,597
4.0
4.0
4.0
4.0
4.0
3.0
$20.50
175.00
113.75
90.00
$399.25
$133.00
200.00132.86(66.61)
$399.25
IncomeStatement:
Sales
Costofsales
Depreciationexpense
Sellingexpense
Netincome
3,500
(2,345)
(60)
(630)
465
3.5
3.5
3.5
3.5
$1,000.00
(670.00)
(17.14)
180.00)
$132.86
*TranslationAdjustment=600{1-1}=600(1/12)=$(50.00)
{34}
+465{1-1}=465(1/28)=(16.61)
{3.54}$(66.61)
b.(i)Dollar:
Inventoryandfixedassetstranslatedathistoricalrates.
Pont:
Allassetsandliabilitiestranslatedatcurrentexchangerates.
Dollar:
Translationgain(loss)computedonthebasisofnetmonetaryassets.
Pont:
Translationgain(loss)computedonthebasisofnetinvestment(allassetsandliabilities).
(ii)Dollar:
Allrevenuesandotherexpensesaretranslatedattheaverageratefortheperiod;costofsalesanddepreciationexpensetranslatedathistoricalrate.
Pont:
Allrevenuesandexpensestranslatedataverageratesfortheperiod.
Dollar:
Translationgain(loss)includedinnetincome(volatilityincreased).
Pont:
Translationgain(loss)reportedinseparatecomponentofstockholders,equity.Netincomeislessvolatile.
(iii)Dollar:
Financialstatementratiosskewedbytranslationeffects.
Pont:
Ratiosindollarsaresimilartoratiosinponts.
4.{S}a.Functionalcurrency=hibmeansthatlocalfinancialstatementsarepreparedinhibandthentranslatedintodollars.
First-in-First-Out
Last-in-First-Out
Costofgoodssold:
Openinginventoryofhib6,000becomesCOGS;translateatratewhensold($1=6hib)makesCOGS$1,000
Endinginventory:
Purchasesduringtheyearofhib7,500translatedatclosingrateof$1=6hibmakesinventory$1,250
Purchasesduringtheyearofhib7,500becomesCOGS;translateatratewhensold($1=6hib)makesCOGS$1,250
Openinginventoryofhib6,000remainsininventory;whentranslatedattheclosingratemakesinventory$1,000
Note:
COGSandendinginventorymusttotalhib13,500,thesumofopeninginventoryandpurchases,regardlessofinventorymethod.
b.Functionalcurrency=dollarmeansthatcalculationsaremadeusingdollars;temporalmethodrulesapply.
First-in-First-Out
Last-in-First-Out
Costofgoodssold:
Openinginventoryof$1,500(hib6,000/4)becomesCOGS
Endinginventory:
Purchasesduringtheyearof$1,500remainininventory
Purchasesduringtheyearof$1,500(hib7,500/5)becomeCOGS
Openinginventoryof$1,500remainsininventory
Note:
COGSandendinginventorymusttotal$3,000,thesumofopeninginventoryandpurchases.
c.TheessenceofLIFOisthat(withrisingprices)higherpricedpurchasesbecomeCOGS,whereaslowerpricedgoodsremainininventory;FIFOisthereverse,resultinginhigherincome(lowerCOGS)andhigherinventoryvaluation.
Thechoiceoffunctionalcurrencyinteractswiththechoiceofinventorymethod.Whenthefunctionalcurrencyisthehib(localcurrency),thenormalLIFO/FIFOeffectsaredirectlytransmittedtotheparen
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