CMA Accelerated Program - 2011/2012

Lecture Student Weekly File - Week 10

Financial Accounting - Module 2

(6) Foreign Currency Transactions

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Foreign Currency Transactions Monetary Balances •

record initial transaction at the current rate of exchange

•

on settlement, any difference between the amount accrued and the settlement amount gets recorded as a gain/loss on foreign exchange

•

monetary assets and liabilities (and nonmonetary items carried at market) are translated at the exchange rate on the balance sheet date -> the offsetting entry on adjustment gets recorded as a FX gain/loss

•

monetary assets and liabilities are defined as those fixed in a given amount of currency

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Financial Accounting - Module 2

Offsetting monetary balances with a forward contract •

offsetting a monetary balance with a forward contract after the transaction date: – set up the transaction at the spot rate – on day the forward contract is taken out - no entry – intervening year end: adjust the AR or AP to the spot rate, any changes in the market value of the Forward Contract are offset by FX gains/losses » forward contract is marked to market by the forward rate ending on the same date as the original contract – on settlement: settle with bank (dr. or cr. Cash), clear AP or AR, clear any entries to the forward contract account; difference to FX gains/losses 64

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Problem 15 – Foreign Currency Transactions Richmond-Davis Company, a Canadian firm, sold hospital equipment to Salem Ltd. Of the UK on November 2, 20x7 for £100,000, payable in 90 days, on January 30, 20x8. Richmond-Davis's year end is December 31, 20x7. Relevant rates are as follows: October 1, 20x7 October 1, 20x7 November 2, 20x7 November 3, 20x7 November 3, 20x7 December 31, 20x7 December 31, 20x7 January 30, 20x8 February 15, 20x8

120-day forward rate Spot rate Spot rate Spot rate 90-day forward rate Spot rate 30-day forward rate Spot rate Spot rate

£1 = $1.642 £1 = $1.645 £1 = $1.650 £1 = $1.650 £1 = $1.638 £1 = $1.660 £1 = $1.663 £1 = $1.665 £1 = $1.668

Required Prepare all journal entries on the following assumptions: a. no forward contract is taken out to offset the receivable b. a forward contract is taken out to offset the receivable on November 3, 20x7 c. a forward contract is taken out to offset the receivable on November 3, 20x7 but the payment from the customer is received on February 15, 20x8

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Problem 17 – Foreign Currency Transactions Sable Company has a calendar year end. On January 1, 20x1, the company borrowed 2,000,000 Euros from a German bank. The loan is to be repaid on January 1, 20x5. Interest of 8% is payable at December 31 of each year. During the first year of the loan, the following exchange rates were in effect: January 1, 20x1 December 31, 20x1 20x1 average rate

1 Euro = $C0.945 1 Euro = $C0.939 1 Euro = $C0.941

Required Prepare the journal entries to record the transactions on 20x1.

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Financial Accounting - Module 2

(7) Foreign Currency Translation

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Functional and Presentation Currencies •

local currency - the currency in which the foreign operation measures and records its transactions

•

functional currency - the currency of the primary economic environment in which the entity operates

•

presentation currency - the currency in which the financial statements of the parent company are presented

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Financial Accounting - Module 2

Foreign Currency Translation •

integrated - financially or operationally interdependent with the reporting enterprise such that the exposure to exchange rate changes is similar to the exposure which would exist had the transactions and activities of the foreign operation been undertaken by the reporting enterprise – IFRS: the functional currency is deemed to be the same as the presentation currency – ASPE: the temporal method should be used

•

self-sustaining foreign operation - independent; exposure to exchange rate changes is limited to the net investment in the foreign operation – IFRS: the functional currency is deemed to be the local currency – ASPE: the current rate method should be used

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Self-Sustaining vs. Integrated Look for: •

cash flows of the reporting enterprise (RE) insulated or directly affected by the foreign operation (FO)

•

sales prices for the FO’s are determined more by local competition or world-wide competition

•

sales market of the FO outside the RE’ country?

•

labour, materials and other costs of the FO’s products are obtained locally

•

financing of day-to-day operations of the FO

•

degree of intercompany transactions

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Financial Accounting - Module 2 Translation Methodology when the functional currency = the presentation currency (temporal method) •

use when the functional currency = presentation currency

•

revenues and expenses are translated at their historical rates

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calculate gain/loss on holding net monetary items

•

monetary items : current rate

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non-monetary items: historical rate

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share capital: historical rate

•

retained earnings: accumulation of translated net income – dividends are translated when the dividend is declared

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Problem 18 – Foreign Currency Translation The income statement for 20x6 and comparative Statement of Financial Positions for Hilary Co., expressed in Swiss Francs (SF), as follows: SF Sales revenue Cost of goods sold: Opening inventory Purchases Ending inventory Depreciation Other operating expenses Interest expense

3,000,000 200,000 1,000,000 -400,000

Net income

800,000 SF 20x5

Cash Accounts receivable Inventory Land Equipment (net)

Accounts payable Bonds payable Common shares Retained earnings

800,000 300,000 900,000 200 000 2,200,000

500,000 300,000 200,000

20x6

2,000,000

200,000 400,000 400,000 500,000 1,700,000

3,000,000

3,200,000

400,000 1,800,000 500,000 300,000

500,000 1,800,000 500,000 400,000

3,000,000

3,200,000

Hilary Co. is 100% owned by Bryan Inc., a Canadian corporation. All amounts except depreciation occurred evenly throughout the year. Interest was paid at year-end. The opening inventory was purchased on October 1, 20x5; the ending inventory was purchased on November 1, 20x6. The depreciable assets were purchased when the exchange rate was $0.60. The common shares were issued when the exchange rate was $0.50. The land was purchased at the end of 20x6. The bonds were issued at the end of 20x4 and mature at the end of the year 20x10. Dividends are declared and paid at the end of each year. Other exchange rate information is as follows:

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December 31, 20x4 October 1, 20x5 December 31, 20x5 Average for 20x6 November 1, 20x6 December 31, 20x6

Lecture Student Weekly File - Week 10

$ 0.60 0.72 0.75 0.80 0.83 0.85

Required: Prepare a translated income statement, statement of retained earnings and Statement of Financial Position for Hilary Company for the year ending December 31, 20x6 assuming that … 1. Hilary Company’s functional currency is the Canadian dollar 2. Hilary Company’s functional currency is the Swiss Franc, and that the cumulative translation adjustment at December 31, 20x5 is $155,000 credit.

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Financial Accounting - Module 2 Translation Methodology when the functional currency = the local currency (current rate method) •

use when the functional currency = the foreign currency where the foreign operation operates

•

income statement: translate all accounts at average rate

•

assets and liabilities: translate at current rate

•

common stock and retained earnings: same as for the temporal method

•

any amount required to balance is debited/credited to the ‘Cumulative Translation Adjustment’ which is part of OCI – note that this amount can be calculated

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Problem 10 – Investments On December 31, 20x2, the Peters Company purchased 60 percent of the outstanding voting shares of the Seto Company for $720,000 in cash. On that date, subsequent to the completion of the business combination, the Statement of Financial Positions of the Peters and Seto Companies and the fair values of Seto's identifiable assets and liabilities were as follows:

Cash And Accounts Receivable Inventories Investment In Seto Plant And Equipment (Net)

Current Liabilities Long-Term Liabilities Common Stock Retained Earnings

December 31, 20x2 Peters Seto $ 350,000 $ 200,000 950,000 500,000 720,000 -02,400,000 700,000 $4,420,000 $1,400,000 $ 400,000 1,000,000 1,000,000 2,020,000 $4,420,000

$ 100,000 400,000 800,000 100,000 $1,400,000

Fair Values Seto $200,000 450,000 800,000

$100,000 360,000

The Plant And Equipment of Seto on December 31, 20x2 has an estimated useful life of 10 years while the Long-Term Liabilities that were present on that date mature on December 31, 20x5. Both Companies use the straight line method of amortization. The Income Statements for the year ending December 31, 20x4 and the Statement of Financial Positions as at December 31, 20x4 of the Peters and Seto Companies are as follows: Peters and Seto Companies Income Statements For The Year Ending December 31, 20x4 Sales Other Revenues Cost Of Goods Sold Depreciation Expense Other Expenses Net Income

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Peters $2,500,000 100,000 2,600,000 1,200,000 400,000 800,000 2,400,000 $200,000

Seto $1,300,000 30,000 1,330,000 750,000 250,000 180,000 1,180,000 $ 150,000

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Peters and Seto Companies Statement of Financial Positions As At December 31, 20x4 Cash Accounts Receivable Inventories Investment In Seto Plant And Equipment (Net)

Current Liabilities Long-Term Liabilities Common Stock Retained Earnings

Peters $ 100,000 430,000 1,150,000 720,000 2,1 50,000

Seto $ 70,000 180,000 400,000

$4,550,000

$1,500,000

$ 300,000 1,000,000 1,000,000 2,250,000

$ 40,000 400,000 800,000 260,000

$4,550,000

$1,500,000

850,000

Other Information: 1.

During 20x4, the Peters Company declared and paid $100,000 in dividends while the Seto Company declared and paid $40,000.

2.

On December 31, 20x4, Seto still owes Peters for management fees earned during 20x4. Fees of $25,000 have been charged by Peters and none of this amount has been paid by Seto in 20x4.

3.

Goodwill has been tested for impairment in both 20x3 and 20x4. The test procedures found impairment of $16,000 in 20x3, an amount that was recognized as a Goodwill Impairment Loss in that year. A further impairment of $20,000 was found in 20x4.

Required: 1. 2. 3. 4.

Prepare a consolidated statement of income and retained earnings for the year ended December 31, 20x4. Provide a proof of the ending Consolidated Retained balance. Prepare the consolidated statement of financial position as at December 31, 20x4. Provide a reconciliation of the NonControlling Interest account (on the statement of financial position) from the opening balance to the ending balance.

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Accelerated Program Week 10 Work Plan Suggested study plan for this week: Primary List

Secondary List

1.

Review what we did in class on Saturday.

2.

Foreign Currency Transactions • Problems 1, 2, 3, 4 • Prepare IC14 (Charlie), IC16 (Zip) and IC20 these will be taken up next week

3.

Foreign Currency Translation • Problems 2, 3, 4, 5 Problems 1 • Prepare IC19 (Cancorp) - will be taken up next week)

4.

Prepare the following problem on Investments will be taken up next week: • IC11 – Passy/Sassy

5.

Prepare Week 9 Quiz.

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Problem 11 – Investments On January 1, 20x2, Pantry Ltd. purchased 70% of the common shares of Santry Ltd. for $506,100. Financial data for Santry Ltd. are as follows: Santry Ltd. Statement of Financial Position January 1, 20x2 Cash Accounts receivable Inventory Capital assets Accumulated depreciation

Current liabilities Bonds payable at 12% interest Common shares Retained earnings

Book value Fair market value $ 56,000 $56,000 102,000 108,000 197,000 180,000 1,250,000 700,000 (500,000) $1,105,000 $ 140,000 240,000 375,000 350,000 $1,105,000

140,000 270,000

Additional Information: 1. 2 3. 4.

The capital assets are being written off over 10 years on a straight-line basis. Goodwill is tested annually for impairment. Impairment losses are as follows: 20x4 $30,000 20x5 20,000 The bonds have ten years remaining. During 20x5, Pantry declared and paid $50,000 of dividends. Santry declared and paid $40,000 of dividends.

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Financial statements of Pantry Ltd. and Santry Ltd. as at December 31, 20x5 are: Statement of Financial Positions December 31, 20x5 Cash Accounts receivable Inventory Capital assets – net Investment in subsidiary (cost)

Current liabilities Bonds payable at 12% interest Common shares Retained earnings

Pantry Ltd $ 145,500 300,000 609,500 1,000,000 506,100 $2,561,100 $ 100,000 400,000 2,061,100 $2,561,100

Santry Ltd $ 85,000 200,000 400,000 800,000 $1,485,000 $ 131,000 264,000 375,000 715,000 $1,485,000

Income Statements Year Ended December 31, 20x5 Sales and other revenues Cost of goods sold Depreciation Interest expense Other expenses Income tax expense Net income

Pantry Ltd $ 1,200,000 (800,000) (80,000) (107,000) (85,200) $ 127,800

Santry Ltd $ 925,000 (500,000) (70,000) (42,000) (80,000) (69,900) $ 163,100

Required: 1. 2. 3. 4.

Prepare a consolidated statement of income and retained earnings for the year ended December 31, 20x5. Provide a proof of the ending Consolidated Retained balance. Prepare the consolidated Statement of Financial Position as at December 31, 20x5. Provide a reconciliation of the NonControlling Interest Liability account from the opening balance to the ending balance.

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Problem 14 – Foreign Currency Transactions The Charlie Company purchased inventory from a U.S. company on April 30, 20x8, for $US80,000. The amount is payable on July 31, 20x8, in US dollars. Charlie Company has a June 30th year-end. The relevant exchange rates are as follows: April 30, 20x8 June 30, 20x8 July 31, 20x8

$US 1.00 = $C1.47 $US 1.00 = $C1.45 $US 1.00 = $C1.51

Required: Prepare the journal entries to account for the above transactions.

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Problem 16 – Foreign Currency Transactions On August 1, 20x4, Zip Ltd. Purchased some merchandise from a company in Switzerland for SF450,000. The liability was not due until March 1, 20x5. Zip was quite confident that the exchange rate fluctuations were not a problem and took no action to hedge the liability. On November 1, 20x4, Zip looked at the exchange rates and decided that they had better offset the liability with a 120-day forward contract. Assume a December 31 year end and that all months have 30 days. EXCHANGE RATES August 1, 20x4 November 1, 20x4 November l, 20x4 December 31, 20x4 December 31, 20x4 Aug 1 – Dec 31, 20x4 March 1, 20x5 December 31, 20x5 March 1, 20x6

spot rate spot rate 120-day forward rate spot rate 60-day forward rate average rate spot rate spot rate spot rate

C$1 = SF2.5 C$1 = SF2.1 C$1 = SF1.9 C$1 = SF1.7 C$1 = SF1.6 C$1 = SF2.0 C$1 = SF2.7 C$1 = SF2.9 C$1 = SF2.4

Required: 1. Prepare all the journal entries for the years 20x4 and 20x5 for Zip for this transaction. 2. Assume that the liability was a note due on March 1, 20x6 (instead of 20x5, as given above), and that Zip does not offset with a forward contract. Prepare all the journal entries for the year 20x4. Assume that the interest in the note is 10%.

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Problem 19 – Foreign Currency Translation Cancorp Ltd. purchased 90% of the shares of Forsub Inc. on January 1, 20x1. Forsub is located in the country of Amandaland. The financial statements of Forsub as at December 31, 20x2 are as follows: Forsub Statement of Financial Position as at December 31, 20x2 CORBINS Cash Accounts receivable Inventory Fixed Assets Accumulated depreciation

150,000 175,000 650,000 1,480,000 (520,000) 1,935,000

Current liabilities Long-term liabilities, 8% Common shares Retained earnings, January 1, 20x2 Net income - 20x2 Dividends (declared and paid on December 31, 20x2)

125,000 300,000 100,000 1,350,000 100,000 (40,000) 1,935,000

Forsub Income Statement for the year ended December 31, 20x2 Sales Cost of goods sold Depreciation Interest expense Other Gain on sale of fixed assets Net income

700,000 (450,000) (70,000) (28,000) (72,000) 20,000 100,000

Additional Information 1. The inventory is on a FIFO basis. The opening inventory was 175,000 CORB at 1 CORB = $0.700 and 200,000 CORB at 1 CORB = $0.729. The purchases during 20x2 were 350,000 CORB at 1 CORB = $0.686, 240,000 CORB at 1 CORB = $0.660 and 135,000 CORB at 1 CORB = $0.673.

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2. The fixed asset account is composed of land, 345,000 CORB which was purchased when the exchange rate was 1 CORB = $0.449 and buildings and equipment, 1,135,000 CORB purchased when the exchange rate was 1 CORB = $0.479. There have been no fixed asset acquisitions since January 1, 20x1. 3. The long-term liabilities were issued on January 1, 20x1. On July 1, 20x2 the longterm debt was reduced by 100,000 CORB. On April 1, 20x2, fixed assets were sold for proceeds of 40,000 CORB. Exchange rates are as follows: January 1, 20x1 July 1, 20x1 =Average for 20x1 December 31, 20x1 April 1, 20x2 July 1, 20x2 = Average for 20x2 Average for Jan-Jun 20x2 Average for Jul- Dec 20x2 December 31, 20x2

1 CORB = $0.625 1 CORB = $0.673 1 CORB = $0.745 1 CORB = $0.725 1 CORB = $0.686 1 CORB = $0.700 1 CORB = $0.670 1 CORB = $0.660

Part (A) Prepare a translated income statement assuming that Forsub’s functional currency is te Canadian dollar. Part (B) Use the same data as in Part (A), but assume that Forsub’s functional currency is the CORB. Forsub earned 250,000 CORB in 20x1 and declared and paid dividends of 100,000 CORB on December 31, 20x1. Calculate the balance in the Cumulative translation gain/loss account .

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Problem 20 – Foreign Currency Transactions On September 1, 20x5 you order a machine from a Swiss supplier. The cost of the machine is SF1,000,000. The machine is received on November 30, 30x5. You pay the invoice on March 31, 20x6. Your year-end is December 31. The following rates are available: Spot

Sep 1, 20x5 Nov 30, 20x5 Dec 31, 20x5 Mar 31, 20x6

1SF = $0.75 1SF = $0.86 1SF = $0.92 1SF = $1.02

Forward

Sep 1 (7 months) Oct 31 (5 months) Nov 30 (4 months) Dec 31 (3 months)

1SF = $0.82 1SF = $0.90 1SF = $0.97 1SF = $0.99

Required – Prepare all journal entries for the above transactions assuming that … a. no forward contract is taken out to offset the payable. b. a forward contract is taken out to offset the payable on November 30, the day the goods are received.

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