FINANCIAL ACCOUNTING 4 Module 8

Transcription

1 FINANCIAL ACCOUNTING 4 Module 8 Foreign Subsidiaries Canadian companies are required by GAAP to produce consolidated financial statements. Thus, if the company has operations in England then the company must translate the British statements into Canadian dollars before consolidation can occur. (you cannot add pounds and dollars together, its like adding apples and oranges) So now the question is how do we translate a set of financial statements, that include transactions from various points in the year, when the exchange rates were different for each transaction? When a company has foreign operations it is often necessary to translate the financial statements of the foreign operation into the "home country" currencies for performance evaluation purposes or for consolidation purposes. Consolidation is the procedure whereby two legally separate entities combine their financial statements and report as one economic entity. Consolidation is only required when one company (the parent) controls another company (subsidiary). The definition of control is a matter of whether the parent company can decide the operating, financing and investing activities of the subsidiary without the consent of other parties. Control usually exists when the parent owns more than 50% of the voting common shares of the subsidiary. Control is equated to ownership. Accounting Exposure Any item translated at the current exchange rate will produce translation gains or losses (the difference between the opening balance (based on older rates) and ending balances (based on current rates)). The net balance of all items translated at the current rate under a given method is known as the accounting exposure to exchange rate fluxuations. Economic Exposure It is argued that when a foreign asset is held, exchange rate fluxuations will cause an economic gain. An economic gain is simply an increase in value of an asset, the company holding the foreign asset realizes an increase in real wealth. Since a company's investment in a foreign operation is a net asset position (A-L=OE), then an increase in the exchange rate will result in a gain to the parent (investing) company because the net assets of the foreign operation have increased. The preferred accounting translation method for foreign operations is the one that yields an accounting exposure that best reflects the economic exposure. There are two basic types of foreign operations, 1. foreign operations where the subsidiary is highly dependent upon the parent (integrated) - a foreign operation which is financially or operationally interdependent with the reporting enterprise (the parent) such that the exposure to exchange rate fluxuations is similar to the exposure which would exist had the transactions been undertaken by the reporting enterprise (the parent). The Foreign Currency Transaction Approach best suits the economic exposure of this situation (formally known as the temporal method). 2. foreign operations where the parent is not involved in daily management (self sustaining operations) - a foreign operation that is financially and operationally ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 1

2 independent of the parent such that the exposure to exchange rate fluxuations is limited to the parent's net investment (ie its share of the OE of the foreign operation). Using the closing rate for the Balance sheet and the transaction rates for the income statement best suits the economic exposure of this situation (formally known as the current rate method). FA4 - Module 8 Example On January 1, 20X0, CP Co. (a Canadian company) purchased 80% of SF Co. (a US company) at a cost of US$50,000. The book values of SF Co. s net assets were equal to fair market values on this date except for the building, which had a FMV of US$65,000 with a remaining useful life of 10 years. Goodwill was not impaired in 20X0. The balance sheet of SF in US dollars on Jan. 1, 20X0 is as follows: Cash + A/R 20,000 Inventory 5,000 Building (net) 55,000 80,000 Current liabilities 18,000 Bonds Payable 25,000 Common Shares 10,000 Retained Earnings 27,000 80,000 The following exchange rates were in effect during 20X0: January 1, 2000 US$1 = $ Average US$1 = $1.38 December 15, 2000 US$1 = $1.41 December 31, 2000 US$1 = $1.39 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 2

3 The financial statement of CP and SF for December 31, 20X0 are as follows: CP (C$) SF (US$) Cash + A/R 64,000 32,000 Inventory (purchased Dec. 15, 2000) 45,000 22,000 Equipment (net) 80,000 Building (net) 100,000 49,500 Investment in SF 70, , ,500 Current Liabilities 50,000 20,000 Bonds Payable 25,000 Mortgage Payable 65,000 Common Shares 60,000 10,000 Retained Earnings, Jan ,000 27,000 Net Income 19,000 23,500 Dividends (paid Dec. 31) 10,000 2, , ,500 Sales 300,000 75,000 Dividend Income 2224 COGS 150,224 20,000 Amortization 18,000 5,500 Other Expenses 115,000 26,000 19,000 23,500 Assume that expenses have been incurred evenly throughout the year. Required: a) Prepare consolidated financial statements using the foreign currency transaction approach. b) Prepare consolidated financial statements assuming that SF is a foreign operation. ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 3

4 Solution: A - foreign currency transaction approach. Step One: Calculation of Goodwill in $CND and Purchase Price Discrepancy Schedule Purchase Price (50,000*1.40) 70,000 Implied Value (70,000/0.80) 87,500 BV of SF: (10,000+27,000)* ,800 AD 35,700 allocation: Building (65,000-55,000)x ,000 GW 21,700 amortization of AD: Jan-X0 Amortization or Impairment Dec-X0 Building (10 years ) 14,000 1,400 12,600 Goodwill 21,700 21,700 Step Two: Calculation of Translation Gain/Loss Net monetary position: Jan 1 position (20,000-18,000-25,000)x ,200 Changes during the year: Sales (75,000*1.38) 103,500 Purchases (20,000-5,000+22,000) x ,060 Purchase = cogs BI + EI Other Expenses (26,000 x 1.38) -35,880 Dividends (2,000 x 1.39) -2,780 calculated current monetary position -18,420 actual current monetary position (32,000-20,000-25,000)x ,070 Translation gain 350 Step Three: Translated Financial Statements Translated Income Statement Sales 103,500 COGS: BI (5,000x1.40) 7,000 Purchases 51,060 EI (22,000x1.41) 31,020 27,040 Amortization (5,500x1.40) 7,700 Other expenses 35,880 Translation gain 350 NI 33,230 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 4

5 Translated Balance Sheet Cash + A/R (32,000x1.39) 44,480 Inventory (22,000x1.41) 31,020 Building (49,500x1.40) 69,300 Total 144,800 Current Liab (20,000x1.39) 27,800 Bonds (25,000x1.39) 34,750 Common Shares (10,000x1.40) 14,000 R/E Jan 1 (27,000x1.40) 37,800 NI 33,230 Dividends (2,000x1.39) -2, ,800 Step Four: Consolidated Financial Statements Consolidated Income Statement Sales (300, ,500) 403,500 COGS (150, ,040) 177,264 Amortization (18,000+7,700+1,400) 27,100 Goodwill impairment 0 Other (115,000+35,880) 150,880 Translation gain 350 NI 48,606 Allocated: NCI (20%x33,230 - (0.20 x 1,400)) 6,366 Parent 42,240 Consolidated Balance Sheet Cash + A/R (64,000+44,480) 108,480 Inventory (45,000+31,020) 76,020 Equipment 80,000 Building (100,000+69,300+12,600) 181,900 GW 21,700 Total 468,100 Current liab (50,000+27,800) 77,800 Bonds 34,750 Mortgage 65,000 NCI* 23,310 CS 60,000 R/E Jan 1 175,000 NI 42,240 Dividends -10, ,100 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 5

6 *NCI 20% of FV: (87,500 x 0.20) 17,500 Net Income 6,366 Dividends (2,000*0.2*1.39) ,310 B - Foreign Operation Step One: Calculation of Goodwill in $US Purchase Price 50,000 Implied value (50,000/0.8) 62,500 BV of SF: (10,000+27,000) 37,000 AD 25,500 allocation: Building (65,000-55,000) 10,000 GW 15,500 Step Two: Calculation of Translation Gains/Losses Net assets - Jan 1 ((10,000+27,000)x1.40) 51,800 Changes: Net Income (23,500x1.38) 32,430 Dividends (2,000x1.39) -2,780 Calculated net asset position 81,450 Net assets - Dec. 31 (10,000+27,000+23,500-2,000)x1.39) 81,315 Loss 135 Step Three: Translate Financial Statements Translated Income Statement $US Exchange Rate $CND Sales 75, ,500 COGS 20, ,600 Amortization 5, ,590 Other 26, ,880 23, ,430 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 6

7 Translated Balance Sheet Cash + A/R 32, ,480 Inventory 22, ,580 Building 49, , , ,865 Current liab 20, ,800 Bonds 25, ,750 Common shares 10, ,000 R/E Jan1 27, ,800 NI 23, ,430 Dividends -2, ,780 Translation loss AOCI , ,865 Step Four: Acquisition Differential Amortization Schedule AD schedule Impairment/ Jan-X0 x1.40 Amort x1.38 Dec-X0 x 1.39 Building 10,000 14,000 1,000 1,380 9,000 12,510 GW 15,500 21, ,500 21,545 35,700 1,380 34,055 translation gain/loss on AD Jan 1 35,700 Amort 1,380 Calc. Balance 34,320 Dec 31 34,055 LOSS 265 Step Five: Calculation of consolidated cumulative translation adjustment NCI Total 20% Consolidated From SF loss From AD Step Six: Consolidated Financial Statements Consolidated Income Statement Sales (103, ,000) 403,500 COGS (27, ,224) 177,824 Amortization (7,590+18,000+1,380) 26,970 Goodwill Impairment 0 Other (35, ,000) 150,880 47,826 NCI (32,430-1,380)x0.20 6,210 41,616 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 7

8 Consolidated B/S Cash + A/R (44,480+64,000) 108,480 Inventory (30,580+45,000) 75,580 Equipment (0+80,000) 80,000 Building (68, ,000+12,510) 181,315 Goodwill 21, ,920 Current liabilities (27,800+50,000) 77,800 Bonds 34,750 Mortgage 65,000 NCI* 23,074 Common shares 60,000 R/E** 206,616 Translation loss (classified with comprehensive income) ,920 *NCI FV at Jan 1 (62,500*1.40*0.20) 17,500 NI 6,210 Dividends (2,000*1.39*0.20) -556 Translation loss ,074 **R/E R/E Jan1 175,000 NI 41,616 Dividends -10, ,616 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 8

9 Problem Calculation, allocation, and amortization of acquisition differential Cost of 70% investment, Jan. 2, Year 1 FP1,400,000 Implied value of 100% investment FP2,000,000 Carrying amounts of White s net assets: Common shares 200,000 Retained earnings 900,000 Total shareholders' equity 1,100,000 Acquisition differential 900,000 Allocation: FV CA Building 100, ,000 Balance goodwill 800,000 Balance Amortization/ Balance Dec. 31 Impairment Dec. 31 Year 5 Year 6 Year 6 Building (10 years) 100,000 10,000 90,000 Goodwill 800,000 80, , ,000 90, ,000 Goodwill carrying amount 720,000 x 0.20 = 144,000 (a) (i) Building net Canadian $ Black s building 3,000,000 White s building (FP2,700,000 x 0.20) 540,000 Unamortized acquisition differential (FP90,000 x 0.20) 18,000 3,558,000 (ii) Goodwill Carrying amount (FP720,000 x 0.20) 144,000 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 9

10 (iii) Depreciation expense buildings Black s depreciation expense 200,000 White s depreciation expense (FP300,000 x 0.20) 60,000 Amortization of acquisition differential (FP10,000 x 0.20) 2, ,000 (iv) Net income (excluding other comprehensive income) Black s income before foreign exchange 150,000 Less: dividend income (FP100,000 x 70% x 0.17) (11,900) 138,100 White s income before foreign exchange (given) 30,000 Foreign exchange gains on White s separate F/S 50,000 Amortization of acquisition differential (FP90,000 x 0.20) (18,000) 62,000 Net income 200,100 Attributable to: Shareholders of Black (138, % x 62,000) 181,500 Non-controlling interest (30% x 62,000) 18,600 (v) Other comprehensive income Not applicable under temporal method 0 (vi) Non-controlling interest on income statement White s adjusted net income 62,000 NCI s share 30% 18,600 (vii) Non-controlling interest on balance sheet White s common shares (FP200,000 x 0.20) 40,000 White s retained earnings, beginning (FP900,000 x 0.20) 180,000 White s net income (30, ,000) 80,000 White s dividends (FP100,000 x 0.17) (17,000) 283,000 Unamortized acquisition differential - building (FP90,000 x 0.20) 18,000 - goodwill 144, ,000 NCI s share 30% 133,500 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 10

11 (b) (i) Building net Canadian $ Black s building 3,000,000 White s building (FP2,700,000 x 0.15) 405,000 Unamortized acquisition differential (FP90,000 x 0.15) 13,500 3,418,500 (ii) Goodwill Unamortized acquisition differential (FP720,000 x 0.15) 108,000 (iii) Depreciation expense buildings Black s depreciation expense 200,000 White s depreciation expense (FP300,000 x 0.18) 54,000 Amortization of acquisition differential (FP10,000 x 0.18) 1, ,800 (iv) Net income (excluding other comprehensive income) Black s income before foreign exchange 150,000 Less: dividend income (FP100,000 x 70% x 0.17) (11,900) 138,100 White s income before foreign exchange (FP160,000 x 0.18) 28,800 Amortization of acquisition differential (FP90,000 x 0.18) (16,200) 12, ,700 Attributable to: Shareholders of Black (138, % x 12,600) 146,920 Non-controlling interest (30% x 12,600) 3,780 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 11

12 (v) Other comprehensive income FP Rate Dollars Net assets, beginning of year 1,100, ,000 Net income 160, ,800 Dividends paid 100, (17,000) Calculated net assets, end of year 231,800 Actual net assets, end of year 1,160, (174,000) Exchange loss from translation of White s financial statements 57,800 Acquisition differential, beginning of year 900, ,000 Amortization for year 90, (16,200) Calculated acquisition differential, end of year 163,800 Actual acquisition differential, end of year 810, (121,500) Exchange loss from translation of acquisition differential 42,300 Total other comprehensive income (loss) (100,100) Attributable to: Shareholders of Black (70% x 101,100) 70,070 Non-controlling interest (30% x 101,100) 30,030 (vi) Non-controlling interest on income statement White s adjusted net income 12,600 NCI s share 30% 3,780 White s other comprehensive income (loss) (100,100) NCI s share 30% (30,030) (26,250) (vii) Non-controlling interest on balance sheet White s common shares (FP200,000 x 0.20) 40,000 White s retained earnings, beginning (FP900,000 x 0.20) 180,000 White s net income (FP160,000 x 0.18) 28,800 White s dividends (FP100,000 x 0.17) (17,000) Accumulated foreign exchange adjustments (100,100) Unamortized acquisition differential (FP810,000 x 0.15) 121, ,200 NCI s share 30% 75,960 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 12

13 Problem 11-3 (a) Net monetary position AP Canadian dollars Opening balance* (95,000) $1 = AP2.9 (32,759) Sales 10,350,000) $1 = AP3.25 3,184,615) Purchases (Note 1) (6,530,000) Note 1 (2,118,590) Other expenses (Note 2) (3,467,500) $1 = AP3.25 (1,066,923) Dividends (200,000) $1 = AP3.6 (55,556) (89,213) Less closing balance** 57,500) $1 = AP3.6 15,972 Exchange gain 105,185) * AP450 + AP405 AP250 AP700 ** AP820 + AP317.5 AP380 AP700 Note 1: 2,000,000 / 3 + 4,530,000 / 3.12 Note 2: 3,590, ,500 (b) Income Statement Argentine Canadian peso dollars Sales 10,350,000) $1 = AP3.25 3,184,615) Cost of sales (6,400,000) Note 3 (2,091,513) 3,950,000) 1,093,102) Other expenses (3,590,000) Note 4 (1,109,164) (16,062)) Foreign exchange gain from part (a) 105,185 Net income 89,123 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 13

14 Note 3: Opening inventory 600,000) $1 = AP2.9* $206,897 + Purchase #1 2,000,000) $1 = AP ,667 + Purchase #2 4,530,000) $1 = AP3.12 1,451,923 7,130,000) 2,325,487 Closing inventory (730,000) $1 = AP3.12 (233,974) Cost of sales 6,400,000) 2,091,513) * Both plant assets and the opening inventory would be translated at the rate of exchange on the date of acquisition by the parent. Note 4: Depreciation (122,500) $1 = AP2.9* (42,241) Other expenses (3,467,500) $1 = AP3.25 (1,066,923) 3,590,000 (1,109,164 ACCTG FA4 Translation and Consolidation of foreign subsidiaries page 14