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Frederick D. S. Choi Gary K. Meek INTERNATIONAL ACCOUNTING Chapter 6: Foreign Currency Translation LEARNING OBJECTIVE: 1. Describe the nature of foreign currency transactions done in the spot, forward, and swap markets. 2. Understand the foreign currency translation terms. 3. Explain the difference between a translation gain or loss and a transaction gain or loss. 4. Comprehend alternative foreign currency translation methods that exist and their rationale. LEARNING OBJECTIVE: 5. Evaluate which of the available foreign currency translation methods are best under which specific business and currency market conditions. 6. Compare and contrast the financial statement effects of the temporal versus the current rate method of foreign currency translation. 7. Understand the relationship between foreign currency translation and inflation. 8. Appreciate how foreign currency translation is handled outside the United States. FOREIGN CURRENCY TRANSACTIONS FOREIGN CURRENCY TRANSACTIONS SINGLE-TRANSACTION PERSPECTIVE TWO-TRANSACTION PERSPECTIVE Under a two-transaction perspective, collection of the foreign currency receivable is considered a separate event from the sale that gave rise to it. EXAMPLE 1 On September 1, 2015, Cormorant Company purchased merchandise from Osaka Company of Japan for 20,000,000 yen payable on October 1, 2015. The spot rate for yen was $0.0079 on September 1 and the spot rate was $0.0077 on October 1. Required: 1. 2. 3. Did the exchange rate strength or weaken from September to October and what are the implications for Cormorant’s business? What journal entry did Cormorant record on September 1, 2015? What journal entry did Cormorant record on October 1, 2015? EXAMPLE 2 On October 15, 2015, Ibis Corporation, a French company, ordered merchandise listed on the Internet for 20,000 Euros from Spoonbill Corporation, a US corporation, which immediately accepted the order. The Euro rate was $1.20 US on October 15. On November 15, 2015 Spoonbill shipped the goods and billed Ibis the purchase price of 20,000 Euros when the Euro rate was $1.30 US. Ibis paid the bill on December 10, 2015. Three days later Spoonbill exchanged the 20,000 Euros for US dollars when the Euro rate was $1.28US. Required: Compute the foreign currency gains or losses on the December 31, 2015 financial statements and show your calculations. EXAMPLE 3 On November 1, 2013, the Penguin Corporation, a US corporation, purchased an extruding machine from Shearwater Corporation, a UK company. The purchase price was $10,000 and Penguin agreed to pay in pounds on February 1, 2014. Both corporations are on a calendar year accounting period. Assume that the spot rates for the British pound on November 1, 2013, December 31, 2013, and February 1, 2014, are $1.60, $1.62, and $1.66, respectively. Required: Record the November 1, December 31, and February 1 transactions in the General Journals of Penguin Corporation and Shearwater Corporation. If no entry is required on a particular date, indicate “No entry” in the General Journal. FOREIGN CURRENCY TRANSLATION Companies operating internationally use a variety of methods to express, in terms of their domestic currency, the assets, liabilities, revenues, and expenses that are stated in a foreign currency. SINGLE RATE METHOD The single rate method, long popular in Europe, applies a single exchange rate, the current or closing rate, to all foreign currency assets and liabilities. Foreign currency revenues and expenses are generally translated at exchange rates prevailing when these items are recognized. For convenience, however, revenues and expenses are typically translated by an appropriately weighted average of current exchange rates for the period. MULTIPLE RATE METHODS CURRENT–NONCURRENT METHOD a foreign subsidiary’s current assets (assets that are usually converted to cash within a year) and current liabilities (obligations that mature within a year) are translated into their parent company’s reporting currency at the current rate. Noncurrent assets and liabilities are translated at historical rates. MULTIPLE RATE METHODS CURRENT–NONCURRENT METHOD Income statement items (except for depreciation and amortization charges) are translated at average rates applicable to each month of operation or on the basis of weighted averages covering the whole period being reported. Depreciation and amortization charges are translated at the historical rates in effect when the related assets were acquired. MULTIPLE RATE METHODS CURRENT–NONCURRENT METHOD Unfortunately, this method does not often square with reality. Using the year-end rate to translate current assets implies that all foreign currency cash, receivables, and inventories are equally exposed to exchange risk; that is, will be worth more or less in parent currency if the exchange rate changes during the year. MULTIPLE RATE METHODS MONETARY–NONMONETARY METHOD a balance sheet classification scheme to determine appropriate translation rates. Monetary assets and liabilities; that is, claims to and obligations to pay a fixed amount of currency in the future are translated at the current rate. Nonmonetary items—fixed assets, long-term investments, and inventories are translated at historical rates. Income statement items are translated under procedures similar to those described for the current–noncurrent framework. MULTIPLE RATE METHODS MONETARY–NONMONETARY METHOD Note, however, that the monetary–nonmonetary method also relies on a classification scheme to determine appropriate translation rates. This may lead to inappropriate results. For example, this method translates all nonmonetary assets at historical rates, which is not reasonable for assets stated at current market values (such as investment securities and inventory and fixed assets written down to market). MULTIPLE RATE METHODS MONETARY–NONMONETARY METHOD Multiplying the current market value of a nonmonetary asset by a historical exchange rate yields an amount in the domestic currency that is neither the item’s current equivalent nor its historical cost. This method also distorts profit margins by matching sales at current prices and translation rates against cost of sales measured at historical costs and translation rates. MULTIPLE RATE METHODS TEMPORAL METHOD In the temporal method, monetary items such as cash, receivables, and payables are translated at the current rate. Nonmonetary items are translated at rates that preserve their original measurement bases. Specifically, assets carried on the foreign currency statements at historical cost are translated at the historical rate. MULTIPLE RATE METHODS TEMPORAL METHOD When nonmonetary items abroad are valued at historical cost, the translation procedures resulting from the temporal method are virtually identical to those produced by the monetary–nonmonetary method. The two translation methods differ only if other asset valuation bases are employed, such as replacement cost, market values, or discounted cash flows. MULTIPLE RATE METHODS The current rate method presumes that the entire foreign operation is exposed to exchange rate risk since all assets and liabilities are translated at the year-end exchange rate. The current–noncurrent rate method presumes that only the current assets and liabilities are so exposed, while the monetary–nonmonetary method presumes that monetary assets and liabilities are exposed. In contrast, the temporal method is designed to preserve the underlying theoretical basis of accounting measurement used in preparing the financial statements being translated. WHICH IS BEST? The object of translation is to change the unit of measure for financial statements of foreign subsidiaries to the domestic currency, and to make the foreign statements conform to accounting principles generally accepted in the country of the parent company. We think these objectives are best achieved by translation methods that use historical rates of exchange. WHICH IS BEST? The temporal principle is appropriate, as it changes a measurement in foreign currency into a measurement in domestic currency without changing the basis of measurement. The temporal translation method is easily adapted to processes that make accounting adjustments during the translation. WHICH IS BEST? When this is so, adjustments for differences between two or more sets of accounting concepts and practices are made along with the translation of currency amounts. For example, inventories or certain liabilities may be restated according to accounting practices different from those originally used. The temporal principle can accommodate any asset valuation framework, be it historical cost, current replacement price, or net realizable values. WHICH IS BEST? The current rate method is also useful when the accounts of an independent company are translated for the convenience of foreign stockholders or other external user groups. WHICH IS BEST? It is also appropriate when price-level-adjusted account are translated to another currency. If reliable price-level adjustments are made in a given set of accounts and if domestic price-level changes for the currency are reflected closely in related foreign exchange rate movements, the current rate translation of price-level adjusted data yields results that are comparable to translating historical cost accounts under the historical rate translation method. APPROPRIATE CURRENT RATE Thus far we have referred to rates of exchange used in translation methods as either historical or current. Average rates are often used in income statements for expediency. The choice of an appropriate exchange rate is not clear-cut because several exchange rates are in effect for any currency at any time. There are buying and selling (bid and ask) rates, spot rates and forward rates, official rates and free-market rates, and so on. APPROPRIATE CURRENT RATE We believe that an appropriate translation rate should reflect economic and business reality as closely as possible. The free-market rate quoted for spot transactions in the country where the accounts to be translated originate is a rate that appropriately measures current transaction values. TRANSLATION GAINS AND LOSSES Exclusion of translation adjustments in current income is generally advocated because these adjustments merely result from a restatement process. Changes in the domestic currency equivalents of a foreign subsidiary’s net assets are unrealized and have no effect on the local currency cash flows generated by the foreign entity. Therefore, it would be misleading to include such adjustments in current income. Under these circumstances, translation adjustments are accumulated separately as a part of consolidated equity. TRANSLATION WHEN LOCAL CURRENCY IS THE FUNCTIONAL CURRENCY If the functional currency is the foreign currency in which the foreign entity’s records are kept, its financial statements are translated to dollars using the current rate method. Resulting translation gains or losses are disclosed in a separate component of consolidated equity. This preserves the financial statement ratios as calculated from the local currency statements. The following current rate procedures are used: TRANSLATION WHEN LOCAL CURRENCY IS THE FUNCTIONAL CURRENCY 1. All foreign currency assets and liabilities are translated to dollars using the exchange rate prevailing as of the balance sheet date; capital accounts are translated at historical rates. 2. Revenues and expenses are translated using the exchange rate prevailing on the transaction date, although weighted average rates can be used for expediency. 3. Translation gains and losses are reported in a separate component of consolidated stockholders’ equity. These exchange adjustments do not go into the income statement until the foreign operation is sold or the investment is judged to have permanently lost value. TRANSLATION WHEN THE PARENT CURRENCY IS THE FUNCTIONAL CURRENCY When the parent currency is a foreign entity’s functional currency, its foreign currency financial statements are remeasured to dollars using the temporal method. All translation gains and losses resulting from the translation process are included in determining current period income. Specifically: TRANSLATION WHEN THE PARENT CURRENCY IS THE FUNCTIONAL CURRENCY 1. Monetary assets and liabilities and nonmonetary assets valued at current market prices are translated using the rate prevailing as of the financial statement date; other nonmonetary items and capital accounts are translated at historical rates. 2. Revenues and expenses are translated using average exchange rates for the period except those items related to nonmonetary items (e.g., cost of sales and depreciation expense), which are translated using historical rates. 3. Translation gains and losses are reflected in current income. TRANSLATION WHEN FOREIGN CURRENCY IS THE FUNCTIONAL CURRENCY A foreign entity may keep its records in on foreign currency when its functional currency is another foreign currency. In this situation, the financial statements are first remeasured from the local currency into the functional currency (temporal method) and then translated into U.S. dollars using the current rate method. Assume a German parent company owns a wholly-owned affiliate in Mexico. The Mexican affiliate subcontracts most of its production to Brazilian vendors. Hence, the Mexican affiliate’s functional currency is deemed to be the Brazilian real. EXAMPLE 1: For each of the 12 accounts listed in the table below, select the correct exchange rate to use when either remeasuring or translating a foreign subsidiary for its US parent company. Codes C H A = = = Current exchange rate Historical exchange rate Average exchange rate … EXAMPLE 1: US dollar is the functional Currency 1. Accounts receivable 2. Marketable debt securities carried at cost 3. Inventories carried at cost 4. Deferred income 5. Goodwill 6. Other paid-in capital 7. Depreciation 8. Refundable deposits 9. Common stock 10. Accumulated depreciation on Buildings 11. Deferred income tax liabilities 12. Accounts payable The foreign currency is the functional Currency TRANSLATE FINANCIAL STATEMENT: EXAMPLE 2 The following assets of Oriole Corporation’s Romanian subsidiary have been converted into US dollars at the following exchange rates: Current Rates Accounts receivable Trademark $ Property plant and equipment Totals $ 850,000 Historical Rates $ 875,000 600,000 575,000 1,200,000 900,000 2,650,000 $ 2,350,000 If the functional currency of the subsidiary is the US dollar, the assets should be reported in the consolidated financial statements of Oriole Corporation and Subsidiary in the total amount of TRANSLATE FINANCIAL STATEMENT: EXAMPLE 3 On January 1, 20X5, Pegler Corporation, a US company, acquired 100% of Selmic Corporation of Canada, paying an excess of 90,000 Canadian dollars over the book value of Selmic’s net assets. The excess was allocated to undervalued equipment with a three-year remaining useful life. Selmic’s functional currency is the Canadian dollar. Exchange rates for Canadian dollars for 20X5 are: January 1, 20X5 Average rate for 20X5 December 31, 20X5 $.77 .75 .73 Required: 1. Determine the depreciation expense stated in US dollars on the excess allocated to equipment for 20X5. 2. Determine the unamortized excess allocated to equipment on December 31, 20X5. 3. If Selmic’s functional currency was the US dollar, what would be the depreciation expense on the excess allocated to the equipment for 20X5? TRANSLATE FINANCIAL STATEMENT: EXAMPLE 4 Peake Corporation, a US company, formed a British subsidiary on January 1, 20X5 by investing £450,000 in exchange for all of the subsidiary’s no-par common stock. The British subsidiary, Searle Corporation, purchased real property on April 1, 20X5 at a cost of £500,000, with £100,000 allocated to land and £400,000 allocated to a building. The building is depreciated over a 40-year estimated useful life on a straight-line basis with no salvage value. The British pound is Searle’s functional currency and its reporting currency. The British economy does not have high rates of inflation. Exchange rates for the pound on various dates were: January 01, 20X5 April 01, 20X5 December 31, 20X5 20X5 average rate = = = = 1£ 1£ 1£ 1£ = = = = $1.50 $1.51 $1.58 $1.56 Searle's adjusted trial balance is presented below for the year ended December 31, 20X5. TRANSLATE FINANCIAL STATEMENT: EXAMPLE 4 (CONT.) Debits: Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of good sold Total debits Credits Accumulated depreciation Accounts payable Common stock Retained earnings Equity adjustment Sales revenue Total credits Required: Prepare Searle's: 1. Translation working papers; 2. Translated income statement; and 3. Translated balance sheet. £ £ £ £ 220,000 52,000 59,000 400,000 100,000 7,500 110,000 220,000 1,168,500 7,500 111,000 450,000 0 0 600,000 1,168,500 EXAMPLE 4 … Searle Corporation Translation Working Papers Debits Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of goods sold 220,000 52,000 59,000 400,000 100,000 7,500 110,000 220,000 x $1.58 x $1.58 x $1.58 x $1.58 x $1.58 x $1.56 x $1.56 x $1.56 = = = = = = = = Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Total credits Credit differential 7,500 111,000 450,000 600,000 x $1.58 x $1.58 x $1.50 x $1.56 = = = = $ 347,600 82,160 93,220 632,000 158,000 11,700 171,600 343,200 $ 1,839,480 $ $ 11,850 175,380 675,000 936,000 0 1,798,230 $ 41,250 EXAMPLE 4 … Searle Corporation Translated Income Statement For the Year Ended December 31, 20X5 Sales revenue $ Expenses: Cost of goods sold Depreciation expense Other expenses Net income 936,000 ( 343,200 ) ( 11,700 ) ( 171,600 ) $ 409,500 EXAMPLE 4 … Searle Corporation Translated Balance Sheet December 31, 20X5 Cash Accounts receivable Inventory Building-net Land Total assets $ Accounts payable Common stock Retained earnings Accumulated comprehensive income Total liabilities & equities $ $ $ 347,600 82,160 93,220 620,150 158,000 1,301,130 175,380 675,000 409,500 41,250 1,301,130 TRANSLATE FINANCIAL STATEMENT: EXAMPLE 5 Searle Corporation, a British subsidiary of Peake Corporation (a US company) was formed by Peake on January 1, 20X5 in exchange for all of the subsidiary's common stock. Searle has now ended its second year of operations on December 31, 20X6. Relevant exchange rates are: January 01, 20X5 = 1£ = $1.50 December 31, 20X6 = 1£ = $1.65 20X6 average rate = 1£ = $1.63 Searle's adjusted trial balance is presented below for the calendar year 20X6. The amount of equity adjustment carried over from 20X5 is a credit balance of $41,250 (in dollars). TRANSLATE FINANCIAL STATEMENT: EXAMPLE 5 (CONT.) In Pounds Debits: Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of good sold Total debits Credits Accumulated depreciation Accounts payable Common stock Retained earnings Sales revenue Total credits £ £ £ £ 75,000 362,000 41,000 400,000 100,000 10,000 133,000 380,000 1,501,000 17,500 154,750 450,000 262,500 616,250 1,501,000 EXAMPLE 5… Searle Corporation Translation Working Papers Debits Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of goods sold 75,000 362,000 41,000 400,000 100,000 10,000 133,000 380,000 x $1.65 x $1.65 x $1.65 x $1.65 x $1.65 x $1.63 x $1.63 x $1.63 = = = = = = = = Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Accumulated comprehensive income Total credits Credit differential 17,500 154,750 450,000 616,250 262,500 x $1.65 x $1.65 x $1.50 x $1.63 = = = = $ 123,750 597,300 67,650 660,000 165,000 16,300 216,790 619,400 $ 2,466,190 $ 28,875 255,338 675,000 1,004,487 409,500 $ 41,250 2,414,450 $ 51,740 EXAMPLE 5… Searle Corporation Translated Income Statement for the year ended December 31, 20X6 Sales revenue $ Expenses: Cost of goods sold Depreciation expense Other expenses Net income Retained earnings, January 1, 20X6 Retained earnings, December 31, 20X6 1,004,487 ( 619,400 ) ( 16,300 ) ( 216,790 ) $ $ 151,997 409,500 561,497 EXAMPLE 5… Searle Corporation Translated Balance Sheet December 31, 20X6 Cash Accounts receivable Inventory Building-net Land Total assets $ $ 123,750 597,300 67,650 631,125 165,000 1,584,825 Accounts payable $ Common stock Retained earnings Accumulated comprehensive income ($41,250 + $51,740) Total liabilities & equities $ 255,338 675,000 561,497 92,990 1,584,825 EXAMPLE 6 The Pearce Corporation, a US corporation, formed a British subsidiary on January 1, 20X7 by investing £550,000 in exchange for all of the subsidiary’s no-par common stock. The British subsidiary, Seakam Corporation, purchased real property on April 1, 20X7 at a cost of £500,000, with £100,000 allocated to land and £400,000 allocated to the building. The building is depreciated over a 40-year estimated useful life on a straight-line basis with no salvage value. The US dollar is Seakam’s functional currency, but it keeps its records in pounds. The British economy does not experience high rates of inflation. Exchange rates for the pound on various dates are: January 01, 20X7 April 01, 20X7 December 31, 20X7 20X7 average rate = = = = 1£ 1£ 1£ 1£ = = = = $1.40 $1.42 $1.45 $1.44 Seakam's adjusted trial balance is presented below for the year ended December 31, 20X7. EXAMPLE 6 (CONT.) In Pounds Debits: Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense Total debits Credits Accumulated depreciation Accounts payable Common stock Retained earnings Equity adjustment Sales revenue Total credits Required: Prepare Seakam's: £ £ £ £ 200,000 72,000 99,000 400,000 100,000 7,500 115,000 208,000 1,201,500 7,500 100,000 550,000 0 0 544,000 1,201,500 EXAMPLE 6 … Seakam Corporation Translation Working Papers Debits Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense 200,000 72,000 99,000 400,000 100,000 7,500 115,000 208,000 x x x x x x x x $1.45 $1.45 $1.45 $1.42 $1.42 $1.42 $1.44 $1.44 = = = = = = = = Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Total credits Credit differential 7,500 100,000 550,000 544,000 0 x x x x $1.42 $1.45 $1.40 $1.44 = = = = $ 290,000 104,400 143,550 568,000 142,000 10,650 165,600 299,520 $ 1,723,720 $ $ 10,650 145,000 770,000 783,360 0 1,709,010 $ 14,710 EXAMPLE 6 … Seakam Corporation Translated Income Statement For the Year Ended December 31, 20X7 Sales revenue Expenses: Salary expense Depreciation expense Other expenses Income before exchange gains or losses Exchange gains Net income Retained earnings, January 1, 20X7 Retained earnings, December 31, 20X7 $ 783,360 ( ( ( $ $ $ 299,520 ) 10,650 ) 165,600 ) 307,590 14,710 322,300 0 322,300 EXAMPLE 6 … Seakam Corporation Translated Balance Sheet December 31, 20X7 Cash Accounts receivable Notes receivable Building-net Land Total assets $ Accounts payable Common stock Retained earnings Total liabilities & equities $ $ $ 290,000 104,400 143,550 557,350 142,000 1,237,300 145,000 770,000 322,300 1,237,300 EXAMPLE 7 Seakam Corporation, a British subsidiary of Pearce Corporation (a US company) was formed by Pearce on January 1, 20X7 in exchange for all of the subsidiary's common stock. Seakam has now ended its second year of operations on December 31, 20X8. Relevant exchange rates are: January 01, 20X7 April 01, 20X7 December 31, 20X8 20X8 average rate = = = = 1£ 1£ 1£ 1£ = = = = $1.40 $1.42 $1.37 $1.36 Seakam's adjusted trial balance is presented below for the calendar year 20X8. EXAMPLE 7 (CONT.) In Pounds Debits: Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense Total debits Credits Accumulated depreciation Accounts payable Common stock Retained earnings Sales revenue Total credits Required: Prepare Seakam's: 1. Translation working papers; 2. Translated income statement; and 3. Translated balance sheet. £ £ £ £ 172,000 308,000 98,000 400,000 100,000 10,000 117,000 376,000 1,581,000 17,500 200,000 550,000 213,500 600,000 1,581,000 EXAMPLE 7… Seakam Corporation Translation Working Papers Debits Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense 172,000 308,000 98,000 400,000 100,000 10,000 117,000 376,000 x x x x x x x x $1.37 $1.37 $1.37 $1.42 $1.42 $1.42 $1.36 $1.36 = = = = = = = = Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Total credits Debit differential 17,500 200,000 550,000 600,000 213,500 x x x x $1.42 $1.37 $1.40 $1.36 = = = = $ 235,640 421,960 134,260 568,000 142,000 14,200 159,120 511,360 $ 2,186,540 $ $ 24,850 274,000 770,000 816,000 322,300 2,207,150 $ 20,610 EXAMPLE 7… Seakam Corporation Translated Income Statement For the Year Ended December 31, 20X8 Sales revenue Expenses: Salary expense Depreciation expense Other expenses Income before exchange gains or losses Exchange loss Net income Retained earnings, January 1, 20X8 Retained earnings, December 31, 20X8 $ 816,000 ( ( ( $ ( $ $ 511,360 14,200 159,120 131,320 20,610 110,710 322,300 433,010 ) ) ) ) EXAMPLE 7… Seakam Corporation Translated Balance Sheet December 31, 20X8 Cash Accounts receivable Notes receivable Building-net Land Total assets $ Accounts payable Common stock Retained earnings Total liabilities & equities $ $ $ 235,640 421,960 134,260 543,150 142,000 1,477,010 274,000 770,000 433,010 1,477,010 EXAMPLE 8 On January 1, 20X4, Pearl Corporation, a US firm, acquired a 70% interest in Segar Corporation, a foreign company, for $120,000, when Segar’s stockholders’ equity consisted of 300,000 local currency units (LCU) and retained earnings of 100,000 LCU. At the time of the acquisition, Segar’s assets and liabilities were fairly valued except for a patent that did not have any recorded book value. All excess purchase cost was attributed to the patent, which had an estimated economic life of 10 years at the date of acquisition. The exchange rate for LCUs on January 1, 20X4 was $.40. A summary of changes in Segar’s stockholders’ equity during 20X4 and the exchange rates for LCUs is as follows: LCU Rates Dollars Stockholders’ equity 1/1/X4 Net income Dividends 12/1/X4 Equity adjustment Stockholders’ equity 12/31/X4 400,000 100,000 ( 50,000 $ .40C .42A ) .43C $ 450,000 .44C $ 160,000 42,000 ( 21,500 17,500 198,000 ) EXAMPLE 8 … Required: Determine the following: 1. Fair value of the patent from Pearl’s investment in Segar on January 1, 20X4. 2. Patent amortization for 20X4. 3. Unamortized patent at December 31, 20X4. 4. Equity adjustment from the patent. 5. Income from Segar for 20X4. 6. Investment in Segar balance at December 31, 20X4. EXAMPLE 8 … Patent Fair Value Cost of 70% interest $ Book value acquired 400,000 LCU x $.40 x 70% = Patent in dollars 120,000 ( 112,000 ) $ 8,000 Patent in LCU = $8,000/$.40 per LCU = 20,000 EXAMPLE 8 … Patent amortization for 20X4 Patent: 20,000 LCU/10 2,000 LCU per year years = 2,000 LCU per year x $.42 equals $ amortization of: 840 EXAMPLE 8 … Unamortized patent Patent (20,000 LCU – 2,000 LCU) x $.44 = $ 7,920 EXAMPLE 8 … Equity adjustment from patent Beginning patent (from Req. 1) $ Patent amortization (from Req. 2) 8,000 ( 840 Subtotal 7,160 Ending goodwill 18,000 LCU x $.44 = 7,920 Equity adjustment $ 760 ) EXAMPLE 8 … Income from Segar Equity in income ($42,000 x 70%) Less: Patent amortization Income from Segar $ 29,400 ( 840 $ 28,560 ) EXAMPLE 8 … Investment in Segar balance at December 31, 20X4 Cost, January 1, 20X4 $ Add: Income for 20X4 (from Req. 5) Less: Dividends ($21,500 x 70%) ( Add: Equity adjustment from patent (from Req. 4) Add: Equity adjustment from translation ($17,500 x 70%) Investment balance, December 31, 20X4 $ Check: Book value: $198,000 x 70% = Unamortized patent (from Req. 3) Investment balance $ $ 120,000 28,560 15,050 760 12,250 146,520 138,600 7,920 146,520 ) FOREIGN CURRENCY TRANSLATION AND INFLATION Use of the current rate to translate the cost of nonmonetary assets located in inflationary environments will eventually produce domestic currency equivalents far below their original measurement bases. FOREIGN CURRENCY TRANSLATION AND INFLATION At the same time, translated earnings would be greater because of correspondingly lower depreciation charges. Such translated results could easily mislead rather than inform. Lower dollar valuations would usually understate the actual earning power of foreign assets supported by local inflation, and inflated return on investment ratios of foreign operations could create false expectations of future profitability.