国际会计第七版英文版课后答案(第九章)

国际财务管理（英文版）课后习题答案9CHAPTER 8 MANAGEMENT OF TRANSACTION EXPOSURE SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS ANDPROBLEMSQUESTIONS1. How would you define transaction exposure? How is it different from economic exposure?Answer: Transaction exposure is the sensitivity of realized domestic currency values of the firm’s contractual cash flows denominated in foreign currencies to unexpected changes in exchange rates. Unlike economic exposure, transaction exposure is well-defined and short-term.2. Discuss and compare hedging transaction exposure using the forward contract vs. money market instruments. When do the alternative hedging approaches produce the same result?Answer: Hedging transaction exposure by a forward contract is achieved by selling or buying foreign currency receivables or payables forward. On the other hand, money market hedge is achieved by borrowing or lending the present value of foreign currency receivables or payables, thereby creating offsetting foreign currency positions. If the interest rate parity is holding, the two hedging methods are equivalent.3. Discuss and compare the costs of hedging via the forward contract and the options contract.Answer: There is no up-front cost of hedging by forward contracts. In the case of options hedging, however, hedgers should pay the premiums for the contracts up-front. The cost of forward hedging, however, may be realized ex post when thehedger regrets his/her hedging decision.4. What are the advantages of a currency options contract asa hedging tool compared with the forward contract?Answer: The main advantage of using options contracts for hedging is that the hedger can decide whether to exercise options upon observing the realized future exchange rate. Options thus provide a hedge against ex post regret that forward hedger might have to suffer. Hedgers can only eliminate the downside risk while retaining the upside potential.5. Suppose your company has purchased a put option on the German mark to manage exchange exposure associated with an account receivable denominated in that currency. In this case, your company can be said to have an ‘insurance’ policy on its receivable. Explain in what sense this is so.Answer: Your company in this case knows in advance that it will receive a certain minimum dollar amount no matter what might happen to the $/€ exchange rate. Furthermore, if the German mark appreciates, your company will benefit from the rising euro.6. Recent surveys of corporate exchange risk management practices indicate that many U.S. firms simply do not hedge. How would you explain this result?Answer: There can be many possible reasons for this. First, many firms may feel that they are not really exposed to exchange risk due to product diversification, diversified markets for their products, etc. Second, firms may be using self-insurance against exchange risk. Third, firms may feel that shareholders can diversify exchange risk themselves, rendering corporate risk management unnecessary.7. Should a firm hedge? Why or why not?Answer: In a perfect capital market, firms may not need to hedge exchange risk. But firms can add to their value by hedging if markets are imperfect. First, if management knows about the firm’s exposure better than shareholders, the firm, not its shareholders, should hedge. Second, firms may be able to hedge at a lower cost. Third, if default costs are significant, corporate hedging can be justifiable because it reduces the probability of default. Fourth, if the firm faces progressive taxes, it can reduce tax obligations by hedging which stabilizes corporate earnings.8. Using an example, discuss the possible effect of hedging on a firm’s tax obligations.Answer: One can use an example similar to the one presented in the chapter.9. Explain contingent exposure and discuss the advantages of using currency options to manage this type of currency exposure.Answer: Companies may encounter a situation where they may or may not face currency exposure. In this situation, companies need options, not obligations, to buy or sell a given amount of foreign exchange they may or may not receive or have to pay. If companies either hedge using forward contracts or do not hedge at all, they may face definite currency exposure.10. Explain cross-hedging and discuss the factors determining its effectiveness.Answer: Cross-hedging involves hedging a position in one asset by taking a position in another asset. The effectiveness of cross-hedging would depend on the strength and stability of the relationship between the two assets.PROBLEMS1. Cray Research sold a super computer to the Max PlanckInstitute in Germany on credit and invoiced €10 million payable in six months. Currently, the six-month forward exchange rate is $1.10/€ and the foreign exchange advisor for Cray Research predicts that the spot rate is likely to be $1.05/€ in six months.(a) What is the expected gain/loss from the forward hedging?(b) If you were the financial manager of Cray Research, would you recommend hedging this euro receivable? Why or why not?(c) Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you recommend hedging in this case? Why or why not?Solution: (a) Expected gain($) = 10,000,000(1.10 – 1.05)= 10,000,000(.05)= $500,000.(b) I would recommend hedging because Cray Research can increase the expected dollar receipt by $500,000 and also eliminate the exchange risk.(c) Since I eliminate risk without sacrificing dollar receipt, I still would recommend hedging.2. IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ￥250 million payable in three months. Currently, the spot exchange rate is ￥105/$ and the three-month forward rate is ￥100/$. The three-month money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM decided to use the money market hedge to deal with this yen account payable.(a) Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation.(b) Conduct the cash flow analysis of the money markethedge.Solution: (a). Let’s first compute the PV of ￥250 million, i.e., 250m/1.0175 = ￥245,700,245.7So if the above yen amount is invested today at the Japanese interest rate for three months, the maturity value will be exactly equal to ￥25 million which is the amount of payable.To buy the above yen amount today, it will cost:$2,340,002.34 = ￥250,000,000/105.The dollar cost of meeting this yen obligation is $2,340,002.34 as of today.(b)________________________________________________________________ ___Transaction CF0 CF1________________________________________________________________ ____1. Buy yens spot-$2,340,002.34with dollars￥245,700,245.702. Invest in Japan - ￥245,700,245.70￥250,000,0003. Pay yens- ￥250,000,000Net cash flow- $2,340,002.34________________________________________________________________ ____3. You plan to visit Geneva, Switzerland in three months to attend an international business conference. You expect to incur the total cost of SF 5,000 for lodging, meals and transportation during your stay. As of today, the spot exchange rate is $0.60/SF and the three-month forward rate is $0.63/SF. You can buy the three-month call option on SF with the exercise rate of $0.64/SFfor the premium of $0.05 per SF. Assume that your expected future spot exchange rate is the same as the forward rate. The three-month interest rate is 6 percent per annum in the United States and 4 percent per annum in Switzerland.(a) Calculate your expected dollar cost of buying SF5,000 if you choose to hedge via call option on SF.(b) Calculate the future dollar cost of meeting this SF obligation if you decide to hedge using a forward contract.(c) At what future spot exchange rate will you be indifferent between the forward and option market hedges?(d) Illustrate the future dollar costs of meeting the SF payable against the future spot exchange rate under both the options and forward market hedges.Solution: (a) Total option premium = (.05)(5000) = $250. In three months, $250 is worth $253.75 = $250(1.015). At the expected future spot rate of $0.63/SF, which is less than the exercise price, you don’t expect t o exercise options. Rather, you expect to buy Swiss franc at $0.63/SF. Since you are going to buy SF5,000, you expect to spend $3,150 (=.63x5,000). Thus, the total expected cost of buying SF5,000 will be the sum of $3,150 and $253.75, i.e., $3,403.75.(b) $3,150 = (.63)(5,000).(c) $3,150 = 5,000x + 253.75, where x represents the break-even future spot rate. Solving for x, we obtain x = $0.57925/SF. Note that at the break-even future spot rate, options will not be exercised.n ga re g oo (d) If the Swiss franc appreciates beyond $0.64/SF, which isthe exercise price of call option, you will exercise the option and buy SF5,000 for $3,200. The total cost of buying SF5,000 will be $3,453.75 =$3,200 + $253.75.This is the maximum you will pay.4. Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €20million which is payable in one year. The current spot exchange rate is $1.05/€ and the one-year forward rate is $1.10/€. The annual interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and would like to hedge exchange exposure.(a) It is considering two hedging alternatives: sell the euro proceeds from the sale forward or borroweuros from the Credit Lyonnaise against the euro receivable. Which alternative would you recommend? Why?(b) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods?Solution: (a) In the case of forward hedge, the future dollar proceeds will be (20,000,000)(1.10) = $22,000,000. In the case of money market hedge (MMH), the firm has to first borrow the PV of its euro receivable, i.e., 20,000,000/1.05 =€19,047,619. Then the firm should exchange this euro amount intodollars at the current spot rate to receive: (€19,047,619)($1.05/€) = $20,000,000, which can be invested at the dollar interest rate for one year to yield:$20,000,000(1.06) = $21,200,000.Clearly, the firm can receive $800,000 more by using forward hedging.(b) According to IRP, F = S(1+i $)/(1+i F ). Thus the“indifferent” forward rate will be:F = 1.05(1.06)/1.05 = $1.06/€.$ Cost Options hedgeForward hedge$3,453.75$3,1500.5790.64(strike price)$/SF$253.755. Suppose that Baltimore Machinery sold a drilling machine to a Swiss firm and gave the Swiss client a choice of paying either $10,000 or SF 15,000 in three months.(a) In the above example, Baltimore Machinery effectively gave the Swiss client a free option to buy up to $10,000 dollars using Swiss franc. What is the ‘implied’ exercise exchange rate?(b) If the spot exchange rate turns out to be $0.62/SF, which currency do you think the Swiss client will choose to use for payment? What is the value of this free option for the Swiss client?(c) What is the best way for Baltimore Machinery to deal with the exchange exposure?Solution: (a) The implied exercise (price) rate is: 10,000/15,000 = $0.6667/SF.(b) If the Swiss client chooses to pay $10,000, it will cost SF16,129 (=10,000/.62). Since the Swiss client has an option to pay SF15,000, it will choose to do so. The value of this option is obviously SF1,129 (=SF16,129-SF15,000).(c) Baltimore Machinery faces a contingent exposure in the sense that it may or may not receive SF15,000 in the future. The firm thus can hedge this exposure by buying a put option onSF15,000.6. Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy Industry. PCC owes Mitsubishi Heavy Industry 500 million yen in one year. The current spot rate is 124 yen per dollar and the one-year forward rate is 110 yen per dollar. The annual interest rate is 5% in Japan and 8% in the U.S. PCC can also buy a one-year call option on yen at the strike price of $.0081 per yen for a premium of .014 cents per yen.(a) Compute the future dollar costs of meeting this obligation using the money market hedge and the forward hedges.(b) Assuming that the forward exchange rate is the best predictor of the future spot rate, compute the expected future dollar cost of meeting this obligation when the option hedge is used.(c) At what future spot rate do you think PCC may be indifferent between the option and forward hedge?Solution: (a) In the case of forward hedge, the dollar cost will be 500,000,000/110 = $4,545,455. In the case of money market hedge, the future dollar cost will be: 500,000,000(1.08)/(1.05)(124) = $4,147,465.(b) The option premium is: (.014/100)(500,000,000) = $70,000. Its future value will be $70,000(1.08) = $75,600.At the expected future spot rate of $.0091(=1/110), which is higher than the exercise of $.0081, PCC will exercise its call option and buy ￥500,000,000 for $4,050,000 (=500,000,000x.0081).The total expected cost will thus be $4,125,600, which is the sum of $75,600 and $4,050,000.(c) When the option hedge is used, PCC will spend “at most” $4,125,000. On the other hand, when the forward hedging is used,PCC will have to spend $4,545,455 regardless of the future spot rate. This means that the options hedge dominates the forward hedge. At no future spot rate, PCC will be indifferent between forward and options hedges.7. Airbus sold an aircraft, A400, to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned with the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and six-month forward exchange rate is $1.10/€ at the moment. Airbus can buy a six-month put option on U.S. dollars with a strike pric e of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six-month interest rate is 2.5% in the euro zone and 3.0% in the U.S./doc/e67180396.html,pute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using aforward contract.b.If Airbus decides to hedge using money market instruments, what action does Airbus need to take?What would be the guaranteed euro proceeds from the American sale in this case?c.If Airbus decides to hedge using put options on U.S. dollars, what would be the ‘expected’ europroceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.d.At what future spot exchange rate do you think Airbus will be indifferent between the option andmoney market hedge?Solution:a. Airbus will sell $30 million forward for €27,272,727 = ($30,000,000) / ($1.10/€).b. Airbus will borrow the present value of the dollar receivable, i.e., $29,126,214 = $30,000,000/1.03, and then sell the dollar proceeds spot for euros: €27,739,251. This is the euro amount that Airbus is going to keep.c. Since the expected future spot rate is less than the strike price of the put option, i.e., €0.9091< €0.95, Airbus expects to exercise the option and receive €28,500,000 = ($30,000,000)(€0.95/$). This is gross proceeds. Airbus spent €600,000 (=0.02x30,000,000) upfront for the option and its future cost is equal to €615,000 = €600,000 x 1.025. Thus the net euro proceeds from the American sale is €27,885,000, which is the difference between the gross proceeds and the option costs.d. At the indifferent future spot rate, the following will hold:€28,432,732 = S T (30,000,000) - €615,000.Solving for S T , we obtain the “indifference” future spot exchange rate, i.e., €0.9683/$, or $1.0327/€.Note that €28,432,732 is the future value of the proceeds under money market hedging:€28,432,732 = (€27,739,251) (1.025).Suggested solution for Mini Case: Chase Options, Inc.[See Chapter 13 for the case text]Chase Options, Inc.Hedging Foreign Currency Exposure Through Currency OptionsHarvey A. PoniachekI. Case SummaryThis case reviews the foreign exchange options market and hedging. It presents various international transactions thatrequire currency options hedging strategies by the corporations involved. Seven transactions under a variety of circumstances are introduced that require hedging by currency options. The transactions involve hedging of dividend remittances, portfolio investment exposure, and strategic economic competitiveness. Market quotations are provided for options (and options hedging ratios), forwards, and interest rates for various maturities.II. Case Objective.The case introduces the student to the principles of currency options market and hedging strategies. The transactions are of various types that often confront companies that are involved in extensive international business or multinational corporations. The case induces students to acquire hands-on experience in addressing specific exposure and hedging concerns, including how to apply various market quotations, which hedging strategy is most suitable, and how to address exposure in foreign currency through cross hedging policies.III. Proposed Assignment Solution1. The company expects DM100 million in repatriated profits, and does not want the DM/$ exchange rate at which they convert those profits to rise above 1.70. They can hedge this exposure using DM put options with a strike price of 1.70. If the spot rate rises above 1.70, they can exercise the option, while if that rate falls they can enjoy additional profits from favorable exchange rate movements.To purchase the options would require an up-front premium of:DM 100,000,000 x 0.0164 = DM 1,640,000.With a strike price of 1.70 DM/$, this would assure the U.S.company of receiving at least:DM 100,000,000 – DM 1,640,000 x (1 + 0.085106 x 272/360) = DM 98,254,544/1.70 DM/$ = $57,796,791by exercising the option if the DM depreciated. Note that the proceeds from the repatriated profits are reduced by the premium paid, which is further adjusted by the interest foregone on this amount.However, if the DM were to appreciate relative to the dollar, the company would allow the option to expire, and enjoy greater dollar proceeds from this increase.Should forward contracts be used to hedge this exposure, the proceeds received would be:DM100,000,000/1.6725 DM/$ = $59,790,732,regardless of the movement of the DM/$ exchange rate. While this amount is almost $2 million more than that realized using option hedges above, there is no flexibility regarding the exercise date; if this date differs from that at which the repatriate profits are available, the company may be exposed to additional further current exposure. Further, there is no opportunity to enjoy any appreciation in the DM.If the company were to buy DM puts as above, and sell an equivalent amount in calls with strike price 1.647, the premium paid would be exactly offset by the premium received. This would assure that the exchange rate realized would fall between 1.647 and 1.700. If the rate rises above 1.700, the company will exercise its put option, and if it fell below 1.647, the other party would use its call; for any rate in between, both options would expire worthless. The proceeds realized would then fall between: DM 100,00,000/1.647 DM/$ = $60,716,454andDM 100,000,000/1.700 DM/$ = $58,823,529.o This would allow the company some upside potential, while guaranteeing proceeds at least $1 million greater than the minimum for simply buying a put as above.Buy/Sell Options DM/$ Spot Put Payoff “Put” Profits Call Payoff “Call” Profits Net Profit 1.60(1,742,846)01,742,84660,716,45460,716,4541.61(1,742,846)0 1,742,84660,716,45460,716,4541.62(1,742,846)01,742,84660,716 ,45460,716,4541.63(1,742,846)01,742,84660,716,45460,716,4541 .64(1,742,846)01,742,84660,716,45460,716,4541.65(1,742,846)60 ,606,0611,742,846060,606,0611.66(1,742,846)60,240,9641,742,8 46060,240,9641.67(1,742,846)59,880,2401,742,846059,880,2401. 68(1,742,846)59,523,8101,742,846059,523,8101.69(1,742,846)59, 171,5981,742,846059,171,5981.70(1,742,846)58,823,5291,742,84 6058,823,5291.71(1,742,846)58,823,5291,742,846058,823,5291.7 2(1,742,846)58,823,5291,742,846058,823,5291.73(1,742,846)58,8 23,5291,742,846058,823,5291.74(1,742,846)58,823,5291,742,84605 8,823,5291.75(1,742,846)58,823,5291,742,846058,823,5291.76(1, 742,846)58,823,5291,742,846058,823,5291.77(1,742,846)58,823, 5291,742,846058,823,5291.78(1,742,846)58,823,5291,742,84605 8,823,5291.79(1,742,846)58,823,5291,742,846058,823,5291.80(1, 742,846)58,823,5291,742,846058,823,5291.81(1,742,846)58,823, 5291,742,846058,823,5291.82(1,742,846)58,823,5291,742,84605 8,823,5291.83(1,742,846)58,823,5291,742,846058,823,5291.84(1, 742,846)58,823,5291,742,846058,823,5291.85(1,742,846)58,823,5291,742,84658,823,529Since the firm believes that there is a good chance that the pound sterling will weaken, locking them into a forward contract would not be appropriate, because they would lose the opportunity to profit from this weakening. Their hedge strategy should follow for an upside potential to match their viewpoint. Therefore, they should purchase sterling call options, paying a premium of:5,000,000 STG x 0.0176 = 88,000 STG.If the dollar strengthens against the pound, the firm allows the option to expire, and buys sterling in the spot market at a cheaper price than they would have paid for a forward contract; otherwise, the sterling calls protect against unfavorable depreciation of the dollar.Because the fund manager is uncertain when he will sell the bonds, he requires a hedge which will allow flexibility as to the exercise date. Thus, options are the best instrument for him to use. He can buy A$ puts to lock in a floor of 0.72 A$/$. Since he is willing to forego any further currency appreciation, he can sell A$ calls with a strike price of 0.8025 A$/$ to defray the cost of his hedge (in fact he earns a net premium of A$ 100,000,000 x (0.007234 –0.007211) = A$ 2,300), while knowing that he can’t receive less than 0.72 A$/$ when redeeming his investment, and can benefit from a small appreciation of the A$.Example #3:Problem: Hedge principal denominated in A$ into US$. Forgo upside potential to buy floor protection.I. Hedge by writing calls and buying puts1) Write calls for $/A$ @ 0.8025Buy puts for $/A$ @ 0.72# contracts needed = Principal in A$/Contract size100,000,000A$/100,000 A$ = 1002) Revenue from sale of calls = (# contracts)(size of contract)(premium)$75,573 = (100)(100,000 A$)(.007234 $/A$)(1 + .0825 195/360)3) Total cost of puts = (# contracts)(size of contract)(premium)$75,332 = (100)(100,000 A$)(.007211 $/A$)(1 + .0825 195/360)4) Put payoffIf spot falls below 0.72, fund manager will exercise putIf spot rises above 0.72, fund manager will let put expireg 5) Call payoffIf spot rises above .8025, call will be exercised If spot falls below .8025, call will expire 6) Net payoffSee following Table for net payoff Australian Dollar Bond Hedge Strike Price Put Payoff “Put” Principal Call Payoff “Call” PrincipalNet Profit 0.60(75,332)72,000,00075,573072,000,2410.61(75,332)72,000,00 075,573072,000,2410.62(75,332)72,000,00075,573072,000,2410. 63(75,332)72,000,00075,573072,000,2410.64(75,332)72,000,0007 5,573072,000,2410.65(75,332)72,000,00075,573072,000,2410.66( 75,332)72,000,00075,573072,000,2410.67(75,332)72,000,00075,5 73072,000,2410.68(75,332)72,000,00075,573072,000,2410.69(75, 332)72,000,00075,573072,000,2410.70(75,332)72,000,00075,573 072,000,2410.71(75,332)72,000,00075,573072,000,2410.72(75,33 2)72,000,00075,573072,000,2410.73(75,332)73,000,00075,57307 3,000,2410.74(75,332)74,000,00075,573074,000,2410.75(75,332) 75,000,00075,573075,000,2410.76(75,332)76,000,00075,573076, 000,2410.77(75,332)77,000,00075,573077,000,2410.78(75,332)78,000,00075,573078,000,2410.79(75,332)79,000,00075,573079,00 0,2410.80(75,332)80,000,00075,573080,000,2410.81(75,332)075,57380,250,00080,250,2410.82(75 ,332)075,57380,250,00080,250,2410.83(75,332)075,57380,250,00 080,250,2410.84(75,332)075,57380,250,00080,250,2410.85 (75,332)75,57380,250,00080,250,2414. The German company is bidding on a contract which they cannot be certain of winning. Thus, the need to execute a currency transaction is similarly uncertain, and using a forward or futures as a hedge is inappropriate, because it would force them to perform even if they do not win the contract.Using a sterling put option as a hedge for this transaction makes the most sense. For a premium of:12 million STG x 0.0161 = 193,200 STG,they can assure themselves that adverse movements in the pound sterling exchange rate will not diminish the profitability of the project (and hence the feasibility of their bid), while at the same time allowing the potential for gains from sterling appreciation.5. Since AMC in concerned about the adverse effects that a strengthening of the dollar would have on its business, we need to create a situation in which it will profit from such an appreciation. Purchasing a yen put or a dollar call will achieve this objective. The data in Exhibit 1, row 7 represent a 10 percent appreciation of the dollar (128.15 strike vs. 116.5 forward rate) and can be used to hedge against a similar appreciation of the dollar.For every million yen of hedging, the cost would be:Yen 100,000,000 x 0.000127 = 127 Yen.To determine the breakeven point, we need to compute the value of this option if the dollar appreciated 10 percent (spot rose to 128.15), and subtract from it the premium we paid. This profit would be compared with the profit earned on five to 10 percent of AMC’s sales (which would be lost as a result of the dollar appreciation). The number of options to be purchased which would equalize these two quantities would represent the breakeven point.Example #5:Hedge the economic cost of the depreciating Yen to AMC.If we assume that AMC sales fall in direct proportion to depreciation in the yen (i.e., a 10 percent decline in yen and 10 percent decline in sales), then we can hedge the full value of AMC’s sales. I have assumed $100 million in sales.1) Buy yen puts# contracts needed = Expected Sales *Current ￥/$ Rate / Contract size9600 = ($100,000,000)(120￥/$) / ￥1,250,0002) Total Cost = (# contracts)(contract size)(premium)$1,524,000 = (9600)( ￥1,250,000)($0.0001275/￥)3) Floor rate = Exercise – Premium128.1499￥/$ = 128.15￥/$ - $1,524,000/12,000,000,000￥4) The payoff changes depending on the level of the ￥/$ rate. The following table summarizes thepayoffs. An equilibrium is reached when the spot rate equals the floor rate.AMC ProfitabilityYen/$Spot Put Payoff Sales Net Profit 120(1,524,990)100,000,00098,475,010121(1,524,990)99,173,66497,648,564122(1,524,990)98,360,65696,835,666123(1,524,990)97,560,97686,035,986124(1,524,990)96,774,19495,249,204125(1,524,990)96,000,00094,475,010126(1,524,990)95,238,09593,713,105127(847,829)94,488,18993,640,360128(109,640)93,750,00093,640,360129617,10493,023,25693,640,3601301,332,66892,307,69293,640,3601312,037,30791,603,05393,640,3601322,731,26990,909,09193,640,3601333,414,79690,225,66493,640,3601344,088,12289,552,23993,640,3601354,751,43188,888,88993,640,3601365,405,06688,235,29493,640,3601376,049,11887,591,24193,640,3601386,683,83986,966,52293,640,3601397,308,42586,330,93693,640,3601407,926,07585,714,28693,640,3601418,533,97785,106,38393,640,3601429,133,31884,507,04293,640,3601439,724,27683,916,08493,640,36014410,307,02783,333,33393,640,36014510,881,74082,758,62193,640,36014611,448,57982,191,78193,640,36014712,007,70781,632,65393,640,36014812,569,27981,081,08193,640,360。

国际会计第七版英文版课后答案（第七章）预览说明:预览图片所展示的格式为文档的源格式展示,下载源文件没有水印,内容可编辑和复制Chapter 7Financial Reporting and Changing PricesDiscussion Questions Solutions1.Historical-based financial statements may be misleading during periods of significant inflation.Many resources may have been acquired in periods when the purchasing power of the monetary unit was much higher. These expenses then typically are deducted from revenues that reflect current purchasing power. The resulting income number is unintelligible. Another problem for statement readers is that the value of assets recorded at their historical acquisition cost is typically understated as a result of inflation. Understated asset values produce understated expenses and overstated earnings.Financial trends are also difficult to interpret, as trend statistics generally include monetary units of different purchasing power. A positive trend in sales may be due to price changes, not real increases in sales.2. A price index is a cost ratio, that is, the ratio of a representative “basket” of goods and servicesconsumed by an average family, compared to the price of that same basket in a benchmark (“base”) year. The price index is invaluable in enabling a statement reader to translate sums of money paid in the past to their current purchasing power equivalents.3.This statement is partly true and shows the confusion thatsurrounds inflation accounting. Inaccounting for changing prices, users must distinguish between general price changes and specific price changes. General prices refer to the prices of all goods and services in the economy. The object of accounting for general price level changes is to preserve the general purchasing power of a company’s money capital. Specific price changes refer to changes in the prices of specific commodities. The object of accounting for specific price changes is to preserve a company’s productive capacity or operating capability.4.The congressman is wrong. The object of inflation accounting is to clarify the distinction betweencapital and income, not to minimize corporate taxes. Inflation accounting shows how much money the company can pay in expenses, taxes, and dividends, while keeping enough resources to maintain its capital.5.Although it is generally conceded in principle that price level-adjusted financial statements are moreuseful than conventional accounting statements during periods of significant inflation, it is a judgment call to identify exactly when price level-adjusted statements become more meaningful. Asa rule of thumb, executives in Brazil use an inflation rate greater than 10 % per month. Investors inGermany or Switzerland may believe that 5 % inflation per year is alarming. Unfortunately, no one has yet developed a formal, rigorous, easy-to-apply definition of meaningfulness.How does one determine whether the benefits of price level-adjusted accounting information exceed the costs? While the costs to generate such information can be measured, it is muchharder to quantify the benefits. Financial accounting deals with information produced by business enterprises for use by external decision makers. Consequently, measurement of the benefits of price level-adjusted information must cover all user groups in an economy. Multiple user groups, uneven distributions of benefits (both within and between groups), and favorable economy-wide spillover effects of price level information complicate the task. Adding international dimensions makes the problem even worse.6.The U.S. approach resembles the price-level adjusted current cost model, whereas the U.K.approach embraces the current cost model. While both require disclosure of the impact ofchanging prices on monetary items, the U.S. approach basically uses the general price level index to compute monetary gains and losses, whereas the U.K. employs specific prices changes by way of its gearing adjustment.1.The International Accounting Standards Board sanctions use of the general price level model orthe current cost framework. Whichever method is employed, these inflation adjustments must be expressed in terms of constant purchasing power as of the balance sheet date. Purchasing powergains or losses are to be included in current income. Firms adjusting their accounts for changingprices must disclose, at a minimum: a) the fact that end-of-period purchasing power adjustmentshave been made, b) the asset valuation framework employed in the primary financial statements,c) the type of inflation index or indexes employed and theirlevel at the end of the period as wellas their movements during the period, and d) the net purchasing power gain or loss on netmonetary items held during the period. Given the options that are available, analysts mustunderstand the differences between the approved inflation accounting methods to be able tocompare companies choosing one option over the other and to assure proper interpretation ofinflation adjusted amounts.2.The historical cost-constant dollar model measures the impact of general price level changes on afirm's reported performance and financial position. The current cost model examines the impact of specific price changes on enterprise income and wealth.The two measurement frameworks are similar in that both attempt to clarify the distinction between capital and income. They differ in reporting objectives. Whereas the historical cost/constant dollar model attempts to preserve the general purchasing power of a firm's original money capital, the current cost model attempts to preserve an entity's physical capital or productive capacity.3.Your authors think that restating foreign and domestic accounts to their current cost equivalentsproduces information that is far more helpful to investor decisions than historical cost methods, whether or not adjusted for changes in general price levels. Such information provides a performance measure that signals the maximum amount of resources that enterprises can distribute without reducing their productive capacity. It also facilitates comparisons ofconsolidated data.10. The gearing adjustment is an inflation adjustment that partially offsets the additional charges toincome associated with assets whose values are restated for inflation (e.g., higher depreciation and cost of sales). This adjustment recognizes that borrowers generally gain from inflation because they can repay their debts with currency of reduced purchasing power. Hence, it is unnecessary to recognize the higher replacement cost of inventory and plant and equipment in the income statement so far as they are financed by debt.11. Accounting for foreign inflation differs from accounting for domestic inflation in two major ways.First, foreign rates of inflation often are higher than domestic rates, which increases potential distortions in an entity's reported results from changing prices. Second, as foreign exchange rates and differential national rates of inflation are seldom perfectly negatively correlated, care must be taken to avoid double-dipping when consolidating the results of foreign operations.12.Double-dipping refers to methods that count the effects of foreign inflation twice in reportedearnings. Earnings are reduced once when cost of sales is adjusted upwards for inflation, andagain when inventories are translated to domestic currency using a current exchange rate, whichyields a translation loss. Since the change in the exchange rate itself was caused by inflation, the result is a double charge for inflation.Exercise Solutions1.This exercise is a good way to test students’ understanding of the various approaches toaccounting for changin g prices. Vestel’s earnings numbers are based on the general price levelmodel whereas Infosys is measuring its performance based on a current cost framework. Modello goes a step further and adjusts its current cost statements for changes in the general price level.Some may feel that current cost data, which is based on the notion of replacement costs, is toosubjective a notion to be reliable. Since general price level data are based on general price level indices, the numbers appearing in Vestel’s income statement are much more objective andfacilitates comparisons among companies using a similar methodology. Moreover, Vestel’sstatements do not violate the historical cost doctrine. Others will argue that the value of stockinvestments are based on discounted future cash flows. Accordingly, the current cost framework provided by Infosys is more germane to investor decisions as it measures the amount of earnings that could be distributed as dividends without reducing the firm’s future dividend gen eratingpotential. Moreover, current cost earnings, including the gearing adjustment , reflects how thefirm is impacted by prices that are more germane to the firm, as opposed to the general public.Some will argue that Modello’s income statement combin es the best of both worlds. However,there is merit to the argument that the income statementshould measure the performance of thefirm and that this is best accomplished with the current cost framework. Since individualinvestors are affected by the g eneral price level, they should adjust their share of a firm’s current cost earnings distributions for general inflation.2. a.Income Statement Historical Price Level Historical Cost-Cost Adjustment Constant Dollar Revenue MXP 144,000,000 420/340 MXP 177,882,353 Operating expenses (86,400,000) 420/340 (106,729,412) Depreciation (36,000,000) 420/263 (57,490,494)Operating income MXP 21,600,000 MXP 13,662,447a Monetary gains(losses) - (73,248,759)Net income MXP 53,280,000 MXP(59,586,312)Balance SheetCash MX(P 157,600,000 420/420 MXP 157,600,000Land 180,000,000 420/263 287,452,471Building 720,000,000 420/263 1,149,809,885Acc. Depreciation (36,000,000) 420/263 (57,490,494)Total MXP 1,021,600,000 MXP 1,537,371,862Owners' equity(beg.) MXP1,000,000,000 rolled forward b MXP 1,596,958,174Net income (loss) 21,600,000 (59,586,312)Owner's equity MXP 1,021,600,000 MXP 1,537,371,862(end)a Monetary loss:CashBeginning balance 1,000,000,000 420/263 1,596,958,174 Purchase ofreal estate ( 900,000,000) 420/263 (1,437,262,356)Rental revenues 144,000,000 420/340 177,882,353Operating expenses (86,400,000) 420/340 106,729,412)157,600,000 230,848,759-157,600,000 Monetary loss (73,248,759)b Beginning equity x price level adjustment = adjusted amount= P 1,000,000,000 x 420/263 = P 1,596,958,1742.b.Cost HC/Constant DollarReturn on Assets 21,600,000 (59,586,312)1,021,600,000 1,537,371,862= 2.1% = -3.9%Cost-based profitability ratios tend to provide a distorted (overstated) picture of a company's operating performance during a period of inflation.3.20X7 20X8Cash MJR 2,500 MJR 5,100Current liabilities (1,000) (1,200)LT-Debt (3,000) (4,000)Net monetary liabilities MJR (1,500) MJR (100)Zonolia Enterprise’s net monetary liability position changed by MJR1,400 during the year (MJR100) –(MJR1,500).4.Nominal Restate for ConstantMJR’s Majikstan GPL MJR’sNet monetary liab.'s MJR 1,500 x 32,900/30,000 = MJR1,645 12/31/X7Decrease during year (1,400) = (1,400)Net monetary liab.'s MJR 100 x 32,900/36,000 = MJR 9112/31/X8Monetary (general purchasing power) gain MJR 1545. Historical Current Cost Current Income Statement Cost Adjustment Cost Revenues MXP 144,000,000 - MXP 144,000,000 Operating expenses 86,400,000 - 86,400,000 Depreciation (36,000.000) 1.8 64,800,000 Net Income (loss) MXP 21,600,000 MXP (7,200,000)Balance SheetCash MXP 157,600,000 - P 157,600,000 Land 180,000,000 1.9 342,000,000 Building 720,000,000 1.8 1,296,000,000 Acc. Depreciation (36,000,000) 1.8 (64,800,000) Total MXP1,021,600,000 MXP 1,730,800,000 Owners' Equity Beg. Balance MXP1,000,000,000 MXP 1,000,000,000 OE revaluation a - 738,000,000Net income (loss) 21,600,000 (7,200,000) Total MXP1,021,600,000 MXP 1,730,800,000a Revaluation of land MXP 162,000,000Revaluation of building 576,000,000MXP 738,000,0006. Solution in 000,000's:MJR8,000 X 137.5/100.0 = MJR11,00020X7 20X8Current cost MJR8,000 MJR11,000Acc. depreciation (1,600) (3,300)aNet current cost MJR6,400 MJR7,700a Current cost depreciation = MJR800 X 137.5/100.0 = 1,100per year for 3 years.7. As no new assets were acquired during the year, we must determine to what extent the MJR3,000 increase in the current cost of Zonolia's equipment exceeded the change in the general price level during the year. The appropriate calculation follows: MJR11,000 - [MJR8,000 X 36,000/30,000]= MJR11,000 - MJR9,600= MJR1,400Alternatively, if we follow the FASB’s sug gested methodology, where calculations are expressed in average (20X8) dollars, current cost depreciation would be computed by reference to the average current cost of the related assets. Thus, Current cost, 12/31/X7 MJR8,000,000Current cost, 12/31/X8 11,000,000MJR19,000,000Average current cost MJR19,000,000/2 = MJR9,500,000Current cost depreciation at 10% = MJR950,000Increase in current cost of equipment, net of inflation (000's): Current Restate for Current cost/Cost Inflation Constant Zonos Current cost, net12/31/X7 MJR6,400 X 32,900/30,000 MJR7,019Depreciation (950) (950)Current cost, net12/31/X8 7,700 X 32,900/36,000 7,037MJR 2,250 MJR968The increase in the current cost of equipment, net of inflation is MJR968. The difference between the nominal renge amount (MJR2,250) and constant renges (MJR968) is the inflation component of the equipment's current cost increase.8. Restate-translate method:Constant Translate $ Equivalentsrenges of constantrengesIncrease in currentcost of equip., netof inflation MJR968,000 X 1/4,800 = $202Translate-restate method:CC (MJR) Translate CC ($) Restate CC/ Constant $U.S. GPLCC, net MJR 6,400,000 x 1/4,800 = $1,333 x 292.5/281.5 = $1,38512/31/X7Dep. (950,000) x 1/4,800 = (198) = (198)CC, net 7,700,000 x 1/4,800 = 1,604 x 292.5/303.5 = 1,54612/31/X8MJR 2,250,000 $ 469 $ 3599.20X7 20X8￡m ￡mTrade receivables 242 270-Trade payables (170) (160)Net monetary working capital 72 110Change in monetary working capital = ￡38 (￡110 - ￡72) Nominal Restate for Constant￡British PPI ￡Net monetary W/C 72 X 110/100 = 79.212/31/20X7Increase during year 38 = 38.0Net monetary W/C 110 X 110/120 = 100.812/31/20X8Monetary working capital adjustment = (16.4)aa This amount is added to the current cost adjustments for depreciation and cost of sales because trade receivables exceeded trade payables, thus tying up working capital in an asset that lost purchasing power.Gearing adjustment:[(TL – CA)/(FA + I + MWC)] [CC Dep. Adj. + CC Sales Adj. + MWCA]where TL = total liabilities other than trade payablesCA = current assets other than trade receivables and inventoryFA = fixed assets including investmentsI = inventoryMWC = monetary working capitalCC Dep. Adj. = current cost depreciation adjustmentCC Sales adj. = current cost of sales adjustmentMWCA = monetary working capital adjustment= [(128 – 75)/(479 + 220 + 110] [￡m 216]= [.066 ] [216]= ￡14.3The only number I could readily identify in problem 9 is inventory of 220. The next number I could come close on is fixed assets. Looks like the solution above says 479, the text for 08 indicates 473. I could not see where the 110 (MWC) came from. Neither is it clear where the other 3 items in brackets came from. The solution needs to be clearer before I can check the numbers.This gearing adjustment of ￡14.3 million is subtracted from the current cost of sales and depreciation adjustments. It represents the purchasing power gain from using debt to finance part of the firm's operating assets.a.Nominal Thai Historical Translation U.S.baht inflation c ost/constant rate dollaradjustment baht equivalentInven-tory BHT500,000 x 100/200 = BHT250,000 x .02 = $5,000b.Nominal Translation U.S. U.S. Historicalbaht rate dollar inflation c ost/constantequivalent adjustment dollarsInven-tory BHT500,000 x .02 = 10,000 x 180/198 = $9,090Sorry this seems confusing compared to number 2 where the year end index was in the numerator and either the beginning or average index was in the denominator (e.g. 420/340 or 420/263). It is not clear why we do the opposite here where the Thai price level doubles and we put the 200 in the denominator and 100 in the numerator.c. Most students will prefer the restate-translate method. This approach has merit if general and specific pricelevels move in tandem. If not, neither approach is satisfactory as both are based on a historical cost valuation framework that is generally irrelevant for investment decisions.d. For reasons enumerated in this chapter, we favor restating local currency assets for specific price changesand then translating these current cost equivalents to dollars using the current exchange rate.11. We assume that Doosan Enterprises translates its inventory at the current rate and adjusts its cost ofsales for inflation by simulating what it would have been ona LIFO basis. Two adjustments are necessarybecause local inflation impacts exchange rates used to translate foreign currency inventory balances to dollars.With FIFO inventories, a translation loss is recorded in "as reported" earnings when it is originally translatedto U.S. dollars by a current exchange rate that changed (devalued) during the period. This translation loss isan indirect charge for local inflation. The inflation adjustment (simulated LIFO charge) to increase "as reported" cost of sales to a current cost basis is an additional charge for inflation. Absent some offsettingentry, consolidated results would be charged twice for inflation. To avoid this double charge, the translation loss embodied in reported earnings is deducted from the simulated LIFO charge to arrive at a net U.S. dollarcurrent cost of sales adjustment. Steps in the adjustment process are as follows:1. FIFO inventory subject to simulated LIFO charge KRW10,920,0002. Restate line 1 to January 1 currency units(KRW10,920,000 x 100/120). The result is anapproximation of December 31 LIFO inventory KRW9,100,0003. Difference between FIFO and LIFO inventorybalances (line 1 minus line 2) is the additionallira LIFO expense (current cost adjustment)for the current year. KRW1,820,0004. Translate line 3 to dollars at the January 1exchange rate (KRW1,820,000 ÷ 900). The resultis the additional dollar LIFO expense for thecurrent year $ 2,0225. Calculate the translation loss on FIFO inventory(line 1) that has already been reflected in "asreported" results:a. Translate line 1 at Januaryexchange rate (KRW10,920,000 ÷ KRW900) $ 12,133b. Translate line 1 at December 31exchange rate (L 10,920,000 ÷ KRW1,170) $ 9,333c. The difference is the translationloss in “as reported” results $ (2,800)6. The difference between lines 4 and 5c isthe cost of sales adjustment in dollars:a. Additional dollar LIFO expense fromline 4. $ 2,022b. Less: Inventory translation loss alreadyreflected in "as reported” results (fromline 5c) $ (2,800)c. The difference is the net dollar currentcost of sales adjustment $ (778)Here, the current cost of sales adjustment is negative (i.e., reduces the dollar cost of sales adjustment). This is because the won devalued by more than the differential inflation rate (assuming a U.S. inflation rate close to zero). If the lira devalued by less than the differential inflation rate, the cost of sales adjustment would have been positive.12.1. Cost of fixed assets at 12/31 EUR20,0002. FIFO inventory at 12/31 EUR 8,0003. Total EUR28,0004. Less: Owners' equity at 12/31 EUR 2,0005. Liabilities used to financefixed assets and inventory EUR26,0006. Restate liabilities to beginningof period markka (EUR26,000 X300/390) EUR20,0007. Purchasing power gain EUR 6,0008. Purchasing power gain inpounds (EUR 6,000/EUR 1.5) ￡4,0009. Translation gain on appliedliabilities(EUR 26,000/EUR 1.5 -EUR26,000/EUR1.95) ￡4,00010. Net purchasing power gain ￡ -0-In this case the translation gain on liabilities used to finance nonmonetary assets equals the purchasing power gain because the currency devaluation matched the differential inflation of 30%. Hence, no purchasing power gains would be recognized.Case 7-1 SolutionCase 7.1 Kashmir Enterprises1.a–cHistorical Price Level HistoricalCost Adjustment Cost ConstantIncome Statement RupeesRevenues INR6,000,000 160/144 I NR6,666,667Cost of Sales 2,560,000 160/128 3,200,000Selling & Admin. 1,200,000 160/144 1,333,333Depreciation 160,000 160/128 200,000Interest 240,000 160/160 240,000Monetary gains (losses)a - 741,666Net Income INR1,840,000 INR2,435,000Balance SheetCash INR2,480,000 160/160 I NR2,480,000 Inventory 480,000 160/128 600,000Building 3,200,000 160/128 4,000,000Accu. depreciation (160,000) 160/128 (200,000) Total INR6,000,000 INR6,880,000Accounts payable INR 620,000 160/160 I NR 620,000 Notes payable 2,400,000 160/160 2,400,000 Owners' equity 2,980,000 3,860,000INR 6,000,000 INR6,880,000a Monetary gains/(losses):CashBeg. balance INR 720,000 160/128 INR1,150,000 Down payment (800,000) 160/128 (1,000,000) Sales 6,000,000 160/144 6,666,667Selling & Adm. exp. (1,200,000) 160/144 (1,333,333) Payment on account (2,200,000) 160/144 (2,444,444) Interest (240,000) 160/160 (240,000)INR 2,480,000 INR2,798,890-2,480,000Monetary loss INR (318,890)a Monetary gains and losses:Accounts PayableBeg. balance INR 420,000 160/128 INR525,000 Purchases 2,400,000 160/128 3,000,000Payments on account (2,200,000) 160/144 (2,444,444) INR 620,000 INR1,080,556- 620,000Monetary gain INR 460,556a Monetary gains/(losses):Notes PayablePurchase warehouse INR 2,400,000 160/128 INR 3,000,000 - 2,400,000Monetary gain INR 600,000Net monetary loss: INR(318,890) + INR460,556 + INR600,000 = INR741,666.Current Cost Financial StatementsHistorical Adjustment Current Cost Income Statement Cost F actor EquivalentsRevenues INR6,000,000 - INR 6,000,000Cost of Sales 2,560,000 1.3 3,328,000Selling and adm. 1,200,000 - 1,200,000Depreciation 160,000 1.4 224,000Interest 240,000 - 240,000Net Income INR 1,840,000 INR1,008,000Balance SheetCash INR 2,480,000 - INR 2,480,000Inventory 480,000 1.3 624,000Building 3,200,000 1.4 4,480,000Acc. depreciation 160,000 1.4 224,000Total INR 6,000,000 INR 7,360,000Accounts payable INR 620,000 - INR 620,000Notes payable 2,400,000 - 2,400,000Owners' equity 2,980,000 4,340,000INR 6,000,000 INR 7,360,0002. Your authors favor current cost over historical or historical cost/constant dollar financial statements. Finance theory states that investors are interested in a firm's dividend-generating potential, as the value of their investment depends on future cash flows. A firm's dividend-generating potential, in turn, is directly related to its productive capacity. Unless a firm preserves itsproductive capacity or physical capital(e.g.,plant, equipment, inventories), dividends can’t be sustained over time. Under these circumstances, current cost financial statements give investors information important to their decisions. They show the maximum resources that a firm can distribute to investors without impairing its operating capability.3.Translate-Restate MethodBalance Sheet, Jan. 1Local Currency Trans. Dollar Inflation Historical costRate Equivalents Adjustment Constant $Cash INR 920,000 .025 $23,000 - $23,000Inventory 640,000 .025 16,000 - 16,000 Total INR1,560,000 $39,000 $39,000A/P INR 420,000 .025 $10,500 - $10,500 Owners' equity 1,140,000 .025 28,500 - 28,500 Total INR 1,560,000 $39,000 $ 39,000Income StatementDec. 31Revenues INR 6,000,000 .022 $ 132,000 108/104 $ 137,077 Cost of sales 2,560,000 .022 56,320 108/100 60,825Selling & Adm. 1,200,000 .022 26,400 108/104 27,415 Depreciation 160,000 .022 3,520 108/100 3,802 Interest 240,000 .022 5,280 108/108 5,280Net Income INR 1,840,000 $ 40,480 $ 39,755 Monetary gains (losses)a - - 4,468$44,223a Monetary gains/(losses):CashBeg. Bal INR 920,000 .02 $ 18,400 108/100 $ 19,872Downpayment (800,000) .02 (16,000) 108/100 (17,280) Sales 6,000,000 .02 120,000 108/104 124,615Selling & Adm. (1,200,000) .02 (24,000) 108/104 (24,923)Payments on Acc. (2,200,000) .02 (44,000) 108/104 (45,692) Interest (240,000) .02 (4,800) 108/108 (4,800)INR 2,480,000 $ 49,600 51,792-49,600Monetary loss $ (2,192) Accounts PayableBeg. Bal. INR 420,000 .02 $ 8,400 108/100 $ 9,072Purchases 2,400,000 .02 48,000 108/100 51,840Pmt. on acc. (2,200,000) .02 (44,000) 108/104 45,692INR 620,000 $ 12,400 $ 15,592- 12,400Monetary gain $ 2,820Notes payablePur. W/house Rpe 2,400,000 .02 $ 48,000 108/100 $ 51,840 48,000Monetary gain $ 3,840Netmonetary gain: $(2,192) + $2,820 + $3,840 = $4,468.Balance Sheet Local Trans. Dollar Inflation Historical cost- Dec. 31 Currency Rate Equiv. Adjustment Constant $Cash INR 2,480,000 .02 48,600 108/108 $ 48,600 Inventory 480,000 .02 9,600 108/100 10,368 Building 3,200,000 .02 64,000 108/100 69,120Acc. Dep. 160,000 .02 3,200 108/100 3,456Total INR 6,000,000 $120,000 $ 124,632Acc. payable 620,000 .02 12,400 108/108 $ 12,400Notes payable 2,400,000 .02 48,000 108/108 48,000Trans. adj.b - (9,380) (9,978)Owners' equity c 2,980,000 68,980 74,210Total INR 6,000,000 $120,000 $124,632________________________________________________________________ __b Translation adjustment:Beginning net assets Rpe 1,140,000 (.02 - .025) = $ (5,700) X 108/100 = $(6,156)Increase in net assets Rpe 1,840,000 (.02 - .022) = (3,680) X 108/104 = $(3,822)$(9,380) $(9,978) c Balancing residualRestate - Translate MethodBalance Sheet Local Inflation Historical Cost- Trans. D ollar Jan 1. Currency Adjustment Constant rupee Rate equivalents Cash INR 920,000 128/128 INR 920,000 .025 $ 23,000 Inventory d 640,000 128/128 640,000 .025 16,000Total INR1,560,000 INR1,560,000 $ 39,000Acct. payable INR 420,000 128/128 INR 420,000 .025 $ 10,500Owner's equity 1,140,000 1,140,000 28,500Total INR 1,560,000 INR 1,560,000 $ 39,000d Assumes inventory acquired near year-end.Income StatementYear ended Dec. 31Revenues INR 6,000,000 160/144 INR 6,666,666 .022 $ 146,667Cost of Sales 2,560,000 160/128 3,200,000 .022 70,400 Selling & Adm. 1,200,000 160/144 1,333,333 .022 29,333 Depreciation 160,000 160/128 200,000 .022 4,400Interest 240,000 160/160 240,000 .022 5,280Net Income INR1,840,000 INR1,693,334 $ 37,254 Monetary gains(losses)a- 741,666 .022 16,317INR2,435,000 $ 53,571Balance SheetDec. 31Cash INR 2,480,000 160/160 INR 2,480,000 .02 $ 49,600Inventory 480,000 160/128 600,000 .02 12,000Building 3,200,000 160/128 4,000,000 .02 80,000Acc. deprec. 160,000 160/128 200,000 .02 4,000Total INR 6,000,000 INR 6,880,000 $137,600Acc. payable INR620,000 160/160 INR 620,000 .02 $ 12,400 Notes payable 2,400,000 160/160 2,400,000 .02 48,000Owner's equity 2,980,000 3,860,000 87,770 Translation adj.b - (10,570)Total INR 6,000,000 INR 6,880,000 $137,600________________________________________b Beginning net assets INR1,140,000 (.02 - .025) = $ (5,700)Change in net assets 2,435,000 ).02 - .022) = $(4,870)$(10,570)Both methods are inadequate for American investors because they are based on the historical cost valuation framework. A better reporting procedure is to restate local accounts to their current cost equivalents, then translate these amounts to the reporting currency using the year-end (current) foreign exchange rate. This is illustrated here.Restate (current cost)/Translate (current rate)Cash INR 920,000 - INR 920,000 .025 $ 23,000Inventory 640,000 - 640,000 .025 16,000Total INR 1,560,000 INR1,560,000 $ 39,000Acc. payable INR 420,000 - INR 420,000 .025 $ 10,500Owner's equity 1,140,000 - 1,140,000 28,500。

Chapter 11Financial Risk ManagementDiscussion Questions1.Enterprise risk management assesses individual risks in the context of a firm’s business strategy. Risksare viewed from a portfolio perspective with risks of various business functions, e.g., FX risk, interest rate risk, political risk and the like, being coordinated by a senior financial manager responsible for keeping top management apprised of critical risks that could interfere with the accomplishment of a firm’sstrategic objectives and devising risk optimization strategies. The variables that management accountants must track include factors both external and internal to the firm and varies from company to company.2.Market risk refers to the risk of loss due to unexpected changes in the prices of currencies, interest rates,commodities, and equities. It is not confined to price changes. Market risk also includes liquidity risk, market discontinuities, credit risk, regulatory risk, tax risk, and accounting risk. An example of a foreign exchange risk is a situation where an exporter invoices a credit sale to a foreign importer in foreign currency and foreign currency devalues prior to payment.3.An FX risk management program includes the following processes:a.Forecasting the expected movement in the relation between the yuan and your domesticcurrency.b.Measuring on a periodic basis your firm’s exposure to fluctuations in the value of the yuan.c.Designing protection strategies that will minimize losses should the yuan revalue.d.Establishing internal controls to measure your performance in hedging the risk of loss fromchanges in the value of the yuan.4.Translation exposure measures the impact of exchange rate changes on the domestic currency equivalentsof a firm s foreign currency assets and liabilities. It is primarily concerned with currency restatement.Transaction exposure measures the cash flow impact of fluctuating currency values on the settlement of commercial transactions denominated in foreign currencies. Transaction exposure is concerned with acurrency conversion (exchange) process. Economic exposure attempts to measure the impact of changing exchange rates on the future revenues, costs, and sales volume of a multinational entity. It is concerned with the temporal effects of exchange rate changes.Although FAS No. 52 attempts to mitigate concern with translation gains and losses (accounting exposure), it does not totally eliminate it. Companies choosing the U.S. dollar as their functional currency will still use the temporal translation method and report translation gains and losses in period income. Companies designating the local currency as the functional currency will find their asset exposures increased as inventories and fixed assets are translated using current exchange rates. While such translation gains and losses bypass income, the adverse effects of currency fluctuations on a company’s consolidated equity will still exist. This is especially likely where loan covenant and other contractual provisions specify minimum debt-to-equity ratios. This suggests that the issue of accounting versus economic exposure is far from settled.5.The chapter lists 10 specific methods to reduce a firm’s exposure to foreign exchange risk in adevaluation-prone country. These techniques, and possible cost-benefit trade-offs, are summarized in the following table.Methods Trade-Offsa. Minimize cash balances in a. Reduced exposure versusdevaluation-prone country higher business andfinancial risk due to possible "cash-outs."b. Remitting excess cash back b. Same as item a.to the parent company.c. Accelerate the collection c. Reduced exposure versusof local currency receivables possible reduction in salesd. Defer payment of local d. Reduced exposure versuscurrency payables impaired local credit ratinge. Speed up payment of e. Reduced exposure versusforeign currency payables foregone earnings on arelatively cheap creditsourcef. Invest local currency cash f. Reduced exposure versusbalances in inventories and higher transaction costsother assets less prone to and possible mis-devaluation loss allocation of corporateresourcesg. Invest in strong currency g. Reduced exposure versusforeign assets higher transaction costsand possible governmentinterference (e.g.exchange controls)h. Raise selling prices h. Reduced exposure versuspotential erosion ofmarket sharei. Invoice exports in hard i. Reduced exposure versuscurrencies possible reduction insales abroadj. Currency swaps j. Reduced translationexposure versus increasedtransaction exposure ifparent assesses theexposed affiliate aninterest charge in hardcurrency6. A multicurrency transactions exposure report differs from a multicurrency translation exposure report in anumber of ways. First, the transactions exposure report has a cash flow orientation instead of a static balance sheet orientation. It includes off balance sheet items that are executory in nature. Finally, a multicurrency transaction exposure report has a local currency orientation, whereas a multicurrency translation exposure report has a parent currency orientation.7.Derivative instruments are formal agreements that transfer financial risk from one party to another. Thevalue of a derivative is derived from its reference to a basic underlying instrument or variable such as a foreign currency receivable or a quantum of foreign exchange. Thus the value of a forward exchange contract is related to the change in the foreign exchange rate times the notional amount being hedged. An important accounting issue is whether derivatives should receive the same accounting treatment as the basic instruments to which they relate. Specifically, should a derivative instrument hedging a foreign currency asset appear in the financial statements as a foreign currency liability? If so, should its valuation base be identical to basic instruments? Do cash flows associated with derivative instruments have thesame economic meaning as those associated with basic instruments? How should gains and losses associated with derivative instruments be reflected in the income statement? Can and should risks attaching to these financial instruments be recognized and measured?8.Student responses should proceed along the following lines. Pele Corporation, a Brazilian firm, hasborrowed a certain sum of British pounds at 9 percent and is worried that the pound will appreciate relative to the real prior to maturity. To hedge this currency risk, it arranges with a bank to swap the pounds borrowed for an equivalent amount of reals for 3 years bearing the same rate of interest. During the 3-year period, it will make periodic interest payments to the bank in reals, and in return, receive periodic interest payments in pounds. At the end of the 3-year period, it will re-exchange the real principal for pounds at the original exchange rate.9. A futures contract is a commitment to purchase or deliver a specified quantity of a financial instrument orforeign currency at a future date at a price set when the contract is made. It differs from a forward contract in several respects. A futures contract is standardized in terms of size and delivery date whereas a forward contract is tailored to a customer’s needs. Futures contracts are freely traded on organized exchanges. In contrast, there is no secondary market for forward contracts as they are private agreements between two parties. Futures contracts are carried at market values with gains or losses taken immediately to income, whereas profits on a forward contract are realized only at the delivery date. Finally, a party to a futures contract must meet periodic margin requirements. In a forward contract, margins are set once, on the date of the initial transaction.10.Fair value hedges are hedges of a firm’s foreign currency assets and liabilities and firm fore ign currencycommitments. Cash flow hedges are hedges of forecasted transactions such as a future sale or purchase.Net investment hedges are hedges of an exposed balance sheet asset or liability position. For qualifying fair value hedges, all changes in the fair value of the derivative and the underlying item that is being hedged are recognized in earnings. For qualifying cash flow hedges, the change in the fair value of the derivative is recognized in Other Comprehensive Income and recognized in earnings when the hedged cash flows affect earnings. For qualifying hedges of a net investment, changes in the fair value of the derivative are recorded in comprehensive income11.In theory, the term highly effective means that gains or losses on hedging instruments should be shouldexactly offset gains or losses on the item being hedged. In practice, it means that gains or losses on the derivative substantially offset the changes in the value or cash flow of the hedged item. Measurement of this attribute is important. If a hedging instrument does not meet the highly effective test, the hedge is terminated and deferred gains or losses on the derivative are recognized immediately in current earnings.This, in turn, introduces volatility into a firm’s reporte d earnings.12.The notion of an opportunity cost refers to the return associated with your next best opportunity. In thearea of FX risk management, it entails comparing a given risk management strategy with an appropriate standard of comparison. This provides an objective means of assessing the effectiveness of a given risk reduction program. For example, when FX risk management programs are centralized at corporate headquarters, appropriate benchmarks against which to compare the success of corporate risk protection would be programs that local managers could have implemented on their own.Exercises1.Students usually gloss over diagrams without thinking them through. This exercise forces them to thinkthrough each step of the diagram and allows them to better internalize the risk management cycle.Responses might follow the following pattern: Step 1 involves operationalizing a firms strategies intoquantifiable objectives and then identifying developments both external and internal risks that could affect the achievement of these objectives. These risks are measured by the firm’s accountants and quantified in terms of their potential impact on the firm. For example, the firm may have as its strategic objective an increase of 5% of market share in a given country per year given assumptions about the rate of economic growth in that country. The chance that this growth rate may fall short of 5% and the impact of this shortfall for projected sales in that country would be quantified. Response formulation would involve identifying protection strategies to minimize the hit to sales of projected GNP shortfalls such as promotion campaigns to maintain sales or use of alternative sourcing venues to lower sales prices. This strategy would be implemented if projected GNP started to slow beyond a certain cutoff point. The impact of this protection strategy would then be quantified in terms of actual sales relative to forecast sales taking into account the costs of protection. The information contained in risk management performance reports would then be communicated to top management who would be in a position to reaffirm or alter strategic objectives and/or risk identification processes.2.Foreign exchange risk a devaluation of the foreign currency in which an account receivable wasdenominated would cause the domestic currency cash flows to decrease. This would cause current assets to decrease. Alternatively, a revaluation of the foreign currency would cause the account receivable and current assets to increase. Interest rate risk an increase in market rates of interest would cause the price ofa short-term fixed-rate debt instrument being held as a marketable security to decrease. This, in turn,would cause current assets to decrease. A decrease in interest rates would have the opposite effect.Commodity price risk an increase in the price of copper would cause the cost of copper purchases and the resultant unexpired cost of inventories in the current asset section of the balance sheet to increase. A fall in copper prices would have the opposite effect. Equity price risk a fall in stock prices would depress the carrying value of marketable securities (current assets), and conversely.3.The purpose of this exercise is to force students to look at manager ial accounting issues from the user’sperspective. Students may suggest additional information sources with respect to inflation differentials, balance of trade and balance of payments statistics, international monetary reserves, forward exchange quotations, the behavior of related currencies, and interest rate differentials. We recommend that this exercise be assigned to small groups to encourage teamwork. At the time this exercise was prepared, professional forecasters were predicting a rate of 10.5 ecrus to theU.S. dollar.Some groups may contend that exchange markets are efficient and that exchange rate changes are simply random events. Again, they must be prepared to convince management of their case, or at a minimum, identify the consequences of not attempting exchange rate forecasts.4. Current rate Current/Noncurrent Monetary/nonmonetaryExposed assets(PHP):Cash 500,000 500,000 500,000Accounts receivable 1,000,000 1,000,000 1,000,000 Inventories(LCM) 900,000 900,000Fixed assets 1,100,000 -- --Total 3,500,000 2,400,000 1,500,000 Exposed liabilities:Short-term payables 400,000 400,000 400,000Long-term debt 800,000 --- 800,000Total 1,200,000 400,000 1,200,000Positive/(negative) exposure 2,300,000 2,000,000 300,000 Positive exposure X $0.03 $69,000 $60,000 $9,000Positive exposure X $0.02 46,000 40,000 6,000 FX gain/(loss) $(23,000) $(20,000) $(3,000)5.ILS $ £$ EquivalentExposed Assets:Cash & due from banks 100,000 50,000 (40,000) 20,000Loans 200,000 ---- ---- 100,000Fixed assets ---- 30,000 ---- 30,000Exposed Liabilities:Deposits 40,000 ---- 15,000 50,000Owners equity ---- 100,000 ---- 100,000Net exposed assets 260,000 (20,000) (55,000) NIL(liabilities)ILS $ £$ EquivalentExposed Assets:Cash & due from banks 100,000 50,000 (40,000) 20,000Loans 200,000 ---- ---- 100,000Fixed assets ---- 30,000 ---- 30,000Exposed Liabilities:Deposits 40,000 ---- 15,000 50,000Owners equity ---- 100,000 ---- 100,000Net exposed assets 260,000 (20,000) (55,000) NIL(liabilities)6.Trial Balance BeforeILS $ £$ EquivalentCash & due from banks 100,000 50,000 (40,000) 20,000Loans 200,000 ---- ---- 100,000Fixed assets ---- 30,000 ---- 30,000Deposits 40,000 ---- 15,000 50,000 Owners equity ---- 100,000 ---- 100,000Trial Balance After(£/$/ILS = 1/2/8)ILS $ £$ EquivalentCash & due from banks 100,000 50,000 (40,000) (5,000)Loans 200,000 ---- ---- 50,000Fixed assets ---- 30,000 ---- 30,000Deposits 40,000 ---- 15,000 40,000 Owners equity ---- 100,000 ---- 100,000Translation loss $(65,000)7. One recommendation might be to reduce positive exposures by engaging in balance sheet hedging, that is, by remitting excess cash back to the corporate parent, reducing the affiliate bank’s outstanding loans, or increasing its deposits in Israeli shekels.. The trade-offs here are potentially negative effects on operations, such as not satisfying loan demand against hedging translation gains and losses. Another option is to increase the pricing of bank services in Israel to provide a profit margin that can offset any FX losses. Again, the effects of such actions on competitive positioning could far exceed the benefits of hedging. A third option is to buy a forward or currency swap to hedge the exposure. Trade-offs include the out-of-pocket cost of the exchange contract versus the reported losses avoided.1.If the U.S. dollar is the functional currency, the translation gain upon consolidation is aggregated with thetransaction loss on the foreign currency borrowing and disclosed as one line item in the consolidated income statement. This figure is determined as follows:Translation gain = Positive exposure X change in exchange rate= NZD3,000,000 x $.10= $300,000Transaction loss =NZD loan balance X change in exchange rate= NZD1,000,000 x $.10= $ (100,000)Aggregate exchange adjustment = $300,000 + $ (100,000)= $200,000If the New Zealand dollar is the functional currency, the translation gain upon consolidation bypasses income and appears as a separate component in consolidated equity. It is offset by the translation loss on the New Zealand dollar borrowing.9.4/1 CD (¥32,500,000 ÷ ¥120) $250,000Cash $250,000(Purchase of CD)Chips (¥32,500,000 ÷ ¥120) $270,833Cash (¥3,250,000 ÷ ¥120) $ 27,083A/P (¥29,250,000 ÷ ¥120) 243,750(To record credit purchase)7/1 CD (¥30,000,000 ÷ [¥120 - ¥110]) $ 22,727FX gain $ 22,727(To record gain on CD investment)Purchases (¥29,250,000 ÷ [¥120 - ¥110]) 22,159Accts. Payable 22,159(To record increase in purchases and related liability accounts owing to yen appreciation) 7/1 Cash (¥30,000,000 ÷ ¥110) $278,182Interest income (¥30,000,000 X .08 X ¼) ÷ ¥110] $ 5,455CD 272,727(To record maturation of CD)Interest expense [(¥29,250,000 x.08 x 3/12) ÷ ¥110) 5,318Accts. payable (¥29,250,000 ÷ ¥110) 265,909Cash 271,227(To record settlement of purchase transaction)10. Journal entries:6/1 CHF Contract receivable $133,333Deferred premium 3,334$ Contract payable $136,667(To record contract with the foreign currency dealer to exchange $136,667 for CHF 166,667)6/30 CHF Contract receivable 1,667Transaction gain 1,667(To record transaction gain from increased dollar equivalent of forward contract receivable; $.81 - $.80 x SWF 166,667)6/30 Premium expense 1,111Deferred premium 1,111(To amortize deferred premium for 1 month)9/1 SWCHF Contract receivable 3,333Transaction gain 3,333(To record additional transaction gain by adjusting forward contract to the new current rate; $.83 - $.81 x CHF 166,667)9/1 Premium expense 2,223Deferred premium 2,223(Amortization of deferred premium balance)9/1 $ Contract payable 136,667Cash 136,667 Foreign currency 138,333CHF Contract receivable 138,333(To record delivery of $136,667 to foreign currency dealer in exchange for CHF166,667 with a dollar equivalent of $138,334 (=CHF166,667 x $.83). The Swiss francs will, in turn be used to pay for the chocolate supplies).11. Calculations:If the premium on the forward contract is considered an operating expense, and the conditions for hedge treatment are met, i.e., management designates the forward contract as a hedge, documents its risk management objective and strategy, identifies the hedging instrument, the item being hedged and the risk exposure, and that the forward is effective both prospectively and retrospectively in hedging the risk, the gain on the forward can be offset against the loss on the payable as follows:Amount paid to settle the account payable on the purchase $138,333Less Transaction gain on forward contract (5,000)Cost of purchase $133,333The $133,000 is what was originally anticipated, CHF166.667 X $0.80 = $133,333.12. Journal entries:The call option is intended to hedge an uncertain cash flow. Accordingly, gains or losses on the hedging instrument would bedisclosed in comprehensive income and reclassified into earnings in the period the sale actually takes place.June 1 Premium expense $28,125Cash $28,125($.018 X CHF 62,500 X 25)August 31 Cash $40,625Comprehensive income $40,625[($.416 - $.39) X CHF 62,500 X 25]Case 11-1Exposure Identification1. Infosys appears to have several exposures as enumerated below.Foreign Exchange RiskPage Value-Drivers88 Revenues/Selling and administrative expenses89 Cash flows from interest/dividend income96 Revenue recognition/LT leases97 Operating income/foreign currency transactions/FA98 Marketing/Overseas staff expenses99 Derivative values100 Lease obligations101 Investment returns102 Segment revenues/expenses103 Dividends to ADS holders142 Penalties on export obligations149 Valuing intangibles150 Export revenuesCommodity Price RiskPage Value-Drivers98 Power and fuel expenses145 Brand valuation147/48 Current cost disclosures149 Value of intangiblesEquity Price RiskPage Value Drivers87 Share capital98 Diluted eps100 Stock option compensation expense103 Convertible preferreds145 Cost of capital151 Economic value-addedInterest Rate RiskPage Value Drivers88 Interest expense89 Cash flows from security investments/interest income97 Gratuity/Superannuation/Provident obligations143 Employee compensation145 Cost of capital149 Value of intangibles.151 Economic value-addedInformation on the company’s risk management policies are contained on pages 108-109 of their annual report which were not reproduced in Chapter 1. We include the relevant information here. Infosys derives its revenues from 51 countries of which 78 percent were denominated in US dollars. To minimize both transaction and translation risk the company:1.Tries to match expenses in local currency with receipts in the same currency.es forward exchange contracts to cover apportion of outstanding receivables.3.Denominates contracts in non-US and non-EU regions in internationally tradable currencies to minimizeexposures to local currencies that may have non-tradability risks.Case 11-2Value At Risk: What Are Our Options?Students should be asked to play the role of the consultant, and will find it to be a contentious issue. Suggested remedies that have merit are:1. The FASB should permit deferral accounting for rolling options which would take the derivative gain or loss on each option to equity until the anticipated event occurs, as opposed to taking it immediately to income. This, however, might encourage companies to game the system, so students should also suggest ways to keep this from happening.2. Another tack would be to adhere to generally accepted accounting principles and record the gain or loss on the derivative in current income as it is marked to market, but to disclose which transactions were undertaken for hedge purposes. Management could also game the system here as speculative activities could be disclosed as hedge activities.3. Another option that students might suggest is to revert back to the earlier U.S. practice of keeping the option off balance sheet and providing supplementary disclosure of mark-to-market accounting. This might be confusing to lay readers, but it would enable analysts to better understand the components of reported earnings.It is clear from the annual report clipping that management will ignore accounting pronouncements when it is in their interest to do so. Analysts must be alert to situations where management departs from GAAP to better reflect the economics of what transpired as opposed to doing so to manage earnings.精品文档，知识共享！！！。

CHAPTER 9 MANAGEMENT OF ECONOMIC EXPOSURESUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTERQUESTIONS AND PROBLEMSQUESTIONS1. How would you define economic exposure to exchange risk?Answer: Economic exposure can be defined as the possibility that the firm’s cash flows and thus its market value may be affected by the unexpected exchange rate changes.2. Explain the following statement: “Exposure is the regression coefficient.”Answer: Exposure to currency risk can be appropriately measured by th e sensitivity of the firm’s future cash flows and the market value to random changes in exchange rates. Statistically, this sensitivity can be estimated by the regression coefficient. Thus, exposure can be said to be the regression coefficient.3. Suppose that your company has an equity position in a French firm. Discuss the condition under which the dollar/franc exchange rate uncertainty does not constitute exchange exposure for your company.Answer: Mere changes in exchange rates do not necessarily constitute currency exposure. If the French franc value of the equity moves in the opposite direction as much as the dollar value of the franc changes, then the dollar value of the equity position will be insensitive to exchange rate movements. As a result, your company will not be exposed to currency risk.4. Explain the competitive and conversion effects of exchange rate changes on the firm’s operating cash flow.Answer: The competitive effect: exchange rate changes may affect operating cash flows by altering the firm’s competitive position.The conversion effect: A given operating cash flows in terms of a foreign currency will be converted into higher or lower dollar (home currency)amounts as the exchange rate changes.5. Discuss the determinants of operating exposure.Answer: The main determinants of a firm’s operating exposure are (1) the structure of the markets in which the firm sources its inputs, such as labor and materials, and sells its products, and (2) the firm’s ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing.6. Discuss the implications of purchasing power parity for operating exposure.Answer: If the exchange rate changes are matched by the inflation rate differential between countries, firms’ competitive positions will not be altered by exchange rate changes. Firms are not subject to operating exposure.7. General Motors exports cars to Spain but the strong dollar against the peseta hurts sales of GM cars in Spain. In the Spanish market, GM faces competition from the Italian and French car makers, such as Fiat and Renault, whose currencies remain stable relative to the peseta. What kind of measures would you recommend so that GM can maintain its market share in Spain.Answer: Possible measures that GM can take include: (1) diversify the market; try to market the cars not just in Spain and other European countries but also in, say, Asia; (2) locate production facilities in Spain and source inputs locally; (3) locate production facilities, say, in Mexico where production costs are low and export to Spain from Mexico.8. What are the advantages and disadvantages of financial hedging of the firm’s operating exposure vis-à-vis operational hedges (such as relocating manufacturing site)?Answer: Financial hedging can be implemented quickly with relatively low costs, but it is difficult to hedge against long-term, real exposure with financial contracts. On the other hand, operational hedges are costly, time-consuming, and not easily reversible.9. Discuss the advantages and disadvantages of maintaining multiple manufacturing sites as a hedge against exchange rate exposure.Answer: To establish multiple manufacturing sites can be effective in managing exchange risk exposure, but it can be costly because the firm may not be able to take advantage of the economy of scale.10. Evaluate the following statement: “A firm can reduce its currency exposure by diversifying across different business lines.”Answer: Conglomerate expansion may be too costly as a means of hedging exchange risk exposure. Investment in a different line of business must be made based on its own merit.11. The exchange rate uncertainty may not necessarily mean that firms face exchange risk exposure. Explain why this may be the case.Answer: A firm can have a natural hedging position due to, for example, diversified markets, flexible sourcing capabilities, etc. In addition, to the extent that the PPP holds, nominal exchange rate changes do not influenc e firms’ competitive positions. Under these circumstances, firms do not need to worry about exchange risk exposure.PROBLEMS1. Suppose that you hold a piece of land in the City of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £2,000 and one British pound will be worth $1.40. If the British economy slows down, on the other hand, the land will be worth less, i.e., £1,500, but the pound will be stronger, i.e., $1.50/£. You feel that the British economy will experience a boom with a 60% probability and a slow-down with a 40% probability.(a) Estimate your exposure b to the exchange risk.(b) Compute the variance of the dollar value of your property that is attributable to the exchange rate uncertainty.(c) Discuss how you can hedge your exchange risk exposure and also examine the consequences of hedging.Solution: (a) Let us compute the necessary parameter values:E(P) = (.6)($2800)+(.4)($2250) = $1680+$900 = $2,580E(S) = (.6)(1.40)+(.4)(1.5) = 0.84+0.60 = $1.44Var(S) = (.6)(1.40-1.44)2 + (.4)(1.50-1.44)2= .00096+.00144 = .0024.Cov(P,S) = (.6)(2800-2580)(1.4-1.44)+(.4)(2250-2580)(1.5-1.44)= -5.28-7.92 = -13.20b = Cov(P,S)/Var(S) = -13.20/.0024 = -£5,500.You have a negative exposure! As the pound gets stronger (weaker) against the dollar, the dollar value of your British holding goes down (up).(b) b2Var(S) = (-5500)2(.0024) =72,600($)2(c) Buy £5,500 forward. By doing so, you can eliminate the volatility of the dollar value of your British asset that is due to the exchange rate volatility.2. A U.S. firm holds an asset in France and faces the following scenario:In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the asset.(a) Compute the exchange exposure faced by the U.S. firm.(b) What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against thisexposure?(c) If the U.S. firm hedges against this exposure using the forward contract, what is the variance of thedollar value of the hedged position?Solution: (a)E(S) = .25(1.20 +1.10+1.00+0.90) = $1.05/€E(P) = .25(1,800+1,540+1,300 +1,080) = $1,430Var(S) = .25[(1.20-1.05)2 +(1.10-1.05)2+(1.00-1.05)2+(0.90-1.05)2]= .0125Cov(P,S) = .25[(1,800-1,430)(1.20-1.05) + (1,540-1,430)(1.10-1.05)(1,300-1,430)(1.00-1.05) + (1,080-1,430)(0.90-1.05)]= 30b = Cov(P,S)/Var(S) = 30/0.0125 = €2,400.(b) Var(P) = .25[(1,800-1,430)2+(1,540-1,430)2+(1,300-1,430)2+(1,080-1,430)2]= 72,100($)2.(c) Var(P) - b2Var(S) = 72,100 - (2,400)2(0.0125) = 100($)2.This means that most of the volatility of the dollar value of the French asset can be removed by hedging exchange risk. The hedging can be achieved by selling €2,400 forward.MINI CASE: ECONOMIC EXPOSURE OF ALBION COMPUTERS PLCConsider Case 3 of Albion Computers PLC discussed in the chapter. Now, assume that the pound is expected to depreciate to $1.50 from the current level of $1.60 per pound. This implies that the pound cost of the imported part, i.e., Intel’s microprocessors, is £341 (=$512/$1.50). Other variables, such as the unit sales volume and the U.K. inflation rate, remain the same as in Case 3.(a) Compute the projected annual cash flow in dollars.(b) Compute the projected operating gains/losses over the four-year horizon as the discounted present value of change in cash flows, which is due to the pound depreciation, from the benchmark case presented in Exhibit 12.4.(c) What actions, if any, can Albion take to mitigate the projected operating losses due to the pound depreciation?Suggested Solution to Economic Exposure of Albion Computers PLCa) The projected annual cash flow can be computed as follows:______________________________________________________Sales (40,000 units at £1,080/unit) £43,200,000Variable costs (40,000 units at £697/unit) £27,880,000Fixed overhead costs 4,000,000Depreciation allowances 1,000,000Net profit before tax £15,315,000Income tax (50%) 7,657,500Profit after tax 7,657,500Add back depreciation 1,000,000Operating cash flow in pounds £8,657,500Operating cash flow in dollars $12,986,250______________________________________________________b) ______________________________________________________Benchmark CurrentVariables Case Case______________________________________________________Exchange rate ($/£) 1.60 1.50Unit variable cost (£) 650 697Unit sales price (£) 1,000 1,080Sales volume (units) 50,000 40,000Annual cash flow (£) 7,250,000 8,657,500Annual cash flow ($) 11,600,000 12,986,250Four-year present value ($) 33,118,000 37,076,946Operating gains/losses ($) 3,958,946______________________________________________________c) In this case, Albion actually can expect to realize exchange gains, rather than losses. This is mainly due to the fact that while the selling price appreciates by 8% in the U.K. market, the variable cost of imported input increased by about 6.25%. Albion may choose not to do anything.。

Chapter 10Managerial Planning and ControlDiscussion Questions Solutions1.Four critical dimensions of long-range planning are:∙Identifying key drivers of a company’s future progress.∙Develop forecasts of key developments and assess the company’s ability to capitalize on these developments.∙Develop the information systems to support strategic choices.∙Translate strategic choices into actions.2. A standard costing system has as its objective the notion of cost control. It estimates annuallywhat costs should be under ideal operating conditions. Actual results are then compared with standard costs with variances reported to those responsible for incurring the variances. Kaizen costing has as its objective continuous cost reductions based on continuous manufacturing improvements. Cost reduction targets are set monthly with variances based on constant cost reductions; i.e., were costs this month lower than last month? If not, why?3.Financial managers must be prepared to evaluate foreign investments from multiple reportingperspectives. This significantly complicates the information requirements for decisions on foreign investment. Management’s objective from a parent company perspective is to maximize shareholder wealth. To do this, management must select investment opportunities that promise the highest risk-adjusted net present values. Therefore, management accountants must identify cash flows that can be repatriated to the parent company, taking into consideration future exchange rate changes. Because only after-tax cash flows are relevant, the timing and amounts of taxes payable on foreign source income must be estimated.A project evaluated from a host country s point of view necessitates an increase in the quantity ofinformation supplied. The social costs and benefits of investment proposals must supplement traditional cash flow information. Quantification of risk and the identification of acceptable rates of return to sovereign governments call for measurement techniques new to internal accounting tool kits.4.Many variables must be considered when measuring a multinational entity’s cost of capital. Thesevariables include:a. Differential interest rates between national marketsb. Foreign business riskc. Foreign exchange riskd. Political riske. Investor valuation models in different countriesf.International taxesg. International financial reporting and disclosure practicesh. Governmental restrictions on fund remittancesi. Joint venture arrangementsj. National financial normsk. Differential inflationl. Different financial institutions and instrumentsm. International diversification effectsn. National savings patterns5. A major complexity in designing multinational information and control systems is culture.Cultural differences in attitudes towards risk and authority, need achievement levels, and language often result in misunderstood directives, lower tolerance to criticism, unwillingness to seek assistance when in doubt, unwillingness to delegate authority, and reluctance to assume responsibility. As a result, performance standards and incentive structures must often be adjusted for foreign nationals. Global competition also means that a firm’s production, marketing, and financing strategy must be truly international in scope. The likely result is that foreign subsidiaries will be viewed as parts of an integrated network. To coordinate parent and subsidiary decisions, management will need information that enables it to plan, coordinate, and control global production, marketing, and financial strategies.6.The first variance holds exchange rates constant and examines how the local manager performedin terms of his or her primary operating responsibilities. In effect, the local manager is not held accountable for exchange rate changes. The second variance examines what portion of the local managers actual results were attributable to exchange rate changes. This exchange rate variance will hopefully be offset by other exchange rate exposures encountered by sister affiliates which the international division manages. The final variance looks at the original budget and says, if the budgeted performance were actually achieved, how successful was Treasury in forecasting foreign exchange rates for that particular country.7.An examination of the seven caveats near the end of the chapter will highlight some of the majorissues involved in designing and implementing international performance evaluation systems.We illustrate two major issues raised by these caveats.First, foreign subsidiaries should not be evaluated as independent profit centers when they are really strategic components of a multinational system. Company-wide return-on-investment criteria should be replaced by performance measures more in line with the specific objectives and environments of each foreign subsidiary being evaluated. One example of a dysfunctional evaluation system is the practice of appraising international financial subsidiaries in terms of traditional rate-of-return criteria. These subsidiaries should be evaluated according to their intended mission, which is to increase the supply of funds to the multinational enterprise at the lowest possible cost. Rate-of-return statistics should be replaced by measures reflecting the quantity and cost of funds secured domestically. Another approach would be to evaluate the overseas financing subsidiary in terms of the benefits that its operations make possible for the multinational system as a whole as opposed to the costs it incurs in securing the necessary funds.Second, to protect the value of assets located in devaluation-prone countries, headquarters management often will remove surplus funds from foreign operating subsidiaries by increasing the transfer prices the subsidiaries must pay for imported components. Evaluating foreign managers in terms of their reported profits is grossly unfair when artificial transfer prices are imposed. It is more appropriate to discount the effects of strategic pricing actions on subsidiary management performance, that is, measure performance in terms of physical production statistics or value-added.8.Money loses purchasing power every day in a highly inflationary economy. To properly measureeconomic performance, transactions should be recorded in hard currency equivalents on the day the transaction is settled. If a sale is made for cash, its value is its hard currency equivalent on that date. Recording the sale at any other date distorts the transaction by introducing changes in the purchasing power of money (or implicit interest) into the analysis; that is, the recorded amount will not reflect the transaction s true value.9.We favor the budgetary exchange rate combination that uses a projected rate to set the budget andthe end-of-period rate to track performance. Use of a projected rate to set the budget encourages managers to incorporate the effects of anticipated exchange rate changes into their operating plans and decisions. Use of the ending rate to monitor performance motivates managers to respond to unanticipated exchange rate changes. Where local managers have the authority and means to hedge currency changes, it is justifiable to hold them accountable for unexpected rate changes. While they cannot control exchange rate changes, they can counter their adverse effects some before and some after the rate change. We think that making local managers accountable for unexpected exchange rate changes when they do not have the necessary hedging authority is unjustified.10.This discussion question is designed to get students to think outside the box, so their suggestionsshould not be constrained but supported by their analysis. A good tack would be to break the class into small discussion groups and have each group select a spokesperson to report back on alternative strategies they identified.11.For:a. There is a reduced cost of implementation.b. Financial control may not be a critical problem during the initial phase of operationsc. There are fewer problems related to preparing and analyzing consolidated reports of domesticand foreign operations.d. The financial control system can be installed more quickly as system testing and design havealready been completed.e. Headquarters personnel assigned abroad will feel comfortable with a familiar control system.f. The system facilitates centralized control from corporate headquarters.Against:a. The organization and environment of foreign operations may be sufficiently different towarrant tailor-made control systems.b. Foreign personnel may become frustrated and demoralized in having to adapt to an unfamiliarcontrol system.c. Reconciliation of data generated by two different but parallel control systems may not be aserious problem given extant data processing technology.d. Local managers adapting to the transplanted control system may engage in decisions that aredysfunctional to the success of local operations.e. It is the mission of the foreign unit and not the executives need to feel comfortable that shoulddictate the type of control system employed.f. Successful implementation of the transplanted control system may dictate the sole use ofdomestic company personnel, which may sour relations with the host government.12.Value reporting is forward looking whereas the traditional financial reporting model studentslearn is historical in its orientation. Those who favor value reporting will appreciate its focus on what financial statement analysis is trying to achieve. Moreover, it provides a way of eliminating the arbitrary distinction that is drawn between managerial and financial accounting. Thoseopposed to value reporting will argue that the information is less objective and leaves too much to management discretion.Discussion Questions1. €2,250/100 units = €22.50 X 1.10 = €24.75.2. Slovenia’s target cost is derived as follows:Selling price = €21.50 X 100 units = €2,150Allowable costs = €2,150 - .10X = XX = €1,955This calculation implies that Glasgow Corporation needs to reduce production costs by €295 [€2,250 - €1,955].3. The following analysis ignores Russian withholding taxes on dividends remitted to the U.S. parent. Chapter 11 treats this aspect of international taxation.Cash FlowsRussian Subsidiary Year 1 Year 2a. Pre-tax earnings RUB 55,600,000 RUB 130,332,000b. Income tax at 40% 22,240,000 52,132,800c. Net income RUB 33,360,000 RUB78,199,200d. Dividend to U.S. parent(line c X 70%) RUB 23,352,000 RUB 54,739,440U.S. Parente. Income RUB 23,352,000 RUB 54,739,440f. Dividend gross-up(line d./line c. X line b) 15,568,000 36,492,960g. Taxable income RUB 38,920,000 RUB 91,232,400h. U.S. tax at 34% 13,232,800 31,019,016i. Less: Foreign tax credit(line f) 15,568,000 36,492,960j. U.S. taxes payable(line h - line i) -0- -0-k. Net cash flow (rubles)(line e - line j) RUB 23,352,000 RUB 54,739,440l. Net cash flow (dollars) $ 1,167,600 $ 2,606,6404. This exercise should make for interesting discussion and should be used to highlight the many measurement issues surrounding foreign investment decisions.Year Cash Flow Exchange Cash Flow PV factor Present Value(Rubles) Rate (Dollars) at 20% equivalent0 -8,000,000 1.000 -8,000,0001 23,352,000 R20 = $1 1,167,600 .833 $ 972,6112 54,739,440 R21 = $1 2,606,640 .694 $1,809,0083 57,476,412 R23 = $1 2,498,974 .579 $1,446,9064 60,350,232 R25 = $1 2,414,009 .482 $1,163,5525 63,367,743 R25 = $1 2,534,710 .402 $1,018,9536 66,536,130 R25 = $1 2,661,445 .335 $ 891,584Net present value $ (697,386) Because the net present value is negative, the investment might not appear attractive. However, students will quickly and rightly begin to question the exercise s assumptions. Points that students should raise include:1. The measurement of cash flow: Should one ignore cash flows beyond year 6?2. Do accounting principles differences affect the measurement of income and cash flow?3. What is the terminal value (including the recapture of working capital at the end of the 6-year investment horizon)?4. Is it wise to penalize all future cash flows by a 10 percent premium? One could argue that the risk premium might be partly offset by an international diversification discount. How does one quantify risk ina multinational setting?5. How reasonable are exchange rate forecasts?6. Tax rates are seldom constant.7. How valid are the strategic dimensions of the investment decision?5. This question should generate useful ideas and discussion on the importance of strategic thinking and analysis.6. Y TL1,000,000 Expenses in Month 1Varying Invoice Dates and Payment Dates_____________________________________________________________________________________ Invoice Payment Conventional ProposedDay Day Measure Measure Difference________________________________________________________________1 Cash 7,692 10,000 2,3085 15 days 7,692 8,361 6695 25 days 7,692 7,692 0.0 7. The answer will depend on the student s domicile. The purpose of this exercise is to force students to think about how environmental considerations affect the measurement and interpretation of accounting-based performance measures. Political considerations such as legally required capital infusions from the parent company (e.g., Mexico) will increase the denominator of the ROI ratio and reduce that statistic relative to a company that can fill most of its financial needs by local borrowing (Singapore). Economic considerations such as inflation and currency devaluation (Mexico) will tend to lower the numerator of the ROI statistic relative to a strong currency country (Singapore) with lower rates of inflation. Social and cultural considerations would affect a firm s operating leverage (i.e., the ratio of fixed costs to variable costs in a firm s operating cost structure). This, in turn, would magnify changes in income or lossesrelative to a change in sales for that company. Finally, legal considerations (such as the impact of tax law on financial reporting) would tend to impart a conservative bias to reported earnings where generous depreciation allowances, such as accelerated and excess depreciation, are permitted.8.Unit(attributable items)Sales $4,000,000Other income 120,000Costs and expenses:Cost of Sales 3,200,000Selling and administrative 330,000Depreciation 160,000Interest 162,000Exchange gains & losses ------Income before taxes 268,000Performance evaluation metrics of a foreign unit should reflect its mission in relation to overall corporate goals. Accordingly, all revenues and expenses attributable to the foreign unit are germane. As FX risk and taxation are managed by corporate headquarters, one could argue that these should not be included in the performance of the unit.9. Manager(controllable items)Sales $4,000,000Other income 120,000Cost and expenses: 4,120,000Cost of sales 3,050,000Selling and administrative 280,000Depreciation 160,000Interest 42,000Exchange gains & losses ------Income before taxes $588,000Income taxesThe inclusion of select items of revenue and expense in the performance report of the manger of Compagnie de Calais reflects the general principle that a manager should only be held accountable for items over which he or she has some control.10.Sales Exchange$ Equivalent VarianceRateLocal currency MXP8,000,000 CAD.00032 CAD 2,560operating variance(foreign management)-9,000,000 CAD.00032 2,880 CAD 320Parent currency 9,000,000 CAD.00032 CAD 2,880operating variance(headquarters mgt.)-9,000,000 CAD.00024 2,160 CAD (720)Expenses Exchange$ Equivalent VarianceRateLocal currency MXP6,400,000 CAD.00032 CAD2,048operating variance -7,000,000 CAD.00032 2,240 CAD (192)Parent currencyoperating variance MXP7,000,000 CAD.00032 CAD2,2407,000,000 CAD.00024 1,680 CAD 560If we ignore the effects of unanticipated exchange rate changes, the local manager appears to have performed well. Although his expenses, from a local currency perspective, exceeded his budget by CAD192,000, his actual sales performance exceeded his budget by CAD320,000, resulting in a net positive contribution of CAD128,000.11. If the local currency is deemed the functional currency, the exchange rate variance in Exhibit 10.10 will change to negative 239. The difference in currency effects is due to the use of the current instead of the temporal currency translation method (i.e., the use of the current rate to translate inventories and fixed assets and their associated expenses).Analysis of variance procedures would be the same as under the temporal method using the beginning-of-year exchange rate as our benchmark. Thus, the volume price/cost and expense variances would reflect the same relationships after translation to the parent currency as before with the exception of the currency variance. The favorable exchange variance of PC456 in operating earnings would be attributed to the following factors:Higher sales volume PC +400Lower selling price -300Lower production cost +720Higher operating expenses -75Higher Interest expense -50Exchange rate changes -239PC +45612.Sub Nominal Country Risk-adjustment Actual ROI Risk ROI ROICoefficientX 10% 30/60 = 50% .10/.50 = 20% 25%Y 10% 21/60 = 35% .10/.35 = 28.6% 30%Z 10% 15/60 = 25% .10/.25 = 40% 40% On this analysis, Subsidiary X performed best.Case 10-1Foreign Investment Analysis: A Tangled AffairFollowing is a comparison of the translation adjustment with MBI’s exposure:2007 $1.698 billion - $1.917 billion$15.034 billion = -1.46%2008 $3.266 billion - $1.698 billion$15.443 billion = +10.15%Changes in the trade-weighted index:2007: -1.0%2008: +10.6%As can be seen, the trade-weighted index is a reasonable proxy for MBI’s exchange rate experience. Assuming that 90 percent of MBI s net assets abroad are also in local currencies, the impact of foreign currency (FC) changes on net assets employed (a measure of MBI s foreign currency exposure per the current rate translation method) follows:2008 2007 2006Non-U.S. net assets (billions) $18.985 $17.159 16.704Local currency =Functionalcurrency (90%) $17.086 $15.443 $15.034Cumulative translation Adjustment $ 3.266 $ 1.698 $ 1.917Real Change in Net Assets:Year Reported Change Change in Real ChangeTranslationAdjustment2007 $ 455 $(219) $6742008 1,826 1,568 258The impact of foreign currency (FC) changes on revenues is determined as follows (in millions):2008 20072006Non-U.S. revenues $41,886 $36,965 $34,361Non-$ FC revenues (90%) 37,697 33,268 30,925Percent increase +13.3% +7.6% ---Dollar index 89.1 98.6 92.7FC revenues FC33,588 FC32,802FC28,667Percent increase 2.4% +14.4%The impact of foreign exchange changes on net income is determined as:2008 2007 2006Foreign pre-tax income(bil.) $7.844 $7.496 $7.088Non-$ FC income (90%) 7.059 6.746 6.379Percent increase 4.6% 5.8% ---Dollar index 89.1 98.6 92.7Adj. Pre-tax income 6.289 6.651 5.913Percent increase -5.4% +12.5% ---When the effect of exchange rate changes have been eliminated, we see a completely different picture than that portrayed by the unadjusted consolidated figures. Investments in earnings assets have actually been declining, which is mirrored in the local currency earnings stream. On the basis of this analysis, MBI does not look attractive, barring other strategic considerations.Case 10-2Assessing Foreign Subsidiary Performance in a World of Floating Exchange RatesA useful pedagogical approach to this case analysis is to have your students participate in a team debate. One team should advocate the merits of ICI s method of evaluating its foreign managers in a world of floating exchange rates; the other should make a case for GE s method. At the conclusion of the team debate, students should be asked to individually reflect on the strengths of all arguments made and decide for themselves which approach they feel is best. A good way to personalize the issue is to ask them to vote for the company for which they would prefer to work as a foreignsubsidiary manager, and why.The following summarizes selected responses of some of our students to this performance evaluation comparison.General ElectricMerits:1. Focuses on returns most germane to U.S. investors.2. Develops exchange risk management capabilities of local managers.3. Fixes responsibility with appropriate authority to carry out that responsibility.4. Local manager knows exactly what is expected.Limitations:1. Emphasis on dollar profits after exchange gains and losses could encourage local managers to hedge accounting exposure as opposed to economic exposure.2. Morale problems could surface if local managers feel that hedging accounting exposure, which is important from a corporate standpoint, reduces their ability to effectively compete in the local market.ICIMerits:1. Encourages local managers to focus on economic as opposed to accounting exposure.2. Holds local managers accountable only for controllable items Minimizes potential morale problems associated with inattention to local competitive pressures.Limitations:1. Easy for local mangers to pass the buck.2. Downplays accounting exposure, which could be germane to accounting user groups who are sensitive to currency effects on reported earnings.3. Difficult to implement as performance standards are often fuzzy (i.e., it is very difficult to measure economic exposure in practice).。

Chapter 8Global Accounting and Auditing StandardsDiscussion Questions1.Argument for measurement:•Discrepancies in international measurement may produce accounting amounts that are vastly different (even where financial transactions and position areidentical), leading to incorrect comparisons. Here it doesn’t matter what isdisclosed; no reliable comparisons are possible anyway.Arguments for disclosure:•If companies do not disclose complete information, they can hide losses or future problems from financial statement users. For example, losses can behidden by offsetting them against gains. Expected future problems related toloss contingencies can be hidden simply by not disclosing them. Thus, ifdisclosure is incomplete, even the application of similar measurementprinciples will lead to incorrect comparisons.Clearly, international accounting convergence requires that both measurement anddisclosure be made comparable.2. The term convergence is associated with the International Accounting StandardsBoard. Before the IASB, harmonization was the commonly used term.Harmonization means that standards are compatible; they do not contain conflicts.Harmonization was generally taken to mean the elimination of differences inexisting accounting standards, in other words, finding a common ground amongexisting standards. Convergence means the gradual elimination of differences innational and international accounting standards. Thus, the terms harmonizationand convergence are closely aligned. However, convergence might also involvecoming up with a new accounting treatment not in any current standards.3.a. Reciprocity, or mutual recognition, exists when regulators outside of thehome country accept a foreign firm’s financial sta tements based on the homecountry’s principles, or perhaps IFRS. For example, the London Stock Exchangeaccepts U.S. GAAP-based financial statements in filings made by non-U.K. foreigncompanies. Reciprocity does not increase cross-country comparability offinancial statements, and it can create an unlevel playing field in that foreigncompanies may be allowed to apply standards that are less rigorous than thoseused by domestic companies.b. With reconciliation, foreign firms can prepare financial statements using theaccounting standards of their home country or IFRS, but also must provide areconciliation between accounting measures (such as net income andshareholders’ equity) of the home country and the country where the financial statements are being filed. Reconciliations are less costly than preparing a full set of financial statements under a different set of accounting principles, but provide only a summary, not the full picture of the enterprise.c. International standards are a result of either international or political agreement, or voluntary (or professionally encouraged) compliance. When accounting standards are applied through political, legal, or regulatory procedures, statutory rules typically govern the process. All other international standards efforts in accounting are voluntary in nature.include:a. A growing body of evidence indicates that the goal of internationalconvergence of accounting, disclosure and auditing has been widely accepted.b.All dimensions of accounting are becoming converged worldwide.c.Increasing numbers of highly credible organizations strongly support the goalsof the IASB.d.National differences in the underlying factors that lead to variation inaccounting, disclosure, and auditing practices are narrowing as capital and product markets become more international.e.International standards will improve the comparability of internationalfinancial information.f.Time and money will be saved on international consolidations, the componentsof which now are subject to different national laws and practices.g.There may be a tendency for accounting standards throughout the world to beraised to the highest possible level.h.Widespread application of IFRS might also result in:•Improved managerial decision making within multinational enterprises.•Improved allocations of corporate investment money worldwide.•Better international understandability of financial statements.•Cost reductions in accounting information processing and financial disclosure costs for multinational enterprises.•Greater international credibility for published financial statements.a.Accounting has built-in flexibility. Its ability to adapt to widelydifferent situations is one of its most important features. Critics doubtthat international standards can be flexible enough to handle differencesin national backgrounds, traditions, and economic environments, and may bea politically unacceptable challenge to sovereignty.b.It is claimed that international accounting standard setting is a tactic ofthe large international accounting service firms to expand their marketshare.c.International standards may create standards overload for companies that dobusiness internationally.d.National political concerns frequently intrude on accounting standards.International political influences would compromise internationalaccounting standards.e.International standards are not suitable for small and medium-sizedcompanies, particularly unlisted ones with no public accountability.f.Risks of misinformation —uniform standards may give the appearance ofsimilarities when in fact countries and companies may be highly dissimilar.g.Political costs of the necessary international treaties on financialaccounting and reporting which would have to be negotiated to enforce theuse of IFRS.6.Evidence indicating wide acceptance of IFRS around the world:a.Growing numbers of companies are adopting IFRS voluntarily and refer totheir use of IFRS in their annual reports.b.Dozens of countries base their national accounting standards on IFRS.c.Some 7,000 EU listed companies now use IFRS in their consolidated financialstatements.d.Many international organizations, such as IOSCO, endorse the use of IFRS.e.IFRS are used as an international benchmark in many major industrializedcountries.f.IFRS are accepted by many stock exchanges and securities regulators.g.IFRS are recognized by the European Commission (EC) and other supranationalbodies.h.Norwalk Agreement committed FASB and IASB to convergence.7. The International Accounting Standards Board is overseen by the International Accounting Standards Committee, consisting of 22 trustees: six from North America, six from Europe, six from the Asia-Pacific region, and four from any area. The trustees appoint the members of the IASB. The IASB receives advice from the Standards Advisory Council on its agenda and priorities. The SAC consists of around 30 members appointed by the IASC trustees and they represent a diversity of geographic and professional backgrounds.The IASB consists of 14 members, 12 full-time and two part-time. It follows a due process in setting accounting standards. For each standard, the board normally publishes a discussion paper that sets out the various possible requirements for the standard and the arguments for and against each one. Later, the board publishes an exposure draft for public comment, and it then examines the arguments put forward in the comment process. A final standard is issued when nine of the 14 board members have voted in its favor.8.Accounting harmonization in the EU is just one element of the overall project of harmonizing the legal and economic systems of the member states, and is part of the process of harmonizing company law.The Fourth Directive illustrates the concept of harmonization, and specifies accounting measurement (valuation) and disclosure requirements. It provides format rules for the balance sheet and the profit and loss account. The true and fair view is the overriding requirement and holds for footnote disclosures as well as the financial statements. The Fourth Directive also sets out the requirements for financial statement audits.The Seventh Directive addresses consolidated financial statements. It requires consolidations for groups of companies above a certain size, specifies disclosures and notes, and requires a directors’ report. When it was issued in 1983, consolidated financial statements were the exception rather than the rule in Europe.The Eighth Directive addressed various aspects of the qualifications of professionals authorized to carry out legally required (statutory) audits. Now referred to as the Statutory Audit Directive, it was substantially amended in 2006. The new directive tightens oversight of the audit profession and has standards for, among other points, auditor appointment and rotation, and continuing professional education.The EU abandoned its approach to harmonization to one favoring the IASB for practical and political reasons. The Fourth and Seventh Directives were incomplete and essentially remained as they were issued. Improvements to them proved difficult to achieve and the directives did not achieve the comparability expected. Some saw a set of Europe-wide standards as an unnecessary redundancy given the emergence of comprehensive IFRS. Others saw U.S. GAAP as a rival to IFRS. The EU cannot influence U.S. GAAP, but can influence IFRS. By putting its weight behind the IASB, the EU could serve as a counterweight to U.S. GAAP.9.International accounting harmonization/convergence should address many, if not most, investor concerns about cross-national differences in accounting practices. The key issue here is comparability –investors want to make “apples to apples” comparisons of financial statements of companies from countries around the world. However, converged standards are only the beginning. Standards must also becomparably applied and they must be rigorously enforced. The financial statements must also be similarly audited to ensure comparable reliability.10.Convergence of auditing standards will help ensure that audit quality will reach acceptable levels worldwide. Auditing convergence may be less difficult to achieve than accounting convergence because auditing is more technically oriented and there is wider agreement as to what constitutes best practices in auditing than there is for accounting principles.IFAC is a worldwide organization of over 160 member organizations in 120 countries. Its mission includes establishing and promoting adherence to high-quality auditing and other professional standards, and furthering the international convergence of such standards. Its work is done through standard setting boards and standing committees. Among its standard setting boards are:•International Accounting Education Standards Board•International Auditing and Assurance Standards Board•International Ethics Standards Board for AccountantsIts work spans the entire array of professional responsibilities of auditors and includes standards covering professional education, the conduct of the audit, and professional ethics.11.IOSCO consists of securities regulators from more than 100 countries. Together, IOSCO members are responsible for regulating more than 90 percent of global securities markets. One of IOSCO’s objectives is promoting “high standards of regulation in order to maintain just, ef ficient, and sound markets.” IOSCO has worked extensively on international disclosure and accounting standards to facilitate the ability of companies to raise capital efficiently in global securities markets. It has a technical committee whose sole focus is multinational disclosure and accounting. Model disclosure standards were published in 1998 and 2002.IOSCO’s disclosure harmonization work is important because it has established a set of high quality disclosure standards, globally recognized, that serves as a model for nations around the world as they develop national requirements for cross-border offerings and initial listings.12.The UN and OECD now play supporting roles in harmonizing accounting and auditing standards. The IASB and IFAC are now the clear leaders in this endeavor, but in the 1970s and 1980s, both the UN and OECD were potential rivals. Most of the effort of the UN and OECD is directed toward providing technical accounting assistance to developing countries. For example, the UN has focused much attention on Russia and countries of the former Soviet bloc, and on African countries.Exercises1.One of the main problems with mutual recognition (or reciprocity) is that itactually may make financial statements within the home market noncomparable. If many different accounting standards are acceptable, then companies domiciled in countries with rigorous standards (such as the United States) would be at a disadvantage to companies whose home country standards are not as stringent, but still would be acceptable. Investors also would face the difficult task of having to master many sets of accounting principles in order to be able to understand the associated financial statements.The U.S. SEC considers reconciliation to be a cost-effective means to allow foreign firms to list on a domestic exchange. With reconciliation, differences between accounting standards are identified and quantified without the need to prepare a second set of financial statements. However, significant differences between domestic and foreign accounting principles can increase the burdens associated with reconciliation, and reconciliations do not provide a full picture of the enterprise as would result from a second set of financial statements.The use of International Financial Reporting Standards would provide many benefits for cross-border listings. Companies would have to provide only one set of financial statements for all nondomestic capital markets, and investors would have to be familiar with only one set of accounting principles to properly understand and interpret nondomestic financial statements. However, as with reconciliation, domestic companies required to comply with domestic standards still would compete for capital with nondomestic companies that would be required to comply with a different (and possibly less stringent) standard.Preferred approaches from perspectives of different groups:a.Investors might prefer international standards, as they would increase theease in understanding information from nondomestic companies. Knowledge ofonly one set of standards would be required to understand all nondomesticstatements. However, there is also a case for reconciliation, which presentsin an economical manner the significant differences between nondomestic anddomestic financial statements and does not require investors to be familiarwith any set of accounting standards other than the home country.pany management might prefer mutual recognition, as it does not require acompany to prepare any additional information and requires no additionalexpense or time commitments. However, companies in some countries mightadopt IFRS voluntarily to increase their credibility with investors andincrease the overall quality of their financial reporting.c.Regulatory authorities might prefer reconciliation as it places the burden oncompanies yet provides adequate disclosure and investor protection.d.Stock exchanges might prefer convergence as it is the only method thatprovides truly complete and identical information disclosure from companies outside the home market.e.Professional associations will take positions according to their constituents–associations of stockbrokers might prefer convergence to the extent that it would make company information easier to understand, whereas associations of company executives might prefer reciprocity.2.The following discussions are based on the respective organizations’ Web sites at the time of writing.International Federation of Accountants (IFAC)IFAC, an organization of national professional accountancy organizations, plays a critical role in the convergence of auditing standards and other international auditing initiatives. The organization has over 160 member organizations in 120 countries, representing more than 2.5 million accountants. Organized in 1977, IFAC’s goal is to develop the accountancy profession and converge its professional standards worldwide to enable accountants to provide services of consistently high quality in the public interest.To achieve its objective, IFAC develops and promotes technical, professional and ethical standards for accountants, provides leadership on emerging issues, and serves as a voice for the world’s accountants on issues of public and profess ional concern. IFAC fosters the advancement of strong national professional accountancy organizations, and works closely with regional accountancy organizations and outside agencies to accomplish this.The IFAC Council, comprised of one representative from each member body, provides overall leadership of IFAC. The council elects the IFAC Board, and is responsible setting policy and overseeing IFAC operations, the implementation of programs, and the work of IFAC’s standard setting groups and committees. The Public Interest Oversight Board (PIOB), an independent board, provides additional oversight. Day-to-day administration is provided by the IFAC chief executive located in New York, which is staffed by accounting professionals from around the world.IFAC’s professional work is done through its standard setting boards and standing committees. IFAC standard setting boards are:•International Accounting Education Standards Board•International Auditing and Assurance Standards Board•International Ethics Standards Board for Accountants•International Public Sector Accounting Standards BoardIFAC standing committees are the following:•Compliance Advisory Panel•Developing Nations Committee•Nominating Committee•Professional Accountants in Business Committee•Small and Medium Practices Committee•Transnational Auditors CommitteeIFAC issues standards in these key areas: auditing, assurance, and related services; education; ethics; and public sector accounting. IFAC’s International Auditing and Assurances Standards Board issues International Standards on Auditing (ISA), which are intended for international acceptance. ISA s deal with topics such as auditors’ responsibilities, risk assessment and evidence, and audit reporting.IFAC has close ties with organizations such as the IASB and IOSCO, and its pronouncements are receiving growing recognition for their quality and relevance. Financial statements of companies around the world are increasingly being audited in conformity with International Standards on Auditing.United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR)ISAR was created in 1982 and is part of the United Nations’ Conference on Trade and Development (UNCTAD). ISAR is the only intergovernmental working group devoted to accounting and auditing at the corporate level. Its objective “is to promote the transparency, reliability and comparability of corporate accounting and reporting as well as to improve disclosures on corporate governance by enterprises in developing countries and countries with economies in transition. ISAR achieves this through an integrated process of research, intergovernmental consensus building, information dissemination and technical cooperation.”In recent years, ISAR focused on important topics that other organizations were not yet ready to address, such as environmental accounting. It has also conducted technical assistance projects in a number of areas such as accounting reforms and retraining in the Russian Federation, Azerbaijan and Uzbekistan, and designing and developing a long-distance learning program in accountancy for French-speaking Africa. Topics discussed at recent ISAR conferences include practical implementation of IFRS, corporate responsibility reporting, and corporate governance disclosures.Organization for Economic Cooperation and Development (OECD)OECD is the international organization of 30 (mostly industrialized) market economy countries. It functions through its governing body, the OECD Council, and its extensive network of committees and working groups. Its publication Financial Market Trends, issued two times each year, assesses trends and prospects in the international and major domestic financial markets of the OECD area.The OECD often publishes reports on the structure and regulation of securities markets, and has played a leading role in promoting improved corporate disclosure and governance around the world. With its membership consisting of larger, industrialized countries, the OECD is often a counterweight to other bodies (such as the United Nations and the International Confederation of Free Trade Unions) that have built-in tendencies to act contrary to the interests of its members.3.As an example, consider the Financial Accounting Standards Board (FASB) in the United States. The FASB’s Web site presents detailed information on the FASB’s international activities, including an overview, convergence with IASB, cooperative efforts with other standards setters, and the FASB/IASB memorandum of understanding.The FASB’s objective for participating in international activities is to increase the international comparability and the quality of standards used in the United States. This objective is consisten t with the FASB’s obligation to its domestic constituents, who benefit from comparability of information across national borders. The FASB pursues that objective in cooperation with the International Accounting Standards Board (IASB) and national standard setters.The FASB believes that the ideal outcome of cooperative international accounting standard-setting efforts would be the worldwide use of a single set of high-quality accounting standards for both domestic and cross-border financial reporting. At present, a single set of high-quality international accounting standards that is accepted in all capital markets does not exist. In the United States, for example, domestic firms that are registrants with the SEC must file financial reports using U.S. GAAP. Foreign firms filing with the SEC can use U.S. GAAP, their home country GAAP, or international standards – although if they use their home country GAAP or international standards, foreign issuers must provide a reconciliation to U.S. GAAP.The FASB engages in a variety of activities in pursuit of the goals of high-quality international standards and increased convergence of the accounting standards used in different nations. Almost every FASB project is a matter of interest in some other country or with the IASB.4. a. Comparison of standard-setting proceduresEuropean UnionAccounting and auditing requirements are established under EU company law directives, which are legal instruments that member countries must implement. Thus, all accounting and auditing standards in EU directives become legally enforceable. The EU comprises several key organizations that need to be understood in order to understand how EU directives come into being. Briefly, the European Commission initiates EUp olicy and acts in the community’s general interest. Commissioners are completely independent and may not seek or take instructions from governments or interest groups. The Council of the European Commission is the EU’s decision-maker. Here, the member states legislate for the EU, deciding some matters by majority vote and others unanimously. The European Parliament represents the EU’s citizens. Its main functions are to enact legislation and to scrutinize and control the use of executive power. The Trea ty of European Union of 1993 strengthened the European Parliament’s responsibilities. Only the Commission can propose new directives. Proposals typically undergo many drafts. Proposed directives are submitted to the Council of the European Commission, which first seeks opinions of the Economic and Social Committee and the European Parliament. Next, a working party set up by the Council discusses the proposal. Member countries typically are allowed several years to implement a new directive after its final adoption. (Note to instructors: The information contained in this paragraph is based on information on the EU’s Web site at the time of writing.)IASBThe IASB follows due process in setting accounting standards. For each standard, the Board may publish a discussion paper that sets out the various possible requirements for the standard and the arguments for and against each one. Subsequently, the Board publishes an exposure draft for public comment, and then examines the arguments put forward in the comment process before deciding on the final form of the standard. An exposure draft and final standard can be issued only when nine (of 14) members of the board vote in favor of it.IFACThe standard setting boards of IFAC also follows a due process procedure. Meetings to discuss the development and approval of standards are open to the public and, where practicable, are broadcast over the Internet. Issues papers and draft standards are published on the IFAC Web site along with updated project summaries and meeting highlights. New projects are based on a review of national and international developments and comments from interested observers. An advisory group is consulted to determine priorities and activities. Task forces are usually assigned the responsibility for the development of new standards. These task forces conduct research and consult interested parties on the issues under consideration. One or more public forums or roundtables may be held before an exposure draft is issued. Re-exposure is sometimes necessary. Final standards are issued after considering comments to the exposure draft. (Note to instructors: The information contained in this paragraph is taken from IFAC’s Web site at the time of writing.)a.At what types and sizes of enterprises are their standards primarilydirected?EU company law directives apply both to public and private companies inthe EU, without respect to size.IFRS are financial reporting standards for business whose applicabilitydepends on the context. For example, if IFRS are adopted as nationalaccounting standards in a particular country, their applicability dependson the type of entities that are subject to those national standards.IFAC’s standards are directed toward the audits of both public and private companies.In summary, all three sets of standards are meant to apply to most (if notall) enterprises, without regard to size or whether the enterprises areprivate or public.b.Brief critique of statementIt is true that IFRS are particularly useful to companies that operate inmore than one country, because IFRS are widely recognized and are acceptablein many different countries and stock exchanges. However, as stated in thetext, IFRS also are used as the basis for national accounting standards inmany countries, and these national standards typically apply to a wide rangeof companies, not just multinational companies.5. Following is a sample essay on the 1995 European Commission adoption of a new approach to accounting harmonization. The essay is based on material in articles by Gerhard G. Mueller, "Harmonization: Efforts in the European Union," in Frederick D.S. Choi, ed., International Accounting and Finance Handbook, New York: John Wiley & Sons, 1997, page 11.28; and Peter Walton, “European Harmonization,” in Frederick D.S. Choi, ed., International Finance and Accounting Handbook, New York: John Wiley & Sons, 2003, page 17.7Beginning in the early 1990s, the Commission examined a number of alternative harmonization strategies. These included, among others, substantive revisions of the existing accounting Directives, creation of a Europe-wide accounting standards-setting board, exempting certain European companies from all EU accounting requirements so that these companies might apply accounting standards of other jurisdictions, or re-enforce its earlier push for mutual recognition.The reality of international pressures and the need of European multinationals to be listed on several stock exchanges finally made it clear that the creation of a strong European regional level of accounting regulation was simply adding an unnecessary third tier, sandwiched between national regulations and the international capital markets.In the end, the European Commission adopted a new accounting harmonization strategy on November 14, 1995 and forwarded respective recommendations to the European Council。

Chapter 21Cost-Volume-Profit (CVP) Analysis√ Quick CheckAnswers:1. b 3. a 5. d 7. b 9. a2. d 4. b 6. a 8. c 10. cExplanations:2. d. $110,000 = (100,000 × $1) + $10,0003. a. Breakeven sales $50,000in units = $60 − $10 = 1,000 passengers4. b. Breakeven sales $0.60 millionin dollars = 0.40 =$1.5 million$3 billion − $1.8 billionContribution margin ratio (40%)=$3 billion5. d. Target sales $50,000 + $100,000in dollars = 0.40 =$375,000$60 − $36Contribution margin ratio (40%) =$609. a. Margin of safety ($0) = Expected sales ($800,000*) − breakeven sales ($800,000)*($600,000 + $700,000 + $900,000 + $800,000 + $1,000,000) / 5 = $800,00010. c. Breakeven sales $50,000in total units =$40* =1,250 passengers625 regular 625 discount*Weighted-average ($60 − $10) + ($40 − $10)contribution margin = 2 =$40per unit√Short Exercises(5-10 min.) S 21-1 F 1. Depreciation on routers used to cut wood enclosures V 2. Wood for speaker enclosuresF 3. Patents on crossover relaysV 4. Crossover relaysV 5. Grill clothV 6. GlueF 7. Quality inspector’s salary(5-10 min.) S 21-2 F 1. Building rentF 2. ToysF 3. Playground equipmentV 4. Afternoon snacksF 5. Sally’s salaryV 6. Wages of after-school employeesV 7. Drawing paperF 8. Tables and chairs(5-10 min.) S 21-3 Req. 1a. Call for 20 minutes$5.00 + (20 × $0.35)$5.00 + $7.00 = $12.00b. Call for 40 minutes$5.00 + (40 × $0.35)$5.00 + $14.00 = $19.00c. Call for 80 minutes$5.00 + (80 × $0.35)$5.00 + $28.00 = $33.00(continued) S 21-3 Req. 2(5-10 min.) S 21-4 Req. 1Variable cost per unit =Change in total cost ÷ Change inofactivityvolume− $2,200) ÷ (1,000 machine=($2,400− 500 machine hours)hours=$200 ÷ 500 hours = $.40 per machinehourReq. 2Total fixed cost =Total mixed cost − Total variable cost− ($.40 × 1,000 machine hours)=$2,400− $400 = $2,000=$2,400In this example the highest cost and volume were chosen to calculate the total fixed cost, but the lowest cost and volume also could be used to calculate the $2,000 total fixed cost:Total fixed cost =Total mixed cost − Total variable cost− ($.40 × 500 machine hours)=$2,200− $200 = $2,000=$2,200(5-10 min.) S 21-5Income statement approach:Fixed OperatingSales revenue− Variable costs −costs =incomeVariable cost Units Fixed OperatingSale price Units per unit × sold − per unit × sold −costs =income ($60 × Units sold) − ($20 × Units sold)−$275,000 = $0 ($60 − $20) × Units sold −$275,000 = $0 $40×Units sold = $275,000 Units sold = 6,875 ticketsAlternative: Shortcut contribution margin approach:Units sold Fixed costs + Operating income(to break even) =Contribution margin per unit $275,000 + 0=$40* = 6,875 tickets*Contribution margin $60 sale $20 variable costper person = price −per personProof:Sales revenue (6,875 × $60)................................….. $412,500 Variable costs (6,875 × $20)........................….......... 137,500 Contribution margin............................................….. 275,000 Fixed costs........................................………….......... (275,000) Operating income......................................……….… $ 0(continues S 21-4) (5 min.) S 21-6Req. 1Contribution margin ratioContribution margin per person $40*Sale price per person =$60= 0.66667*Sale price ($60) minus variable cost per person ($20)Req. 2Breakeven Fixed costs + Operating incomesales in dollars =Contribution margin ratio $275,000 + $0=0.66667 = $412,500(10 min.) S 21-7Req. 1Fixed OperatingSales revenue− Variable costs −costs =incomeVariable cost Units Fixed OperatingSale price Units per unit × sold − per unit × sold −costs =income ($50 × Units sold) − ($20 × Units sold)−$275,000 = $0 ($50 − $20) × Units sold −$275,000 = $0 $30×Units sold = $275,000 Units sold = 9,167 tickets9,167 tickets × $50 = $458,350Reducing the sale price increases the breakeven point.Alternatively,Contribution Contribution margin per unitmargin ratio =Sale price per unit$50 − $20=$50 = 0.60Breakeven Fixed costs + Operating incomein dollars =Contribution margin ratio $275,000 + $0=0.60 = $458,333The difference between the income statement approach breakeven sales ($458,350) and the contribution margin ratio formula breakeven sales ($458,333) is a small rounding error.(continued) S 21-7Req. 2Fixed OperatingSales revenue− Variable costs −costs =IncomeVariable cost Units Fixed OperatingSale price Units per unit × sold − per unit × sold −costs =Income ($60 × Units sold) − ($15 × Units sold)−$275,000 = $0 ($60 − $15) × Units sold −$275,000 = $0 $45×Units sold = $275,000 Units sold = 6,111 tickets6,111 tickets × $60 = $366,660Reducing variable costs reduces the breakeven point.Alternatively,Contribution Contribution margin per unitmargin ratio =Sale price per unit$60 − $15=$60 = 0.75Breakeven Fixed costs + Operating incomein dollars =Contribution margin ratio $275,000 + $0=0.75 = $366,667(Again, the small difference is due to rounding.)(5-10 min.) S 21-8Fixed OperatingSales revenue− Variable costs −costs =incomeVariable cost Units Fixed OperatingSale price Units per unit × sold − per unit × sold −expenses =income ($60 × Units sold) − ($20 × Units sold)−$200,000 = $0 ($60 − $20) × Units sold −$200,000 = $0 $40×Units sold = $200,000 Units sold = 5,000 tickets5,000 tickets × $60 = $300,000Reducing fixed costs reduces the breakeven point.Alternatively,Contribution Contribution margin per unitmargin ratio =Sale price per unit$60 − $20=$60 = 0.66667Breakeven Fixed costs + Operating incomein dollars =Contribution margin ratio $200,000 + $0=0.66667 = $300,000(5-10 min.) S 21-9a. Margin of safety Expected sales Breakeven salesin units =in units −in units = 7,000 − 6,875 (from S 21-5) = 125 ticketsb. Margin of safety Margin of safety Sale pricein dollars =in units ×per unit = 125 tickets × $60 = $7,500(10-15 min.) S 21-10 Calculate: AContribution margin per unit $ 4 Sale price − Variable costs ($10 − $6) Contribution margin ratio 40%Contribution margin ÷ Sale price ($4 ÷ $10) Breakeven point in units Fixed costs ÷ Contribution margin$4)÷($50,00012,500Breakeven point in sales $ Breakeven in units × Sale price$125,000 (12,500 × $10)Units to achieve target (Fixed costs + income) ÷ CM ($50,000 +÷$4)income 25,000 $50,000)operatingCalculate: BContribution margin per unit $ 8 Sale price − Variable costs ($16 − $8) Contribution margin ratio 50%Contribution margin ÷ Sale price ($8 ÷ $16) Breakeven point in units Fixed costs ÷ Contribution margin$8)÷($21,0002,625Breakeven point in sales $ Breakeven in units × Sale price$42,000 (2,625 × $16)Units to achieve target (Fixed costs + income) ÷ CM ($21,000 +$8)÷income 11,375 $70,000)operating(continued) S 21-10 Calculate: CContribution margin per unit $ 9 Sale price − Variable costs ($30 − $21) Contribution margin ratio 30%Contribution margin ÷ Sale price ($9 ÷ $30) Breakeven point in units Fixed costs ÷ Contribution margin20,000 ($180,000 ÷ $9)Breakeven point in sales $ Breakeven in units × Sale price$600,000 (20,000 × $30)Units to achieve target (Fixed costs + income) ÷ CM ($180,000 +$9)÷operatingincome 30,000 $90,000)(5-10 min.) S 21-11Tickets Individual Family Sale price per unit $ 25 $ 75 Variable costs per unit 15 60 Contribution margin per unit $ 10 $ 15 Sales mix in units 1 3 4Contribution margin $ 10 $ 45 $ 55Weighted-average CM ($55 ÷ 4)…………………………. $ 13.75(5-10 min.) S 21-12Req. 1Units sold Fixed costs + Operating income(to break even) =Weighted-average contribution margin per unit $39,000 + $0=$13 = 3,000 ticketsReq. 23,000 tickets × (2/5) = 1,200 individual tickets 3,000 tickets × (3/5) = 1,800 family tickets√Exercises(15 min.) E 21-13g 1. Costs that do not change in total despite wide changesvolume.ina 2. The sales level at which operating income is zero: Totalrevenues equal total costs.d 3. Drop in sales a company can absorb without incurringoperatingloss.anf 4. Combination of products that make up total sales.b 5. Sales revenue minus variable costs.c 6. Describes how costs change as volume changes.h 7. Costs that change in total in direct proportion tovolume.changesine 8. The band of volume where total fixed costs remainconstant and the variable cost per unit remainsconstant.(5-10 min.) E 21-14 filterOilV 1.rentF 2.BuildingOilV 3.V 4. Wages of maintenance workerF 5.TelevisionManager’ssalaryF 6.registerCashF 7.EquipmentF 8.(5-10 min.) E 21-15 (a) (b) (c)Fixed Expenses$40$30$20$10Cost(thou-sands)Cost(thou-sands)0 2 4 6 8 10Volume(thousands ofunits)Volume(thousands ofunits)Volume(thousands ofunits)(5-10 min.) E 21-16 Req. 1Variable cost per unit = ($4,000 − $3,600) ÷ (1,000 inspections− 600 inspections)= $400 ÷ 400 inspectionsinspectionper=$1Req. 2Total fixed cost = Total mixed cost − Total variable cost=$4,000− ($1 × 1,000 inspections)− $1,000 = $3,000=$4,000Req. 3Total operating cost =$1 per inspection + $3,000The estimated operating cost=($1 × 900 inspections) + $3,000 based on 900 inspections=$3,900(15 min.) E 21-17 Req. 1Contribution margin ratio = $187,500 / $312,500 = 0.60Req. 2Aussie TravelContribution Margin Income StatementsSales revenue $250,000 $360,000 Variable expenses(40% of sales revenue*) 100,000 144,000 Contribution margin 150,000 216,000 Fixed costs 170,000 170,00046,000 Operating income (loss) $ (20,000) $*$125,000 / $312,500 = 0.40Req. 3$170,000 + $0Breakeven sales =0.60=$283,333(15 min.) E 21-18Req. 1Contribution margin per unit:Sale price....................................…………..$1.70 Variable costs.................................………. 0.85 Contribution margin per unit....................$0.85Contribution margin ratio:Contribution margin per unit $0.85Sale price per unit =$1.70= 0.50Req. 2Fixed costs + Operating income Breakeven sales in units=Contribution margin per unit$85,000 + $0=$0.85 =100,000 packagesFixed costs + Operating incomeBreakeven sales in dollars =Contribution margin ratio$85,000 + $0=0.50 =$170,000(10-15 min.) E 21-19Req. 1Contribution Contribution margin per unitmargin ratio =Sale price per unit$5.00 − $1.50=$5.00 =0.70Breakeven sales Fixed costs + Operating incomein dollars =Contribution margin ratio $8,400 + $0=0.70 =$12,000Req. 2If franchisees require a monthly operating income of $8,750:Target sales Fixed costs + Operating incomein dollars =Contribution margin ratio $8,400 + $8,750=0.70 =$24,500Yes, Lo’s franchising concept is a good idea. She expects most locations could sell more ($25,000) than the sales required to earn the target profit ($24,500).(10-15 min.) E 21-20Req. 1Fixed costs + Operating incomeBreakeven sales in dollars=Contribution margin ratio$640,000 + $0=0.80=$800,000Req. 2Gordon’s Steel PartsContribution Margin Income Statementsat Different Sales LevelsSales revenue $ 500,000 $1,000,000Variable expenses:($500,000 × 0.20*) 100,000($1,000,000 × 0.20*) 200,000800,000 Contribution margin 400,000Fixed costs 640,000 640,000Operating income (loss) $(240,000) $ 160,000__________*1 − Contribution margin ratio = Variable expenses as % of revenues1 − 0.80 = 0.20.Req. 3Yes, the results of the contribution margin income statements at the twodifferent sales levels make sense given the breakeven sales level($800,000) computed in Req. 1. Req. 2 shows that if Gordon’s revenue isonly $500,000—well short of the revenue required to break even—thecompany incurs a loss. On the other hand, if revenue is $1,000,000(higher than the revenue required to break even), the company earns aprofit.(15-20 min.) E 21-21Req. 1The vertical axis is dollars and the horizontal axis is students (or units). The sales revenue and total expense lines are labeled on the graph. Fixed cost of $30,000 is labeled. The operating income area and the breakeven point of 500 students ($50,000) also are labeled.Req. 2If Hill attracts only 400 students, the venture will not be profitable. The graph shows the operating loss will be $6,000 if only 400 students register for the course.(continued) E 21-21 Req. 3Breakeven sales = 500 students ($50,000), labeled on the graph. Note: Some students may recognize that the results at 400 students also can be determined as follows:At the breakeven point:Sales revenue = $50,000 for 500 students, so sales revenue is $100 per student.Total expenses are $50,000, of which $30,000 are fixed, so variable expenses are ($50,000 − $30,000) / 500 students = $40 per student.The results at 400 students can be computed as follows: Sales revenue (400 × $100)......................…$40,000Variable costs (400 × $40)................……… 16,000Contribution margin..........................………24,000Fixed costs.................................…………… 30,000Operating loss........................................…..$( 6,000)(15 min.) E 21-22(1.)(2.)(3.)(4.)Breakeven Sale pricedecreaseVariablecostsdecreaseFixedcostsdecreaseSale price per unit $ 200 $ 180 $ 200 $ 200 Variable costs per unit $ 120 $ 120 $ 110 $ 120 Total fixed costs $50,000 $ 50,000 $50,000 $40,000 Calculate: Contribution margin perunit $ 80 $ 60 $ 90 $ 80 Breakeven point in units 625 833 556 500The contribution margin decreases when the sale price decreases. The contribution margin increases when variable costs decrease. Changes in fixed costs do not affect the contribution margin.The breakeven point increases when the sale price decreases. The breakeven point decreases when variable costs decrease. The breakeven point decreases when fixed costs decrease.(15 min.) E 21-23Req. 1Contribution margin ratio = 1.00 − 0.70 = 0.30Fixed costs + Operating incomeBreakeven sales in dollars =Contribution margin ratio$9,000 + $0=0.30 = $30,000Fixed costs + Operating incomeTarget sales in dollars=Contribution margin ratio$9,000 + $12,000=0.30 $21,000=0.30 = $70,000Margin of safety = $70,000 − $30,000= $40,000Req. 2Margin of safety as $40,000a % of target sales =$70,000= 0.57, or 57% of target sales(15-20 min.) E 21-24To Breakeven:Standard Chrome Sale price per unit $54.00 $78.0050.00Variable costs per unit 36.00Contribution margin per unit $18.00 $28.00Sales mix in units 2 3 5Contribution margin $36.00 $84.00 $120.00Weighted-average CM ($120 / 5) $ 24.00Fixed costs + Operating incomeBreakeven units sold =Weighted-average contributionunitpermargin$12,000 + $0=$24scooters=500Number of Standard [500 × (2/5)]200Number of Chrome [500 × (3/5)] 300(continued) E 21-24To earn operating income of $6,600:Standard Chrome Sale price per unit $54 $7850Variable costs per unit 36Contribution margin per unit $18 $28Sales mix in units 2 3 5Contribution margin $36 $84 $120Weighted-average CM ($120 / 5) $ 24Fixed costs + Operating incomeUnits sold =Weighted-average contribution margin per unit$12,000 + $6,600=$24scooters=775Number of Standard [775 × (2/5)]310Number of Chrome [775 × (3/5)] 465√ ProblemsGroup A(15-30 min.) P 21-25A Managers often want to predict the change in profit likely to result from a change in revenue. The contribution margin income statement yields this information. It separates variable expenses from fixed expenses to isolate their effects on profits. As revenues change, variable expenses change also. Fixed expenses may or may not change, depending on the circumstances.The contribution margin is the excess of revenues over variable expenses. Each dollar of additional revenue adds to the contribution margin. In Ralph’s example, $6,000 of added revenue contributes a margin of $3,600, as computed below. Subtracting the fixed advertising expense of $600 yields the $3,000 addition to monthly operating income.Increase in revenues………………………..$6,000 (given) Increase in variable expenses…………….2,400Increase in contribution margin…………..3,600Increase in fixed advertising expense…... 600 (given) Increase in operating income…………….. $3,000 (given) The margin of safety is the excess of sales over breakeven sales. Fox Club’s situation appears to be critical because a decreasing margin of safety means that the business is getting closer to breakeven sales. At that level there will be no profit, and Fox Club Clothiers could be forced out of business.Note: Student responses may vary considerably.(45-60 min.) P 21-26ACost-Volume-Profit AnalysisCompanies North, East, South, WestCOMPANYWestSouthEastNorthTarget sales $703,000 $187,500 $600,000 $195,000Variable costs 421,800 150,000 280,000 156,000Fixed costs 254,000 123,000 138,000 4,000Operating income (loss) $ 27,200 $ (85,500)$182,000 $ 35,000Units sold 190,000 10,000 3,200 3,250Contribution marginper unit $ 1.48 $ 3.75 $ 100 $ 12Contribution marginratio 0.40 0.200 0.533 0.200Computations (top to bottom for each company)North:(1) Units sold × Unit contribution margin = Contribution marginSales − Contribution margin = Variable costs190,000 × $1.48=$281,200; $703,000 − $281,200 = $421,800(2) Sales − Variable costs − Operating income = Fixed costs$703,000 − $421,800 − $27,200 = $254,000(3) Contribution margin / Sales = Contribution margin ratio=0.40$281,200 / $703,000(continued) P 21-26A East:(4) 1.00 − Contribution margin ratio = Variable cost %Variable costs / Variable cost % = Sales1.00 − 0.20 = 0.80; $150,000 / 0.80 = $187,500(5) Sales − Variable costs − Fixed costs = Operating income$187,500 − $150,000 − $123,000 = $(85,500)(6) Sales − Variable costs = Contribution margin;Contribution margin / Units sold = Contribution margin per unit $187,500 − $150,000 = $37,500; $37,500 / 10,000 = $3.75 South:(7) Sales − Variable costs − Fixed costs = Operating income$600,000 − $280,000 − $138,000 = $182,000(8) Sales − Variable costs = Contribution margin;Contribution margin / Contribution margin per unit = Units sold $600,000 − $280,000 = $320,000; $320,000 / $100 = 3,200 units(9) Contribution margin / Sales = Contribution margin ratio$320,000 / $600,000 = 0.533 (rounded)West:(10) 1.00 − Contribution margin ratio = Variable cost %Variable costs / Variable cost % = Sales1.00 − 0.20 = 0.80; $156,000 / 0.80 = $195,000(11) Sales − Variable costs − Operating income = Fixed costs$195,000 − $156,000 − $35,000 = $4,000(12) Sales − Variable costs = Contribution marginContribution margin / Contribution margin per unit = Units sold $195,000 − $156,000 = $39,000; $39,000 / $12 = 3,250 units(continued) P 21-26A Breakeven Sales:$254,000North: B/E =0.40= $635,000$123,000East: B/E=0.20= $615,000$138,000South: B/E =0.533= $258,912$4,000 West: B/E=0.20 = $20,000Lowest breakevenpointCompany West’s low breakeven point results from its low fixed costs.(30-45 min.) P 21-27A Req. 1Revenue per show:1,000 tickets × $60 / ticket........................…………… $60,000 Variable costs per show:Programs: 1,000 guests × $8 / guest....................…. $ 8,000 Cast: 60 cast members × $320 / cast member.......... 19,200 Total variable costs per show.......................……….. $27,200 Req. 2costs −Fixed costs = Operating income Sales revenue− VariableRevenue Number Variable Numberper × of − cost per×of −Fixed costs = Operating income show shows show showsNumber Number=$0 $60,000 × of − $27,200×of −$459,200shows shows($60,000 − $27,200) × Number of shows = $459,200$32,800 × Number of shows = $459,200$459,200Number of shows =$32,800 Breakeven number of shows = 14 shows(continued) P 21-27A Req. 3Contribution margin = $60,000 − $27,200=$32,800Fixed costs + Target operating income Target number of shows =Contribution margin per unit$459,200 + $4,264,000Target number of shows =$32,800$4,723,200Target number of shows =$32,800Target number of shows = 144 showsThis profit goal is not realistic. British Productions performs only 120 shows each year.Req. 4British ProductionsContribution Margin Income StatementYear Ended December 31, 2007Sales revenue (120 × $60,000) $7,200,000 Variable costs (120 × $27,200) 3,264,000 Contribution margin 3,936,000 Fixed costs 459,200 Operating income $3,476,800(30-45 min.) P 21-28A Req. 1Sales Revenue− Variablecosts −Fixed costs = Operating incomeSale Variableprice × Units sold − cost ×Unitssold−Fixed costs = Operating incomeper unit perunit($12.00 × Units sold) − ($4.20 × Units sold)− $639,600 = $0($12.00 − $4.20) × Units sold =$639,600 $7.80 × Units sold =$639,600$639,600Units sold =$7.80Breakeven sales in units = 82,000 flagsReq. 2Contribution margin =$12.00 − $4.20=$7.80Contribution margin ratio =$7.80=$12.00=0.65Fixed costs + Target operating income Target sales in dollars =Contribution margin ratio$639,600 + $32,500Target sales in dollars =0.65$672,100=0.65=$1,034,000(continued) P 21-28A Req. 3Kincaid CompanyContribution Margin Income StatementYear Ended December 31 2007Sales revenue (70,000 × $12.00) $840,000 Variable expenses:Cost of goods sold (70,000 × $4.20 × 0.60) $176,400Operating costs (70,000 × $4.20 × 0.40) 117,600 294,000 Contribution margin 564,000 Fixed costs:Operating costs 639,600 Operating loss $ (93,600)Req. 4New fixed costs =$639,600 × 1.20=$767,520New variable costs =$4.20 + 0.30=$4.50Sale Variableprice × Units sold − cost ×Units sold−Fixed costs = Operating income perper unitunit($12.00 × Units sold) − ($4.50 × Units sold) − $814,320 = $ 0 ($12.00 − $4.50) × Units sold = $767,520$7.50 × Units sold = $767,520$767,520Units sold=$7.50Breakeven sales in units= 102,336 flagsBreakeven sales in dollars = 102,336 × $12.00= $1,228,032(continued) P 21-28A Req. 4 (continued)Kincaid Company’s 2007 sales of 70,000 flags is well below the breakeven point of 82,000. Apparently the company is having trouble generating enough business to fully use the plant capacity it already has. An expansion that would increase Kincaid’s variable and fixed costs would be a good idea only if the company could use its expanded facilities to generate enough new business to earn additional income. This seems unlikely in this case.(30-45 min.) P 21-29AReq. 1Contribution margin ratio =0.70 (1.00 − 0.09 − 0.12 − 0.04 − 0.05)Monthly fixed costs =$19,600 ($8,100 + $1,700 + $2,000 +$1,000 + $2,000 + $4,800)Fixed costs + Operating incomeBreakeven sales in dollars =Contribution margin ratio$19,600 + $0 =0.70= $28,000$28,000 Breakeven sales in units (trades)=$700= 40 tradesReq. 2Operating Sales revenue − Variable costs − Fixed costs =incomeSales revenue − 0.30 Sales revenue − $19,600= $9,800 0.70 Sales revenue= $29,400 Sales revenue = $29,400 0.70Sales revenue= $42,000(continued) P 21-29A Req. 3(continued) P 21-29AReq. 4Breakeven sales in dollars= $28,000(from Req. 1)$28,000Breakeven sales in units (trades)=$800trades=35 The increase in the average trade commission revenuedecreases the breakeven point from 40 to 35 trades.(20 min.) P 21-30AReq. 1Plain/doz Filled/doz Sale price per unit $6.00 $7.004.20Variable costs per unit 2.00Contribution margin per unit $4.00 $2.80Sales mix in units 2 1 3$10.80Contribution margin $8.00$2.80Weighted-average CM ($10.80 / 3)$ 3.60Fixed costs + Operating incomeBreakeven sales in units =Weighted-average contributionunitmarginper$43,200 + $0=$3.60units=12,000Breakeven units 12,000Number of plain [12,000 × (2/3)] 8,000Number of custard-filled [12,000 × (1/3)] 4,000(continued) P 21-30AProof:TotalFilled/dozPlain/dozSales revenue $48,000 $28,000 $76,00032,800Variable costs 16,00016,800Contribution margin $32,000 $11,200 43,200Fixed costs 43,200Operating income $ 0Req. 2Margin of Safety = Expected Sales Dollars−Breakeven Sales Dollars=$128,000 −$76,000$52,000Req. 3If monthly sales volume increases 10%, sales revenue will be$140,800 ($128,000 × 1.10). The new operating income iscomputed as follows:Fixed costs + Operating incomeSales in dollars =Contribution margin ratio$43,200 + Operating income$140,800 =0.568*Operating income = $36,774*From Req. 1 “proof,” $43,200 / $76,000 = 0.568.√ProblemsGroup B(15-20 min.) P 21-31B Plan 1 leans to higher fixed costs because the business pays fixed salaries to employees. The high fixed expenses raise the breakeven point and make it difficult to earn a profit. This plan may provide too much risk for a new business.Plan 2 calls for a higher level of variable expenses, with lower fixed expenses. The lower fixed expenses create a relatively low breakeven point. If the business cannot generate much revenue in the early going, expenses also will be relatively low because more expenses are variable. This plan appears better suited for a new business because it relieves the pressure of fixed expenses, lowers the breakeven point, and increases the likelihood of earning a profit.Note: Student responses may vary considerably.(45-60 min.) P 21-32BCost-Volume-Profit AnalysisCompanies J, K, L, MCOMPANYMLKJTarget sales $810,000 $300,000 $190,000 $900,000Variable costs 270,000 180,000 76,000 260,000Fixed costs 474,000 56,000 100,000 560,000Operating income $ 66,000 $ 64,000 $ 14,000 $ 80,000Units sold 90,000 40,000 12,000 16,000Contributionmargin per unit $ 6 $ 3.00 $ 9.50 $ 40Contributionmargin ratio 0.67 0.40 0.60 0.711Computations (top to bottom for each company)J:(1) Sales − Variable costs − Operating income = Fixed costs$810,000 − $270,000 − $66,000 = $474,000(2) Sales − Variable costs = Contribution marginContribution margin / Unit contribution margin = Units sold$810,000 − $270,000 = $540,000; $540,000 / $6 = 90,000 units(3) Contribution margin / Sales = Contribution margin ratio=0.70$504,000 / $720,000。

第5章国际会计协调化■教学目的与要求一、教学目的通过本章和第6章的学习，既要求学生能深刻领会国际会计协调化的含义和当前的强劲趋势，也要求学生了解各种国际性政府间机构（如联合国会计和报告国际准则政府间专家工作组、经济合作与发展组织常设会计准则工作组）、区域性国家联盟（如欧洲联盟）、官方机构国际组织（如证券委员会国际组织）以及民间国际组织（特别是会计职业界的国际组织，如国际会计师联合会和国际会计准则委员会以及区域性会计师联合会）对国际会计协调化所作的努力和成果。

本章介绍除国际会计准则委员会（将在第6章介绍）以外的各主要国际组织的作用和成果。

二、学习要求1．深刻理解国际会计协调化的含义。

2．了解推动国际会计协调化的6个主要国际组织的性质。

3．在推动国际会计协调化的其他国际组织中，关注欧洲会计师联合会和亚太会计师联合会。

4．了解有助于国际会计协调化的其他国际组织。

5．理解联合国会计和报告国际准则政府间专家工作组现今的作用只是推动国际会计协调化的权威性国际论坛。

6．着重理解欧洲联盟是推动国际会计协调化最具成效的区域性国家联盟。

7．了解经济合作与发展组织国际投资和跨国企业委员会及其常设会计准则工作组的活动。

8．了解证券交易委员会国际组织（IOSCO）作为官方机构的国际组织在国际协调中的重要作用。

9．着重理解国际会计师联合会的活动及国际审计准则。

■教学要点、重点与难点一、教学要点（一）国际会计协调化的含义较深入的阐明：1．对国际会计协调化（即会计的国际协调化），至今尚无公认的严谨的定义。

综合各家之说（参见教本），可以把国际会计协调化理解为：（1）国际会计协调化是一个限制和缩小会计差异，形成一套可接受的准则（标准）和惯例的过程；（2）其目的在于促进各国（和地区）的会计实务和财务信息的可比性；（3）国际会计协调化的意图在于归纳不同的会计制度，把多样化的实务组合成能产生共同协作结果的有序结构。

2．国际会计协调化的作用在于：（1）有助于进行国际商贸和经济合作活动；（2）促进了外国企业在国际货币市场融资（特别是在国际资本市场发行证券）时需提供的财务报表的可比性；（3）有利于跨国投资，便于跨国公司合并其分布在世界各地的子公司的财务报表。

Chapter 6Foreign Currency TranslationDiscussion Questions Solutions1.Foreign currency translation is the process of restating aforeign account balance from onecurrency to another. Foreign currency conversion is theprocess of physically exchanging one currency for another.2.In the foreign exchange spot market, currencies bought andsold must be delivered immediately,normally within 2 business days. Thus a Singaporean tourist buying U.S. dollars at the airportbefore boarding a plane for New York would hand over Singapore dollars and immediatelyAHA12GAGGAGAGGAFFFFAFAFreceive the equivalent amount in U.S. dollars. The forward market handles agreements toexchange a fixed amount of one currency for another on an agreed date in the future. Forexample, a French manufacturer exporting goods invoiced in euros to a Japanese importer on 60-day credit terms would buy a forward contract to sell yen for euros 2 months in the future.Transactions in the swap market involve the simultaneous purchase (or sale) of one currency inthe spot market and the sale (or purchase) of the same currency in the forward market. Thus, aAHA12GAGGAGAGGAFFFFAFAFCanadian investor wishing to take advantage of higher interest rates on 6-month Treasury bills inthe United States would buy U.S. dollars with Canadian dollars in the spot market and invest inthe United States. To guard against a fall in the value of the U.S. dollar before maturity (whenthe U.S. dollar proceeds are converted back to Canadian dollars), the Canadian investor wouldsimultaneously enter into a forward contract to sell U.S. dollars for Canadian dollars 6 months inthe future at today s forward exchange rate.3.The question refers to alternative exchange rates that areused to translate foreign financialAHA12GAGGAGAGGAFFFFAFAFstatements. The current rate is the exchange rate at the financial statement date. It issometimes called the year-end or closing rate. The historical rate is the exchange rate at the timeof the underlying transaction. The average rate is the average of various exchange rates during afiscal period. Since the average rate normally is used to translate income statement items, it isoften weighted to reflect any seasonal changes in the volume of transactions during the period.Translation gains and losses do not occur if exchange rates do not change. However, ifAHA12GAGGAGAGGAFFFFAFAFexchange rates change, the use of current and average rates causes translation gains and losses.These do not occur when the historical rate is used because the same (constant) rate is used eachperiod.4. In this example, the Mexican Affiliate s Canadian dollar loan is denominated in Canadian dollars.However, because the Mexican affiliate’s functional currency is U.S. dollars, the peso equivalentAHA12GAGGAGAGGAFFFFAFAFof the Canadian dollar borrowing would be remeasured in U.S. dollars prior to consolidation. Ifthe Mexican affiliate’s functional currency were the peso, the Canadian dollar loan would beremeasured in pesos before being translated to U.S. dollars.5. A transaction gain or loss occurs when a foreign currency transaction, e.g., a foreign currencyborrowing, is settled at a different exchange rate than that which prevailed when the transactionwas originally incurred. In this case there is an exchange of one currency for another. AAHA12GAGGAGAGGAFFFFAFAFtranslation gain or loss, on the other hand, is simply theresult of a restatement process. There isno physical exchange of currencies involved.6. It is not possible to combine, add, or subtract accounting measurements expressed in differentcurrencies; thus, it is necessary to translate those accounts that are measured or denominated in aforeign currency into a single reporting currency. Foreign currency translation can involverestatement or remeasurement. In restatement, the local (functional) currency is kept as the unitof measure; that is, the translation process multipliesthe financial results and relationships in theAHA12GAGGAGAGGAFFFFAFAFlocal currency accounts by a constant, the current rate.In contrast, remeasurement translateslocal currency results as if the underlying transactions had taken place in the reporting(functional) currency of the parent company; for example, it changes the unit of measure of aforeign subsidiary from its local (foreign) currency tothe U.S. dollar.7. Major advantages and limitations of each of the major translation methods follow.Current Rate MethodAdvantages:AHA12GAGGAGAGGAFFFFAFAFa. Retains the initial relationships in the foreign currency statements.b. Simple to apply.Limitations:a. Violates the basic purpose of consolidation, which is to present the results of a parent and its subsidiaries as if they were a single entity.b. Inconsistent with historical cost.c. Presumes that all local assets and liabilities are subject to exchange risk.d. While stockholders equity adjustments shield an MNC s bottom line from translation gains and losses, such adjustments could distort certain financial ratios and be confusing.AHA12GAGGAGAGGAFFFFAFAFCurrent-noncurrent MethodAdvantages:a. Distortions in translated gross margins are reduced as inventories and translated at the current rate.AHA12GAGGAGAGGAFFFFAFAFb. Reported earnings are shielded from the distorting effects of currency fluctuations as excess translation gains are deferred and used to offset future translation losses. Limitations:a. Uses balance sheet classification as basis for translation.b. Assumes all current assets are exposed to exchange risk regardless of their form.c. Assumes long-term debt is sheltered from exchange rate risk. Monetary-nonmonetary MethodAdvantages:a. Reflects changes in domestic currency equivalent of long-term debt on a timely basis.Limitations:AHA12GAGGAGAGGAFFFFAFAFa. Assumes that only monetary assets and liabilities are subject to exchange rate risk.b. Exchange rate changes distort profit margins as sales transacted at current prices are matched against cost of sales measured at historical prices.c. Uses balance sheet classification as basis for translation.d. Nonmonetary items stated at current market values are translated at historical rates.Temporal MethodAdvantages:a. Theoretically valid: compatible with any accounting measurement method.AHA12GAGGAGAGGAFFFFAFAFb. Has the effect of translating foreign subsidiaries operations as if they were originally transacted in the home currency, which is desirable for foreign operations that are extensions of the parent’s activities.Limitation:a. A company increases its earnings volatility by recognizing translation gains and losses currently.In arguing for one translation method over another, your students should eventually realize that, in the present state of the art, there is probably no one translation method that is appropriate for all circumstances in which translations occur and for all purposes thatAHA12GAGGAGAGGAFFFFAFAFtranslation serves. It is probably more fruitful to havestudents identify circumstances in which they think one translation method is more appropriate than another.8.The current rate method is appropriate when the foreignentity being consolidated is largely independent of the parent company. Conditions which would justify thismethodology is when the foreign affiliate tends togenerate and expend cash flows in the local currency,sells a product locally so that its selling price islargely insulated from exchange rate changes, incursexpenses locally, finances its self locally and does not have very many transactions with the parent company. Incontrast, the temporal method seems appropriate in thoseAHA12GAGGAGAGGAFFFFAFAFinstances when the foreign affiliate’s operations are integrally related to the parent company. Conditions which would justify use of the temporal method are when the foreign affiliate transacts business in the parent currency and remits such cash flows to the parent company, sells a product largely in the parent country and whose selling price is sensitive to exchange rate changes, sources its factor inputs from the parent company, receives most of its financing from the parent and has a large two way flow of transactions with it.AHA12GAGGAGAGGAFFFFAFAF9.The history of foreign currency translation in the UnitedStates suggests that the development ofaccounting principles does not depend on theoretical considerations so much as on political,institutional, and economic influences that affect accounting standard setting. It may be morerealistic to recognize that theoretically sound solutions are impossible as long as policyprescriptions are evaluated on practical grounds. Without specific choice criteria derived frominvestor decision models, it is fruitless to argue the conceptual merits of competing accountingAHA12GAGGAGAGGAFFFFAFAFtreatments. It is far more productive to admit that foreign currency translation choices are simplyarbitrary.Readers of consolidated financial statements should know that the foreign currency translationmethod used is one of several alternatives, and this should be disclosed. This approach is moreopen and reduces the chance that readers will draw misleading inferences.10.Foreign inflation, in particular, the differential rate ofinflation between the country in which a subsidiary islocated and the country of its parent determines foreignAHA12GAGGAGAGGAFFFFAFAFexchange rates. These rates, in turn, are used totranslate foreign currency balances to parent currency. 11.In the United Kingdom, financial statements of affiliatesdomiciled in hyperinflationary environments must first be adjusted to current price levels and then translated using the current rate; in the United States, the temporalmethod would be employed. The second part of thisquestion is designed to get students from abroad to find out what companies in their home countries are doing and thereby be in a position to share their new foundknowledge with their classmates. They need simply get on the internet and read the footnotes of a majormultinational company in their home country.AHA12GAGGAGAGGAFFFFAFAF12.Under FAS No. 52, the parent currency is designated as thefunctional currency for an affiliate, whose operations are considered to be an integral part of the parent company’s operations.Accordingly, anything that affects consolidated earnings, including foreign currency translationgains and losses, is relevant to parent company shareholders and is included in reported earnings.In contrast, when a foreign affiliate s operations are independent of the parent s, the localcurrency is designated as its functional currency. Since the focus is on the affiliate s localAHA12GAGGAGAGGAFFFFAFAFperformance, translation gains and losses that arise solely from consolidation are irrelevant and, therefore, are not included in consolidated income.AHA12GAGGAGAGGAFFFFAFAFExercises Solutions1.¥250,000,000 X .008557 = $2,139,250.¥250,000,000 ÷ ¥116.86 = $2, 139,312 The difference is due to rounding.2.Since £ 1 = US$1.9590 and €1 = US$1.3256, £1 =US$1.9590/US$1.3256 = €1.4778.Alternatively, €1 = US$1.3256/US$1.9590 = £.6767.3.Single Transaction Perspective:4/1 Purchases (¥32,500,000/¥116.91)$277,992Cash $27,800AHA12GAGGAGAGGAFFFFAFAFA/P(¥32,500,000 - ¥3,250,000)/¥116.91250,192(Credit purchase)7/1 Purchases[(¥29,250,000/¥116.91) –(¥29,250,000/¥115.47) 3,120A/P 3,120(To record increase in purchases due to yen appreciation) 7/1 Interest expense(¥29,250,000 X .08 X3/12)/¥115.47 5,066A/P(¥29,250,000/¥115.47)253,312Cash 258,378AHA12GAGGAGAGGAFFFFAFAF(To record settlement)Two Transactions Perspective:4/1 Purchases $277,992Cash $27,800A/P 250,192 7/1 Transaction loss 3,120 A/P 3,120 7/1 Interest expense 5,066 A/P 253,312Cash 258,3784. a. MXN 1,750,000/MXN10.3 = C$169,903.AHA12GAGGAGAGGAFFFFAFAFb. The Canadian dollar equivalent of the Mexican inventory account would not change if the functional currency was the Canadian dollar as the temporal method translates inventory, a nonmonetary asset, at the exchange rate that preserves its original measurement basis. Since inventory is being carried at its net realizable value, it would be translated at the current rate. Had inventory been carried at historical cosuld have been translated at the historical rate or MXN3,750,000/MXN9.3 = C$403,226.AHA12GAGGAGAGGAFFFFAFAF5. Baht is the functional currency:B 2,500,000/20 years = B 125,000B 125,000/B37 = 3,378B 5,000,000/20 years = B 250,000B 250,000/B37 = 6,757U.S. dollar is the functional currency:B 2,500,000/20 years = B 125,000B 125,000/B40 = 3,125B 5,000,000/20 years = B 250,000B 250,000/B38 = 6,579Total depreciation $ 9,704AHA12GAGGAGAGGAFFFFAFAF6. If the euro is the German subsidiary’s f unctionalcurrency, its accounts would be translated into Australian dollars using the current rate method. In this case the translation gain of AUD4,545,455 would appear inconsolidated equity. Thus the only item affecting current income would be the transaction loss(loss on an unsettled transaction) of AUD1,514,515 on the euro borrowing.If the Australian dollar is deemed to be the functional currency, then the transaction loss andtranslation gain would both appear in reported earnings as follows:AUD(1,514,515) transaction lossAUD4,545,455 translation gainAHA12GAGGAGAGGAFFFFAFAFAUD3,030,940 net foreign exchangegain7.U.S. Dollar U.S. Dollar U.S. DollarBefore CNY After CNY After CNYAppreciation Appreciation DepreciationCNY Balance Sheet ($.12=CNY1) ($.15 = CNY1) ($0.09 = CNY1)Assets Amount Current Monetary Current MonetaryNoncurrent Nonmonetary NoncurrentNonmonetaryAHA12GAGGAGAGGAFFFFAFAFCash NT5,000 $600 $ 750 $ 750$ 450 $ 450Accts. Receivable 14,000 1,680 2,100 2,100 1,260 1,260Inventories(cost=24,000) 22,000 2,640 3,3002,640 1,980 2,640Fixed assets, net 39,000 4,680 4,680 4,680 4,680 4,680Total CNY 80,000 $9,600 $10,830 $10,170 $8,370 $9,030AHA12GAGGAGAGGAFFFFAFAFLiabilities & Owners EquityAccts. Payable CNY21,000 $2,520$ 3,150 $ 3,150 $1,890 $1,890Long-term debt 27,000 3,2403,240 4,050 3,240 2,430Stockholders equity 32,000 3,8404,440 2,970 3,240 4,710Total CNY 80,000 $9,600$10,830 $10,170 $8,370 $9,030Accounting exposure CNY20,000 (29,000) 20,000 (29,000)AHA12GAGGAGAGGAFFFFAFAFTranslation gain (loss) US$ 600 (870) (600) 8708.U.S. Dollar U.S. Dollar U.S. DollarBefore CNY After CNY After CNYAppreciation Appreciation Depreciation CNY Balance Sheet ($.12=CNY1) ($.15 = CNY1) ($.09 = CNY1)Assets Amount Temporal Current Temporal CurrentCash CNY5,000 $ 600 $ 750 $ 750 $ 450 $ 450AHA12GAGGAGAGGAFFFFAFAFAccts. Receivable 14,000 1,680 2,1002,100 1,260 1,260Inventories(cost=24,000) 22,000 2,640 3,3003,300 1,980 1,980Fixed assets, net 39,000 3,6003,600 5,850 3,600 3,510Total CNY 80,000 $8,520 $9,750 $12,000 $11,700 $7,200Liabilities & Owners EquityAHA12GAGGAGAGGAFFFFAFAFAccts. Payable CNY21,000 $2,520$3,150 $3,150 $1,890 $1,890Long-term debt 27,000 3,240 4,0504,050 2,430 2,430Stockholders equity 32,000 2,760 2,550 4,800 7,380 2,880Total NT$ 80,000 $8,520 $9,750 $12,000 $11,700 $7,200Accounting exposure NT$ (7,000)32,000 (7,000) 32,000AHA12GAGGAGAGGAFFFFAFAFTranslation gain (loss)US$ (210) 960 210(960)c. Students will quickly discover that each translation method has its advantages and disadvantages. After some discussion, the question of translation objectives will arise. Currency translation objectives are based on how foreign operations are viewed. If foreign operations are considered extensions of the parent, a case can be made for a historical rate method: current-noncurrent, monetary-nonmonetary, or temporal. If foreign operations are viewed from a local company perspective, a case can be made for the current rate method. Given theAHA12GAGGAGAGGAFFFFAFAFcomplexity of multinational business activities, one could argue that a single translation method will not serve all purposes for which translations are done. As long as the objectives of foreign currency translation differ among specific reporting entities, a practical solution is to insist on full disclosure of the translation procedures used so that users have a basis for reconciling any differences that exist. 9.AHA12GAGGAGAGGAFFFFAFAFCompany A (Country A)(Reporting Currency = Apeso)Beginning of Year End of Year Assets: Exchange Rate Translated Exchange Rate TranslatedApeso 100 Apeso 100 Apeso 100 Bol 100 Apeso 1 = Bol 1.25 Apeso 80 Apeso 1 = Bol 2 Apeso 50Apeso 180 Apeso 150 Translation loss = A$ 30Company B (Country B)(Reporting Currency = Bol)AHA12GAGGAGAGGAFFFFAFAFBeginning of Year End of Year Assets: Exchange Rate Translated Exchange Rate TranslatedApeso 100 Apeso 1 = Bol 1.25 Bol 125 Apeso 1 = Bol 2 Bol 200Bol 100 Bol 100 Bol 100Bol 225 Bol 300 Translation gain = Bol 75b. This exercise demonstrates the effect of the reporting currency on foreign currency translation results when the current rate method is used. Both companies are in seemingly identical situations, yet one reports a translation loss whileAHA12GAGGAGAGGAFFFFAFAFthe other reports a translation gain. One company reports shrinking assets while the other reports increasing assets. Nothing has actually happened but an exchange rate change. Also, despite a stronger Apeso, Company A reports a loss. Conversely, the Bol weakened, yet Company B reports a gain. It appears that a strengthening currency is not always good news, nor is a weakening currency always bad news.If the intention is to repatriate the funds invested in the foreign country (Country B from Company A’s perspective, Country A from Company B’s perspective), the scenario makes sense. After all, Company A will be repatriating fewer Apesos than originally invested and Company B will be repatriating more B ol’s than originally invested. Fluctuating exchangeAHA12GAGGAGAGGAFFFFAFAFrates have changed each company s command over a foreign currency. Assuming the company intends to repatriate the currency, it makes sense toinclude the respective gain or loss in income for the current year. On the other hand it can be argued that the gain or loss should be excluded from income if the company intends to keep the foreign assets invested permanently..10.AHA12GAGGAGAGGAFFFFAFAFTranslation RateLocal Currency is Dollar isFunctional Currency FunctionalCurrencyCash Current Current Marketable securities (cost)CurrentHistorical aAccounts receivable Current Current Inventory (market) Current Current Equipment Current Historical Accumulated depreciation CurrentHistoricalAHA12GAGGAGAGGAFFFFAFAFPrepaid expenses CurrentHistoricalGoodwill Current Historical Accounts payable Current Current Due to parent (denominated in dollars) Current CurrentBonds payable Current Current Income taxes payable Current Current Deferred income taxes Current Current Common stock Historical Historical Premium on common stock HistoricalHistoricalAHA12GAGGAGAGGAFFFFAFAFRetained Earnings Balancing Residual Balancing ResidualSales Average Average Purchases Average Average Cost of Sales Average Historical General and administrative expenses AverageAverageSelling expenses AverageHistoricalDepreciation Average Historical Amortization of goodwill AverageHistoricalIncome tax expense Average AverageAHA12GAGGAGAGGAFFFFAFAFInter-company interest expense AverageAverage__________________________________________________________________________________________________________________________a Fixed income securities intended to be held to maturity.11. a. Before riyal depreciation:Cash SAR 60,000,000 ÷ SAR3.75 = $ 16,000,000Inventory 120,000,000 ÷ SAR3.75 = 32,000,000Fixed Assets 750,000,000 ÷ SAR3.75 = 200,000,000AHA12GAGGAGAGGAFFFFAFAFTotal $248,000,000 After riyal depreciation:AHA12GAGGAGAGGAFFFFAFAFCash SAR 60,000,000 ÷ SAR4.125 = $ 14,545,455Inventory 120,000,000 ÷ SAR3.75 = 32,000,000Fixed Assets 750,000,000 ÷ SAR3.75 = 200,000,000Total $246,545,455 Translation loss $(1,454,455) b.The translation loss has no effect on MSC’s cash flowsas it is the result of a restatement process.c.On a pre-tax basis, an analyst would back out thetranslation gain from reported earnings and add it toAHA12GAGGAGAGGAFFFFAFAFconsolidated equity. However, in addition inventory andfixed assets would be translated at the current rate, as opposed to the historical rate, and the resultingtranslation loss would also be taken to consolidatedequity. This would result in a different earnings number as well as asset measures.Before riyal depreciation:Cash SAR 60,000,000 ÷ SAR3.75 = $ 16,000,000Inventory 120,000,000 ÷ SAR3.75 = 32,000,000Fixed Assets 750,000,000 ÷SAR3.75 = 200,000,000AHA12GAGGAGAGGAFFFFAFAFTotal $248,000,000 After riyal depreciation:Cash SAR 60,000,000 ÷ SAR4.125 = $ 14,545,455Inventory 120,000,000 ÷ SAR4.125 = 29,090,909Fixed Assets 750,000,000 ÷ SAR4.125 = 181,818,182Total $225,454,546 Translation adjustnment reflected in equity$(22,545,454)AHA12GAGGAGAGGAFFFFAFAFStudents could also be probed and asked how the adjusted numbers would impact certain ratios such as ROA or ROE, Debt to Equity, and asset turnover.12. a. The currency effects in the first and thirdparagraphs have an impact on Alcan’s cash flows. IN the first paragraph, echange rate changes affect Alcan’s future revenues and costs and directly affect cash receipts and payments. The third paragraph involves settling foreign currency transactions at a different echange rate than when the transaction were entered into.b. Alcan appears to be employing the monetary-nonmonetarymethod.AHA12GAGGAGAGGAFFFFAFAFc. Many analysts back out translation gains and losses from reported earnings as these are largely non-cash items that simply result from a restatement process. This would especially be the case if Alcan were being compared to a company employing the current rate method. Disregarding translation gains and losses would have the following effect on reported earnings:20X5 20X4 20X3With translation G/L $129m $258m $64m Translation G/L (86) (153)(326)Without Translation G/L $215m $411m$390mAHA12GAGGAGAGGAFFFFAFAFThe impact on the pattern of earnings would changesignificantly. The year to year changes in earnings both before and after abstracting from currency translationeffects are:20X5/20X3 20X5/20X4 20X4/20X3 With translation G/L 102% -50% 303%Without Translation G/L 45% -48%5%Case 6-1 Regents CorporationAHA12GAGGAGAGGAFFFFAFAFThe nature of Regents’s operation is such that choice of an appropriate functional currency is ultimately a judgement call. Students can argue for either currency and should be evaluated on the strength of their analysis. A major lesson of this case is that the functional currency choice is important since the currency designation dictates which translation method, (current or temporal) is ultimately used. The financial statement effects can be very different. Thus it is important for a reader of financial statements to understand how the differing measurement options affect the balance sheet and income statement and be prepared to adjust from one frameworkto the other, even if only crudely.AHA12GAGGAGAGGAFFFFAFAF。

Chapter 11Financial Risk ManagementDiscussion Questions1.Enterprise risk management assesses individual risks in the context of a firm’s business strategy. Risksare viewed from a portfolio perspective with risks of various business functions, e.g., FX risk, interest rate risk, political risk and the like, being coordinated by a senior financial manager responsible for keeping top management apprised of critical risks that could interfere with the accomplishment of a firm’sstrategic objectives and devising risk optimization strategies. The variables that management accountants must track include factors both external and internal to the firm and varies from company to company.2.Market risk refers to the risk of loss due to unexpected changes in the prices of currencies, interest rates,commodities, and equities. It is not confined to price changes. Market risk also includes liquidity risk, market discontinuities, credit risk, regulatory risk, tax risk, and accounting risk. An example of a foreign exchange risk is a situation where an exporter invoices a credit sale to a foreign importer in foreign currency and foreign currency devalues prior to payment.3.An FX risk management program includes the following processes:a.Forecasting the expected movement in the relation between the yuan and your domesticcurrency.b.Measuring on a periodic basis your firm’s exposure to fluctuations in the value of the yuan.c.Designing protection strategies that will minimize losses should the yuan revalue.d.Establishing internal controls to measure your performance in hedging the risk of loss fromchanges in the value of the yuan.4.Translation exposure measures the impact of exchange rate changes on the domestic currency equivalentsof a firm s foreign currency assets and liabilities. It is primarily concerned with currency restatement.Transaction exposure measures the cash flow impact of fluctuating currency values on the settlement of commercial transactions denominated in foreign currencies. Transaction exposure is concerned with acurrency conversion (exchange) process. Economic exposure attempts to measure the impact of changing exchange rates on the future revenues, costs, and sales volume of a multinational entity. It is concerned with the temporal effects of exchange rate changes.Although FAS No. 52 attempts to mitigate concern with translation gains and losses (accounting exposure), it does not totally eliminate it. Companies choosing the U.S. dollar as their functional currency will still use the temporal translation method and report translation gains and losses in period income. Companies designating the local currency as the functional currency will find their asset exposures increased as inventories and fixed assets are translated using current exchange rates. While such translation gains and losses bypass income, the adverse effects of currency fluctuations on a company’s consolidated equity will still exist. This is especially likely where loan covenant and other contractual provisions specify minimum debt-to-equity ratios. This suggests that the issue of accounting versus economic exposure is far from settled.5.The chapter lists 10 specific methods to reduce a firm’s exposure to foreign exchange risk in adevaluation-prone country. These techniques, and possible cost-benefit trade-offs, are summarized in the following table.Methods Trade-Offsa. Minimize cash balances in a. Reduced exposure versusdevaluation-prone country higher business andfinancial risk due to possible "cash-outs."b. Remitting excess cash back b. Same as item a.to the parent company.c. Accelerate the collection c. Reduced exposure versusof local currency receivables possible reduction in salesd. Defer payment of local d. Reduced exposure versuscurrency payables impaired local credit ratinge. Speed up payment of e. Reduced exposure versusforeign currency payables foregone earnings on arelatively cheap creditsourcef. Invest local currency cash f. Reduced exposure versusbalances in inventories and higher transaction costsother assets less prone to and possible mis-devaluation loss allocation of corporateresourcesg. Invest in strong currency g. Reduced exposure versusforeign assets higher transaction costsand possible governmentinterference (e.g.exchange controls)h. Raise selling prices h. Reduced exposure versuspotential erosion ofmarket sharei. Invoice exports in hard i. Reduced exposure versuscurrencies possible reduction insales abroadj. Currency swaps j. Reduced translationexposure versus increasedtransaction exposure ifparent assesses theexposed affiliate aninterest charge in hardcurrency6. A multicurrency transactions exposure report differs from a multicurrency translation exposure report in anumber of ways. First, the transactions exposure report has a cash flow orientation instead of a static balance sheet orientation. It includes off balance sheet items that are executory in nature. Finally, a multicurrency transaction exposure report has a local currency orientation, whereas a multicurrency translation exposure report has a parent currency orientation.7.Derivative instruments are formal agreements that transfer financial risk from one party to another. Thevalue of a derivative is derived from its reference to a basic underlying instrument or variable such as a foreign currency receivable or a quantum of foreign exchange. Thus the value of a forward exchange contract is related to the change in the foreign exchange rate times the notional amount being hedged. An important accounting issue is whether derivatives should receive the same accounting treatment as the basic instruments to which they relate. Specifically, should a derivative instrument hedging a foreign currency asset appear in the financial statements as a foreign currency liability? If so, should its valuation base be identical to basic instruments? Do cash flows associated with derivative instruments have thesame economic meaning as those associated with basic instruments? How should gains and losses associated with derivative instruments be reflected in the income statement? Can and should risks attaching to these financial instruments be recognized and measured?8.Student responses should proceed along the following lines. Pele Corporation, a Brazilian firm, hasborrowed a certain sum of British pounds at 9 percent and is worried that the pound will appreciate relative to the real prior to maturity. To hedge this currency risk, it arranges with a bank to swap the pounds borrowed for an equivalent amount of reals for 3 years bearing the same rate of interest. During the 3-year period, it will make periodic interest payments to the bank in reals, and in return, receive periodic interest payments in pounds. At the end of the 3-year period, it will re-exchange the real principal for pounds at the original exchange rate.9. A futures contract is a commitment to purchase or deliver a specified quantity of a financial instrument orforeign currency at a future date at a price set when the contract is made. It differs from a forward contract in several respects. A futures contract is standardized in terms of size and delivery date whereas a forward contract is tailored to a customer’s needs. Futures contracts are freely traded on organized exchanges. In contrast, there is no secondary market for forward contracts as they are private agreements between two parties. Futures contracts are carried at market values with gains or losses taken immediately to income, whereas profits on a forward contract are realized only at the delivery date. Finally, a party to a futures contract must meet periodic margin requirements. In a forward contract, margins are set once, on the date of the initial transaction.10.Fair value hedges are hedges of a firm’s foreign currency assets and liabilities and firm fore ign currencycommitments. Cash flow hedges are hedges of forecasted transactions such as a future sale or purchase.Net investment hedges are hedges of an exposed balance sheet asset or liability position. For qualifying fair value hedges, all changes in the fair value of the derivative and the underlying item that is being hedged are recognized in earnings. For qualifying cash flow hedges, the change in the fair value of the derivative is recognized in Other Comprehensive Income and recognized in earnings when the hedged cash flows affect earnings. For qualifying hedges of a net investment, changes in the fair value of the derivative are recorded in comprehensive income11.In theory, the term highly effective means that gains or losses on hedging instruments should be shouldexactly offset gains or losses on the item being hedged. In practice, it means that gains or losses on the derivative substantially offset the changes in the value or cash flow of the hedged item. Measurement of this attribute is important. If a hedging instrument does not meet the highly effective test, the hedge is terminated and deferred gains or losses on the derivative are recognized immediately in current earnings.This, in turn, introduces volatility into a firm’s reporte d earnings.12.The notion of an opportunity cost refers to the return associated with your next best opportunity. In thearea of FX risk management, it entails comparing a given risk management strategy with an appropriate standard of comparison. This provides an objective means of assessing the effectiveness of a given risk reduction program. For example, when FX risk management programs are centralized at corporate headquarters, appropriate benchmarks against which to compare the success of corporate risk protection would be programs that local managers could have implemented on their own.Exercises1.Students usually gloss over diagrams without thinking them through. This exercise forces them to thinkthrough each step of the diagram and allows them to better internalize the risk management cycle.Responses might follow the following pattern: Step 1 involves operationalizing a firms strategies intoquantifiable objectives and then identifying developments both external and internal risks that could affect the achievement of these objectives. These risks are measured by the firm’s accountants and quantified in terms of their potential impact on the firm. For example, the firm may have as its strategic objective an increase of 5% of market share in a given country per year given assumptions about the rate of economic growth in that country. The chance that this growth rate may fall short of 5% and the impact of this shortfall for projected sales in that country would be quantified. Response formulation would involve identifying protection strategies to minimize the hit to sales of projected GNP shortfalls such as promotion campaigns to maintain sales or use of alternative sourcing venues to lower sales prices. This strategy would be implemented if projected GNP started to slow beyond a certain cutoff point. The impact of this protection strategy would then be quantified in terms of actual sales relative to forecast sales taking into account the costs of protection. The information contained in risk management performance reports would then be communicated to top management who would be in a position to reaffirm or alter strategic objectives and/or risk identification processes.2.Foreign exchange risk a devaluation of the foreign currency in which an account receivable wasdenominated would cause the domestic currency cash flows to decrease. This would cause current assets to decrease. Alternatively, a revaluation of the foreign currency would cause the account receivable and current assets to increase. Interest rate risk an increase in market rates of interest would cause the price ofa short-term fixed-rate debt instrument being held as a marketable security to decrease. This, in turn,would cause current assets to decrease. A decrease in interest rates would have the opposite effect.Commodity price risk an increase in the price of copper would cause the cost of copper purchases and the resultant unexpired cost of inventories in the current asset section of the balance sheet to increase. A fall in copper prices would have the opposite effect. Equity price risk a fall in stock prices would depress the carrying value of marketable securities (current assets), and conversely.3.The purpose of this exercise is to force students to look at manager ial accounting issues from the user’sperspective. Students may suggest additional information sources with respect to inflation differentials, balance of trade and balance of payments statistics, international monetary reserves, forward exchange quotations, the behavior of related currencies, and interest rate differentials. We recommend that this exercise be assigned to small groups to encourage teamwork. At the time this exercise was prepared, professional forecasters were predicting a rate of 10.5 ecrus to theU.S. dollar.Some groups may contend that exchange markets are efficient and that exchange rate changes are simply random events. Again, they must be prepared to convince management of their case, or at a minimum, identify the consequences of not attempting exchange rate forecasts.4. Current rate Current/Noncurrent Monetary/nonmonetaryExposed assets(PHP):Cash 500,000 500,000 500,000Accounts receivable 1,000,000 1,000,000 1,000,000 Inventories(LCM) 900,000 900,000Fixed assets 1,100,000 -- --Total 3,500,000 2,400,000 1,500,000 Exposed liabilities:Short-term payables 400,000 400,000 400,000Long-term debt 800,000 --- 800,000Total 1,200,000 400,000 1,200,000Positive/(negative) exposure 2,300,000 2,000,000 300,000 Positive exposure X $0.03 $69,000 $60,000 $9,000Positive exposure X $0.02 46,000 40,000 6,000 FX gain/(loss) $(23,000) $(20,000) $(3,000)5.ILS $ £$ EquivalentExposed Assets:Cash & due from banks 100,000 50,000 (40,000) 20,000Loans 200,000 ---- ---- 100,000Fixed assets ---- 30,000 ---- 30,000Exposed Liabilities:Deposits 40,000 ---- 15,000 50,000Owners equity ---- 100,000 ---- 100,000Net exposed assets 260,000 (20,000) (55,000) NIL(liabilities)ILS $ £$ EquivalentExposed Assets:Cash & due from banks 100,000 50,000 (40,000) 20,000Loans 200,000 ---- ---- 100,000Fixed assets ---- 30,000 ---- 30,000Exposed Liabilities:Deposits 40,000 ---- 15,000 50,000Owners equity ---- 100,000 ---- 100,000Net exposed assets 260,000 (20,000) (55,000) NIL(liabilities)6.Trial Balance BeforeILS $ £$ EquivalentCash & due from banks 100,000 50,000 (40,000) 20,000Loans 200,000 ---- ---- 100,000Fixed assets ---- 30,000 ---- 30,000Deposits 40,000 ---- 15,000 50,000 Owners equity ---- 100,000 ---- 100,000Trial Balance After(£/$/ILS = 1/2/8)ILS $ £$ EquivalentCash & due from banks 100,000 50,000 (40,000) (5,000)Loans 200,000 ---- ---- 50,000Fixed assets ---- 30,000 ---- 30,000Deposits 40,000 ---- 15,000 40,000 Owners equity ---- 100,000 ---- 100,000Translation loss $(65,000)7. One recommendation might be to reduce positive exposures by engaging in balance sheet hedging, that is, by remitting excess cash back to the corporate parent, reducing the affiliate bank’s outstanding loans, or increasing its deposits in Israeli shekels.. The trade-offs here are potentially negative effects on operations, such as not satisfying loan demand against hedging translation gains and losses. Another option is to increase the pricing of bank services in Israel to provide a profit margin that can offset any FX losses. Again, the effects of such actions on competitive positioning could far exceed the benefits of hedging. A third option is to buy a forward or currency swap to hedge the exposure. Trade-offs include the out-of-pocket cost of the exchange contract versus the reported losses avoided.1.If the U.S. dollar is the functional currency, the translation gain upon consolidation is aggregated with thetransaction loss on the foreign currency borrowing and disclosed as one line item in the consolidated income statement. This figure is determined as follows:Translation gain = Positive exposure X change in exchange rate= NZD3,000,000 x $.10= $300,000Transaction loss =NZD loan balance X change in exchange rate= NZD1,000,000 x $.10= $ (100,000)Aggregate exchange adjustment = $300,000 + $ (100,000)= $200,000If the New Zealand dollar is the functional currency, the translation gain upon consolidation bypasses income and appears as a separate component in consolidated equity. It is offset by the translation loss on the New Zealand dollar borrowing.9.4/1 CD (¥32,500,000 ÷ ¥120) $250,000Cash $250,000(Purchase of CD)Chips (¥32,500,000 ÷ ¥120) $270,833Cash (¥3,250,000 ÷ ¥120) $ 27,083A/P (¥29,250,000 ÷ ¥120) 243,750(To record credit purchase)7/1 CD (¥30,000,000 ÷ [¥120 - ¥110]) $ 22,727FX gain $ 22,727(To record gain on CD investment)Purchases (¥29,250,000 ÷ [¥120 - ¥110]) 22,159Accts. Payable 22,159(To record increase in purchases and related liability accounts owing to yen appreciation) 7/1 Cash (¥30,000,000 ÷ ¥110) $278,182Interest income (¥30,000,000 X .08 X ¼) ÷ ¥110] $ 5,455CD 272,727(To record maturation of CD)Interest expense [(¥29,250,000 x.08 x 3/12) ÷ ¥110) 5,318Accts. payable (¥29,250,000 ÷ ¥110) 265,909Cash 271,227(To record settlement of purchase transaction)10. Journal entries:6/1 CHF Contract receivable $133,333Deferred premium 3,334$ Contract payable $136,667(To record contract with the foreign currency dealer to exchange $136,667 for CHF 166,667)6/30 CHF Contract receivable 1,667Transaction gain 1,667(To record transaction gain from increased dollar equivalent of forward contract receivable; $.81 - $.80 x SWF 166,667)6/30 Premium expense 1,111Deferred premium 1,111(To amortize deferred premium for 1 month)9/1 SWCHF Contract receivable 3,333Transaction gain 3,333(To record additional transaction gain by adjusting forward contract to the new current rate; $.83 - $.81 x CHF 166,667)9/1 Premium expense 2,223Deferred premium 2,223(Amortization of deferred premium balance)9/1 $ Contract payable 136,667Cash 136,667 Foreign currency 138,333CHF Contract receivable 138,333(To record delivery of $136,667 to foreign currency dealer in exchange for CHF166,667 with a dollar equivalent of $138,334 (=CHF166,667 x $.83). The Swiss francs will, in turn be used to pay for the chocolate supplies).11. Calculations:If the premium on the forward contract is considered an operating expense, and the conditions for hedge treatment are met, i.e., management designates the forward contract as a hedge, documents its risk management objective and strategy, identifies the hedging instrument, the item being hedged and the risk exposure, and that the forward is effective both prospectively and retrospectively in hedging the risk, the gain on the forward can be offset against the loss on the payable as follows:Amount paid to settle the account payable on the purchase $138,333Less Transaction gain on forward contract (5,000)Cost of purchase $133,333The $133,000 is what was originally anticipated, CHF166.667 X $0.80 = $133,333.12. Journal entries:The call option is intended to hedge an uncertain cash flow. Accordingly, gains or losses on the hedging instrument would bedisclosed in comprehensive income and reclassified into earnings in the period the sale actually takes place.June 1 Premium expense $28,125Cash $28,125($.018 X CHF 62,500 X 25)August 31 Cash $40,625Comprehensive income $40,625[($.416 - $.39) X CHF 62,500 X 25]Case 11-1Exposure Identification1. Infosys appears to have several exposures as enumerated below.Foreign Exchange RiskPage Value-Drivers88 Revenues/Selling and administrative expenses89 Cash flows from interest/dividend income96 Revenue recognition/LT leases97 Operating income/foreign currency transactions/FA98 Marketing/Overseas staff expenses99 Derivative values100 Lease obligations101 Investment returns102 Segment revenues/expenses103 Dividends to ADS holders142 Penalties on export obligations149 Valuing intangibles150 Export revenuesCommodity Price RiskPage Value-Drivers98 Power and fuel expenses145 Brand valuation147/48 Current cost disclosures149 Value of intangiblesEquity Price RiskPage Value Drivers87 Share capital98 Diluted eps100 Stock option compensation expense103 Convertible preferreds145 Cost of capital151 Economic value-addedInterest Rate RiskPage Value Drivers88 Interest expense89 Cash flows from security investments/interest income97 Gratuity/Superannuation/Provident obligations143 Employee compensation145 Cost of capital149 Value of intangibles.151 Economic value-addedInformation on the company’s risk management policies are contained on pages 108-109 of their annual report which were not reproduced in Chapter 1. We include the relevant information here. Infosys derives its revenues from 51 countries of which 78 percent were denominated in US dollars. To minimize both transaction and translation risk the company:1.Tries to match expenses in local currency with receipts in the same currency.es forward exchange contracts to cover apportion of outstanding receivables.3.Denominates contracts in non-US and non-EU regions in internationally tradable currencies to minimizeexposures to local currencies that may have non-tradability risks.Case 11-2Value At Risk: What Are Our Options?Students should be asked to play the role of the consultant, and will find it to be a contentious issue. Suggested remedies that have merit are:1. The FASB should permit deferral accounting for rolling options which would take the derivative gain or loss on each option to equity until the anticipated event occurs, as opposed to taking it immediately to income. This, however, might encourage companies to game the system, so students should also suggest ways to keep this from happening.2. Another tack would be to adhere to generally accepted accounting principles and record the gain or loss on the derivative in current income as it is marked to market, but to disclose which transactions were undertaken for hedge purposes. Management could also game the system here as speculative activities could be disclosed as hedge activities.3. Another option that students might suggest is to revert back to the earlier U.S. practice of keeping the option off balance sheet and providing supplementary disclosure of mark-to-market accounting. This might be confusing to lay readers, but it would enable analysts to better understand the components of reported earnings.It is clear from the annual report clipping that management will ignore accounting pronouncements when it is in their interest to do so. Analysts must be alert to situations where management departs from GAAP to better reflect the economics of what transpired as opposed to doing so to manage earnings.精品文档，知识共享！！！。