ACCOUNTING- Translation and Performance Evaluation: Management compensation

QUESTION

International
Accounting Issues
LE 4.1

1.
Translation and Performance Evaluation: Management compensation is often based on
reported profits. What profit
measurement is appropriate for top management to use in judging the performance
of a U.S. Company’s foreign subsidiary?
Consider a Dutch subsidiary that reported the following results in euros
for 2012 and 2011.

in thousands

2012

2011

Sales

€2,400

€2,000

Cost of Sales

€1,320

€1,200

Gross Margin

€1,080

€800

Other operating expenses

€230

€200

Profit before taxes

€850

€600

Income tax expense

€255

€180

Net Income

€595

€420

Average exchange rate: $1.10/€ for
2012. $1.20/€ for 2011. Composite historical rates relating to cost of sales
and other operating expenses (including depreciation): $1.12/€ for 2012,
$1.23/€ for 2011.

Required:
a.
Prepare a
schedule showing the Dutch subsidiary’s income statement for 2011 and 2012 in
euros and in dollars, using both the current rate and temporal methods. Compute the percentage change in income in
each case.
b.
Comment on the comparability of the translated
income statements, focusing on the impact of the change in dollar value of the
euro. Compute the ratios of net
income/sales using the Euro statements and the dollar financial
statements. How could you adjust the
translated statements to enhance comparability?
Show computations and comment on the results.
c.
Comment on the impact of the euro weakening vs
the euro strengthening in subsequent years.
What will be the impact on the parent company?

2.
Murdock
Company has a Spanish Subsidiary whose functional currency is the euro. Relevant translated data for the subsidiary
appear below.

Date or annual period

Total Assets

Operating Income

Exchange Rate

1/1/2011

$105,000,000

$1.40/€

2011

$12,000,000

$1.20/€

12/31/2011

90,000,000

$1.00/€

2012

10,890,000

$.90/€

12/31/2012

90,000,000

$1.00/€

Required:
a.
Calculate the return on assets for 2011 and 2012
using both translated ($) and euro data.
b.
Explain whether translation has distorted the
Spanish subsidiary’s performance in 2012 compared with 2011. If so, explain how changes in the exchange
rate contributed to the distortion.

3.
Referring
to WalMart’s 2012 annual report:
a.
What is
the functional currency of their foreign subsidiaries?
b.
On
average, did the US dollar strengthen or weaken against the currencies of WalMart’s
subsidiaries from 2010 to 2011? From
2011 to 2012?
c.
What is WalMart’s hedging strategy and has it
been successful in that same time period.
d.
What percent of Walmart’s income is
international?
e.
Referring to Bayer AG’s annual report (use the
interactive version online at .annualreport2011.bayer.com/”>http://www.annualreport2011.bayer.com
or the pdf located in course documents) which is prepared under IFRS: Compare Bayer’s disclosure under IFRS and
treatment of foreign currency and derivatives to Walmart’s under GAAP. What was the gain or loss due to differences
in translation of operations outside the euro zone for 2011? What was the gain or loss from derivate
hedging transactions?

4.
Fine
Foods Inc, a US wholesaler, buys merchandise from suppliers in Germany and pays
the suppliers in euros. It also sells
merchandise to customers in Italy, and receives payment in euros. Fine Foods’ accounting year ends June 30. Exchange rates are as follows:

Date

Spot rate ($/€)

1-Mar-11

1.55

1-Apr-11

1.6

30-Jun-11

1.62

1-Jul-11

1.63

15-Aug-11

1.65

31-Aug-11

1.68

Purchases
of € 1,000,000 are made on March 1, 2011.
Fine Foods pays its German suppliers on August 15, 2011, and sells the
merchandise to its US customers on August 31, 2011. Sales of € 100,000 are made on April 1,
2011. Fine Foods receives payment from
its Italian customers on July 15, 2011.

Required:
What amounts will appear on the financial
statements of Fine Foods for:

a.
Accounts
payable, on the June 30, 2011, balance sheet?
b.
Accounts receivable on the June 30, 2011 balance
sheet?
c.
Exchange gain or loss, on the fiscal 2011 income
statement?
d.
Exchange gain or loss on the fiscal 2012 income
statement?
e.
Sales revenue, on the fiscal 2011 income
statement?
f.
Cost of Goods Sold, on the fiscal 2012 income
statement?
g.
What hedging strategy would you recommend for Fine Foods and why?

5.
Affiliate
X in Ireland sells 10,000 units to Affiliate Y located in Canada per year. The marginal corporate tax rate for Ireland
is 15% and 25% for Canada. The transfer
price per unit is currently set at $2,000 which is variable cost. It can be set
as high as $2,450, which is full cost plus a markup. Calculate the increase in annual after-tax
profits if the higher transfer price of $2,450 per unit is used.

6.
How might a MNC use transfer pricing strategies?
What are the various means the taxing authority of a country might use to
determine if a transfer price is reasonable?

ANSWER:

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