CHAPTER 10 Part B

Accounting for Long-Term Investments and International Operations

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10B-1

ACCOUNTING FOR INTERNATIONAL OPERATIONS

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10B-2

ACCOUNTING FOR INTERNATIONAL OPERATONS

The exhibit below shows the percentages of international sales for three large U. S. companies: Company Coca-Cola Percent of International Sales 62%

IBM
Intel

57
56

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10B-3

ACCOUNTING FOR INTERNATIONAL OPERATONS

Accounting for business activities across national boundaries makes up the field of international accounting

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10B-4

FOREIGN CURRENCIES AND EXCHANGE RATES

The measure of one currency against another is called the foreign-currency exchange rate Using an exchange rate to convert the cost of an item given in one currency to its cost in a second currency is called a translation
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-5

Foreign-Currency Exchange Rates at One Point in Time

Country Canada European Common Market France Germany Great Britain Italy Monetary Unit Dollar Euro Franc Mark Pound Lira Dollar Value $0.66 1.06 0.16 0.54 1.59 0.0005

Japan
Mexico

Yen
Peso

0.0086
0.107
Harrison and 10B-6

2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren

FOREIGN CURRENCIES AND EXCHANGE RATES

If an item costs 200 French francs,its translation to dollars is found by multiplying the amount in francs by the conversion rate: 200 French francs x $0.16 = 32

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10B-7

FOREIGN CURRENCIES AND EXCHANGE RATES

Two main factors determine the supply and demand for a particular currency
The ratio of a countrys imports to its exports
When exports exceed imports, customers must buy the unit of currency in the international currency market to pay for their purchases

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10B-8

FOREIGN CURRENCIES AND EXCHANGE RATES

This demand drives up the price (the foreign exchange rate) of a currency Conversely, as the supply of a currency increases, its price decreases

The rate of return available in the countrys capital market

The rate of return available in a countrys capital markets affects the amount of investment funds flowing into the country
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-9

FOREIGN CURRENCIES AND EXCHANGE RATES

When rates of return are high, international investors buy stocks, bonds, and real estate in that country This activity increases the demand for the nations currency and drives up its exchange rate The exchange rate of a strong currency is rising relative to other nations currencies The exchange rate of a weak currency is falling relative to other currencies
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-10

Shipp Belting sells goods to Artes de Mexico for a price of 1 million pesos on July 28. On that date, a peso was worth $0.107. On August 28, when the peso is worth only $0.104, Shipp receives 1 million pesos from Artes, but the dollar value of Shipps cash receipt is $3,000 less than expected. The following journal entries show how Shipp would account for these transactions: July 28 Accounts Receivable - Artes (1,000,000 pesos x $0.107) Sales Revenue Sale on account Aug. 28 Cash (1,000,000 pesos x $0.104) Foreign Currency Transaction Loss Accounts Receivable - Artes Collection on account
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-11

107,000 107,000

104,000 3,000 107,000

FOREIGN CURRENCIES AND EXCHANGE RATES

Shipp exposed itself to foreign-currency exchange risk and experienced a $3,000 foreign-currency transaction loss If the peso had increased in value, Shipp would have experienced a foreign-currency transaction gain

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10B-12

Assume Shipp Belting buys inventory from Gesellschaft Ltd., a Swiss company. The two companies decide on a price of 20,000 Swiss francs. On September 15, when Shipp receives the goods, the Swiss franc is quoted at $0.7999. When Shipp pays on September 29, the Swiss franc has decreased in value to $0.7810. Shipp would record the purchase and payment as follows: Sept. 15 Inventory (20,000 Swiss francs x $0.7999) 15,980

Accounts Payable - Gesellschaft Ltd.

Purchase on account Sept. 29 Accounts Payable - Gesellschaft Ltd. Cash (20,000 Swiss francs x $0.781) 15,980

15,980

15,620

Foreign Currency Transaction Gain

Payment on account

360

If the Swiss franc had strengthened against the dollar, Shipp would have had a foreign-currency transaction loss
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-13

FOREIGN CURRENCIES AND EXCHANGE RATES

The company reports the net amount of foreign currency transaction gains and losses on the income statement as Other Revenues and Gains, or Other Expenses and Losses

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10B-14

Shipp Belting would combine the $3,000 foreign-currency loss and the $360 gain and report the net loss of $2,640 on the income statement as follows: Other Expenses and Losses: Foreign-currency transaction loss, net $2,640

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10B-15

FOREIGN CURRENCIES AND EXCHANGE RATES

One way for U. S. companies to avoid foreign-currency transaction losses is to insist that international transactions be settled in dollars Another way for a company to protect itself is by hedging
Protection from transaction losses by engaging in a counterbalancing transaction
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FOREIGN CURRENCIES AND EXCHANGE RATES

Some companies buy futures contracts which are contracts for foreign currencies to be received in the future Futures contracts can effectively create a payable to exactly offset a receivable, and vice versa

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10B-17

CONSOLIDATION OF FOREIGN SUBSIDIARIES

The consolidation of a foreign subsidiary poses two special challenges
Accountants must first bring the subsidiarys statements into conformity with American GAAP When the subsidiary statements are expressed in foreign currency, they must be translated into dollars
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-18

CONSOLIDATION OF FOREIGN SUBSIDIARIES

The process of translating a foreign subsidiarys financial statements into dollars usually creates a foreigncurrency translation adjustment
Assets and liabilities in the foreign subsidiaries financial statements are translated into dollars at the exchange rate in effect on the date of the statements Stockholders equity is translated into dollars at the historical exchange rates
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-19

CONSOLIDATION OF FOREIGN SUBSIDIARIES

The foreign-currency translation adjustment is the balancing amount that brings the dollar amount of the total liabilities and stockholders equity of a foreign subsidiary into agreement with the dollar amount of its total assets

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10B-20

U. S. Express Corporation owns Italian Imports, Inc., whose financial statements are expressed in lire
When U. S. Express acquired Italian Imports in 20X1, a lira was worth $0.00070 When Italian Imports earned its retained income during 20X1 - 20X6, the average exchange rate was $0.00067 On the balance sheet date in 20X6, a lira is worth only $0.00060 The following exhibit shows how to translate Italian Imports balance sheet into dollars and shows how the translation adjustment arises:

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10B-21

Translation of Foreign-Currency Balance Sheet into Dollars

Italian Imports, Inc., Amounts Lire Exchange Rate Dollars

Assets
Liabilities Stockholders Equity Common stock Retained earnings Accumulated other comprehensive income: Foreign currency translation adjustment

800,000,000 $0.00060 $480,000

500,000,000 0.00060 $300,000

100,000,000 200,000,000

0.00070 0.00067

70,000

134,000

(24,000)
800,000,000 $480,000
Harrison and 10B-22

2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren

Differences in accounting principles exist among countries around the world as shown below:
Research and Development Costs

Country
United States

Inventories
Specific unit cost, FIFO, LIFO, weighted average Similar to U.S. Similar to U.S.

Goodwill

Amortized over period not Expensed as incurred to exceed 40 years Amortized over 5 years Amortized over 5 years Expensed as incurred May be capitalized and amortized over 5 years Expense research cost Some development costs may be capitalized

Germany
Japan

United Kingdom LIFO is unacceptable for tax purposes and is not widely used

Amortized over useful life or not amortized if life is indefinite

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10B-23

INTERNATIONAL ACCOUNTING STANDARDS

A company that sells its stock through a foreign stock exchange must follow the accounting principles of the foreign country The globalization of business enterprises and capital markets is creating much interest in establishing common, worldwide accounting standards
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INTERNATIONAL ACCOUNTING STANDARDS

The primary organization working to achieve worldwide harmony of accounting standards is the International Accounting Standards Committee (IASC)

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10B-25

USING THE SCF TO INTERPRET INVESTING ACTIVITIES

The purchase and sale of investments in the stocks and bonds of other companies are investing activities that are reported on the cash-flow statement Investing activities are on the statement of cash flows as the second category, as shown in the following exhibit:
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-26

CAMPBELL SOUP CO. Consolidated Statement of Cash Flows

(In millions) 19X5

Cash Flows from Operating Activities 1. Net cash provided by operating activities Cash Flows from Investing Activities 2. Purchases of plant assets 3. Sales of plant assets 4. Businesses acquired 5. Sales of businesses 6. Other 7. Net cash used in investing activities

$ 1,185 (391) 21 (1,255) 12 (45) (1,658)

Cash Flows from Financing Activities 8. Long-term borrowings 312 9. Repayments of long-term borrowings (29) 10. Short-term borrowings 1,087 11. Repayments of short-term borrowings (662) 12. Dividends paid (295) 13. Other 13 14. Net cash provided (used in) financing activities 426
2001 Prentice Hall Business Publishing Financial Accounting, 4/e Horngren Harrison and 10B-27

USING THE SCF TO INTERPRET INVESTING ACTIVITIES

Campbell Soup spent $1.255 billion to acquire other companies (line 4) It sold other companies for a total of $12 million (line 5) Campbell Soup financed acquisitions of other businesses through operating activities (line 1)
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USING THE SCF TO INTERPRET INVESTING ACTIVITIES

Long-term borrowing (line 8) and shortterm borrowing (line 10) far exceeded repayments of borrowings (lines 9 and 11)
This means that the company had the cash to expand

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10B-29

END OF CHAPTER 10

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10B-30