Charles Edward Company established a subsidiary in a foreign country on January 1, 2013, by investing FC 3,200,000 when the exchange rate was $0.50/FC. Charles Edward negotiated a bank loan of FC 3,000,000 on January 5, 2013, and purchased plant and equipment in the amount of FC 6,000,000 on January 8, 2013. It depreciated plant and equipment on a straight-line basis over a 10-year useful life. It purchased its beginning inventory of FC 1,000,000 on January 10, 2013, and acquired additional inventory of FC 4,000,000 at three points in time during the year at an average exchange rate of $0.43/FC. It uses the first-in, first-out (FIFO) method to determine cost of goods sold. Additional exchange rates per FC 1 during the year 2013 follow:
January 1-31, 2013. . . . . . . . . . . . . . $0.50
Average 2013 . . . . . . . . . . . . . . . . . . . 0.45
December 31, 2013. . . . . . . . . . . . . . . 0.38
The foreign subsidiary's income statement for 2013 and balance sheet at December 31, 2013, follow:
INCOME STATEMENT
For the Year Ended December 31, 2013
FC (in thousands)
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FC 5,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Gross profit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
Selling expense . . . . . . . . . . . . . . . . . . ... . . . . . . . . . . . . . . . . 400
Depreciation expense . . . . . . . . . . . . . . . .... . . . . . . . . . . . . . . 600
Income before tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Income taxes. . . . . . . . . . . . . . . . . . . . . . . ... . . . . . . . . . . . . . 300
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . .... . . . . . . . . . . . 700
Retained earnings, 1/1/13 . . . . . . . . . . . . . . . . ... . . . . . . . . . . -0-
Retained earnings, 12/31/13 . . . . . . . . . . . . . . . . .. . . . . . . FC 700
BALANCE SHEET
At December 31, 2013
FC (in thousands)
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FC 1,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . 2,000
Fixed assets. . . . . . . . . . . . . . . . . . . . . . . . . . . .... . . . . . . . . . . 6,000
Less: Accumulated depreciation . . . . . . . . . . . . . .... . . . . . . . . (600)
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . . . . FC 8,400
Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . FC 1,500
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . 3,000
Contributed capital . . . . . . . . . . . . . . . . . . . . . . . . . . . .... . . . . 3,200
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...... . . 700
Total liabilities and stockholders' equity . . . . . . . . . . . . . . FC 8,400
As the controller for Charles Edward Company, you have evaluated the characteristics of the foreign subsidiary to determine that the FC is the subsidiary's functional currency.
Required
a. Use an electronic spreadsheet to translate the foreign subsidiary's FC financial statements into U.S. dollars at December 31, 2013, in accordance with U.S. GAAP. Insert a row in the spreadsheet after retained earnings and before total liabilities and stockholders' equity for the cumulative translation adjustment. Calculate the translation adjustment separately to verify the amount obtained as a balancing figure in the translation worksheet.
b. Use an electronic spreadsheet to re-measure the foreign subsidiary's FC financial statements in U.S. dollars at December 31, 2013, assuming that the U.S. dollar is the subsidiary's functional currency. Insert a row in the spreadsheet after depreciation expense and before income before taxes for the re-measurement gain (loss).
c. Prepare a report for James Edward, CEO of Charles Edward, summarizing the differences that will be reported in the company's 2013 consolidated financial statements because the FC, rather than the U.S. dollar, is the foreign subsidiary's functional currency. In your report, discuss the relationship between the current ratio, the debt-to-equity ratio, and profit margin calculated from the FC financial statements and from the translated U.S. dollar financial statements. Also discuss the meaning of the translated U.S. dollar amounts for inventory and for fixed assets.