CASE: Global Enterprises

Global Enterprises is a recently acquired U.S. manufacturing subsidiary located in Zonolia. Its products are marketed principally in Zonolia with sales invoiced in zonolias, the local currency (FC) and prices determined by local competitive conditions. Expenses (labor, materials, and other production costs) are mostly local although a significant quantity of components is imported from the U.S. parent. Financing is primarily in U.S. dollars and provided by the parent.

With the recent issuance of FAS No. 52 in the United States, headquarters management is faced with the decision of choosing a functional currency designation for its Zanolian operation; that is, should t be the U.S. dollar or the local currency? You are asked to advise management o the appropriate currency designation as well as its relative financial statement effects. Prepare a report that supports your recommendations and identify any policy issues uncovered by your analysis.

Comparative balance sheets for Global Enterprises at January 1, 2003 and 2004, and a statement of income for the year ended December 31, 2004, are presented below. The statements conform with U.S. generally accepted accounting principles prior to translation to dollars.

Financial Statements of Global Enterprises

Balance Sheet 12/31/2003 12/31/2004

Cash FC 300 FC 500

Accounts receivable (net) 1,300 1000

Inventories 1,200 1,500

Fixed assets (net) 9,000 8,000

Total assets FC 11,800 FC 11,000

Accounts payable FC 2,200 FC 2,400

Long-term debt 4,400 3,000

Capital stock 2,000 2,000

Retained earnings 3,200 3,600

Total liability & OE FC 11,800 FC 11,000

Income Statement

Year ended 12/31/2004

Sales FC 10,000

Expenses:

Cost of sales 5,950

Depreciation (st. line) 1,000

Other 1,493 8,443

Operating income FC 1,557

Income taxes 467

Net income FC 1,090

Note: Capital stock was issued and fixed assets acquired when the exchange rate was FC1 = $.20. Inventories at January 1, 2004 were acquired during the fourth quarter of 2003. Purchases (FC 6,250), sales other expenses and dividends (FC690) occurred evenly during 2004. Retained earnings in US dollars at December 31, 2003, under the temporal method, were $526; under current rate method, $796. Global Enterprises beginning-of-period cumulative translation adjustment was $270. Relevant exchange rates were:

January 1, 2004 FC1 = $.23

December 31, 2004 FC1 = $.18

Average during 2004 FC1 = $.22

Average during 4th qtr., 2003 FC1 = $.23

Average during 4th qtr., 2004 FC1 = $.19