Ferguson Pumps, Inc. (Ferguson), a firm domiciled in the United States, manufactures and distributes submersible pumps throughout the United States and Europe. Ferguson has been experiencing strong growth in Europe, but it has been limited due to the long lead times required to build and supply the submersible pumps from the United States. In order to further grow the European market, Ferguson felt it was necessary to open a manufacturing facility in Manchester, England. The wholly-owned subsidiary will carry the name of EuroPumps, Ltd (EPumps) and was formed on January 1, 2021. Fergusons plan is to have EPumps produce the majority of the submersible pumps that are being sold to companies located in Europe; however, certain specialty pumps will still be produced and shipped from the United States.

On January 1, 2021, Ferguson capitalized EPumps with a cash inflow of $1,000,000. Furthermore, in order to assist EPumps in funding their start-up expenses and purchase equipment necessary for operations, Ferguson made the following loans to EPumps:

March 31, 2021 $2,000,000

June 30, 2021 $1,000,000

Ferguson is expecting EPumps to repay the March and June loans within the next 12 months.

EPumps was fully operational and building pumps by March 31, 2021 and began shipping pumps in April 2021. All of EPumps transactions are denominated in British pounds (a.k.a. Pound Sterling) except for intercompany sales and loans, which are denominated in the United States Dollar.

Ferguson designed a new line of pumps in late 2020 for which EPumps currently doesnt have the tooling. Therefore, EPumps is purchasing these pumps from Ferguson for distribution throughout Europe. During the year ended December 31, 2021, Ferguson sold EPumps $4,000,000 (Fergusons selling price) of pumps and $500,000 of these pumps remain in EPumps inventory at year-end. Ferguson realizes a 20% gross margin on all pumps its sells to EPumps (20% of selling price represents gross profit). All intercompany sales were settled between Ferguson and EPumps by December 31, 2021.

During the year ended December 31, 2021, EPumps purchased all of their equipment using the initial capital inflow and intercompany loans from Ferguson. There were no disposals of fixed assets by either Ferguson or EPumps during the year ended December 31, 2021.

In order to facilitate short-term borrowing needs, EPumps opened a line of credit with a local bank in Manchester, England. Maximum borrowings on the line of credit are 4,000,000 and are to be collateralized by EPumps accounts receivable and inventory.

For simplicity purposes, assume all intercompany transactions and elimination entries are on a tax free basis (i.e. ignore the tax effect of these entries).

The following financial statements are attached to assist in completing the case study:

• Balance sheets for Ferguson as of December 31, 2021 and December 31, 2020 on a stand-alone basis.
• Income statements for Ferguson for the years ended December 31, 2021 and 2020 on a stand-alone basis.
• Balance sheet for EPumps as of December 31, 2021 on a stand-alone basis and before intercompany adjustments and the forgiveness of the intercompany loan noted below.
• Income statement for EPumps for the year ended December 31, 2021 on a stand-alone basis and before intercompany adjustments.

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Requirements

1. What is the functional currency of EPumps, Ltd.? Please provide your rationale (including supporting citations).
2. Does EPumps have any foreign currency transactions (and related exchange gains or losses)? If so, prepare any journal entries EPumps should record. If not, discuss why not.
3. Prepare a consolidated balance sheet and income statement for Ferguson Pumps, Inc. and its subsidiary as of and for the year ending December 31, 2021. This will require knowledge of both foreign currency and consolidation issues. Please provide supporting ASC citations for your work, including any consolidation adjustments. Assume a 40% tax rate.