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Exhibit 11.6 Ganado Europe's Translation Loss After Depreciation of the Euro: Temporal Method December 31, 2010 January 2, 2011 Assets In Euros () Exchange Rate (USS/euro) Translated Accounts (USS) Exchange Rate (US$/euro) Translated Accounts (USS) Cash 1,600,000 1.2000 $ 1,920,000 1.0000 $ 1,600,000 Accounts receivable 3,200,000 1.2000 3,840,000 1.0000 3,200,000 Inventory 2,400.000 1.2180 2,923,200 1.2180 2.923,200 4.800.000 1.2760 6.124 8001 1.2760 6.124 800 Net plant and equipment Total 12,000,000 $14,808,000 $13,848,000 Liabilities and Net Worth Accounts payable 800,000 1.2000 $ 960,000 1.0000 $ 800,000 Short-term bank debt 1,600,000 1.2000 1.920,000 1.0000 1,600,000 Long-term debt 1,600,000 1.2000 1.920,000 1.0000 1,600,000 Common stock 1,800,000 1.2760 2,296,800 1.2760 2,296,800 Retained earnings 6,200,000 1.2437(a) 7,711,200 1.2437(b) 7,711,200 Translation gain (loss) $ (160,000)(c) Total 12,000,000 $14,808,000 $13,848,000 (a) Dollar retained earnings before depreciation are the cumulative sum of additions to retained earnings of all prior years, translated at exchange rates in each year (b) Translated into dollars at the same rate as before depreciation of the euro. (c) Under the temporal method, the translation loss of $160,000 would be closed into retained earnings through the income statement rather than left as a separate line item as shown here. Ending retained earnings would actually be 7,711,200 - $160,000 = 7,551,200. Temporal Method Translation of the same accounts under the temporal method shows the arbitrary nature of any gain or loss from translation. This is illustrated in Exhibit 11.6 9. Monetary assets and monetary liabilities in the pre-depreciation euro balance sheet are translated at the current rate of exchange, but other assets and the equity accounts are translated at their historic rates. For Ganado Europe, the historical rate for inventory differs from that for net plant and equipment because inventory was acquired more recently. Under the temporal method, translation losses are not accumulated in a separate equity account. Instead, they are passed directly through each quarter's income statement. Thus, in the dollar balance sheet, translated before depreciation, retained earnings were the cumulative result of earnings from all prior years, translated at historical rates in effect each year, plus translation gains or losses from all prior years. In Exhibit 11.69, no translation loss appears in the pre-depreciation dollar balance sheet, because any losses would have been closed to retained earnings. The effect of the depreciation is to create an immediate translation loss of $160,000. This amount is shown as a separate line item in Exhibit 11.6 0 to focus attention on it for this example. Under the temporal method, this translation loss of $160,000 would pass through the income statement, reducing reported net income and reducing retained earnings. Ending retained earnings would, in fact, be $7,711,200 minus $160,000, or $7,551,200. Whether gains and losses pass through the income statement under the temporal method depends upon the country. In the case of Ganado, the translation gain or loss is larger under the current rate method because inventory and net property, plant, and equipment, as well as all monetary assets, are deemed exposed. When net exposed assets are larger, gains or losses from translation are also larger. If management expects a foreign currency to depreciate, it could minimize translation exposure by reducing net exposed assets. If management anticipates an appreciation of the foreign currency, it should increase net exposed assets to benefit from a gain. Depending on the accounting method, management might select different assets and liabilities for reduction or increase. Thus, real decisions about investing and financing might be dictated by which accounting technique is used, when, in fact, accounting impacts should be neutral. And as illustrated in Global Finance in Practice 11.29, transaction/translation exposures may become intertwined in subsidiary valuation. Exhibit 11.6 Ganado Europe's Translation Loss After Depreciation of the Euro: Temporal Method December 31, 2010 January 2, 2011 Assets In Euros () Exchange Rate (USS/euro) Translated Accounts (USS) Exchange Rate (US$/euro) Translated Accounts (USS) Cash 1,600,000 1.2000 $ 1,920,000 1.0000 $ 1,600,000 Accounts receivable 3,200,000 1.2000 3,840,000 1.0000 3,200,000 Inventory 2,400.000 1.2180 2,923,200 1.2180 2.923,200 4.800.000 1.2760 6.124 8001 1.2760 6.124 800 Net plant and equipment Total 12,000,000 $14,808,000 $13,848,000 Liabilities and Net Worth Accounts payable 800,000 1.2000 $ 960,000 1.0000 $ 800,000 Short-term bank debt 1,600,000 1.2000 1.920,000 1.0000 1,600,000 Long-term debt 1,600,000 1.2000 1.920,000 1.0000 1,600,000 Common stock 1,800,000 1.2760 2,296,800 1.2760 2,296,800 Retained earnings 6,200,000 1.2437(a) 7,711,200 1.2437(b) 7,711,200 Translation gain (loss) $ (160,000)(c) Total 12,000,000 $14,808,000 $13,848,000 (a) Dollar retained earnings before depreciation are the cumulative sum of additions to retained earnings of all prior years, translated at exchange rates in each year (b) Translated into dollars at the same rate as before depreciation of the euro. (c) Under the temporal method, the translation loss of $160,000 would be closed into retained earnings through the income statement rather than left as a separate line item as shown here. Ending retained earnings would actually be 7,711,200 - $160,000 = 7,551,200. Temporal Method Translation of the same accounts under the temporal method shows the arbitrary nature of any gain or loss from translation. This is illustrated in Exhibit 11.6 9. Monetary assets and monetary liabilities in the pre-depreciation euro balance sheet are translated at the current rate of exchange, but other assets and the equity accounts are translated at their historic rates. For Ganado Europe, the historical rate for inventory differs from that for net plant and equipment because inventory was acquired more recently. Under the temporal method, translation losses are not accumulated in a separate equity account. Instead, they are passed directly through each quarter's income statement. Thus, in the dollar balance sheet, translated before depreciation, retained earnings were the cumulative result of earnings from all prior years, translated at historical rates in effect each year, plus translation gains or losses from all prior years. In Exhibit 11.69, no translation loss appears in the pre-depreciation dollar balance sheet, because any losses would have been closed to retained earnings. The effect of the depreciation is to create an immediate translation loss of $160,000. This amount is shown as a separate line item in Exhibit 11.6 0 to focus attention on it for this example. Under the temporal method, this translation loss of $160,000 would pass through the income statement, reducing reported net income and reducing retained earnings. Ending retained earnings would, in fact, be $7,711,200 minus $160,000, or $7,551,200. Whether gains and losses pass through the income statement under the temporal method depends upon the country. In the case of Ganado, the translation gain or loss is larger under the current rate method because inventory and net property, plant, and equipment, as well as all monetary assets, are deemed exposed. When net exposed assets are larger, gains or losses from translation are also larger. If management expects a foreign currency to depreciate, it could minimize translation exposure by reducing net exposed assets. If management anticipates an appreciation of the foreign currency, it should increase net exposed assets to benefit from a gain. Depending on the accounting method, management might select different assets and liabilities for reduction or increase. Thus, real decisions about investing and financing might be dictated by which accounting technique is used, when, in fact, accounting impacts should be neutral. And as illustrated in Global Finance in Practice 11.29, transaction/translation exposures may become intertwined in subsidiary valuation