1. Translation and Performance Evaluation: Management compensation is often based on reported profits. What profit measurement is appropriate for top management to use in judging the performance of a U.S. Company’s foreign subsidiary? Consider a Dutch subsidiary that reported the following results in euros for 2012 and 2011.
International Accounting Issues LE 4.1 1. Translation and Performance Evaluation: Management compensation is often based on reported profits. What profit measurement is appropriate for top management to use in judging the performance of a U.S. Company’s foreign subsidiary? Consider a Dutch subsidiary that reported the following results in euros for 2012 and 2011. in thousands 2012 2011 Sales €2,400 €2,000 Cost of Sales €1,320 €1,200 Gross Margin €1,080 €800 Other operating expenses €230 €200 Profit before taxes €850 €600 Income tax expense €255 €180 Net Income €595 €420 Average exchange rate: $1.10/€ for 2012. $1.20/€ for 2011. Composite historical rates relating to cost of sales and other operating expenses (including depreciation): $1.12/€ for 2012, $1.23/€ for 2011. Required: a. Prepare a schedule showing the Dutch subsidiary’s income statement for 2011 and 2012 in euros and in dollars, using both the current rate and temporal methods. Compute the percentage change in income in each case. b. Comment on the comparability of the translated income statements, focusing on the impact of the change in dollar value of the euro. Compute the ratios of net income/sales using the Euro statements and the dollar financial statements. How could you adjust the translated statements to enhance comparability? Show computations and comment on the results. c. Comment on the impact of the euro weakening vs the euro strengthening in subsequent years. What will be the impact on the parent company? 2. Murdock Company has a Spanish Subsidiary whose functional currency is the euro. Relevant translated data for the subsidiary appear below. Date or annual period Total Assets Operating Income Exchange Rate 1/1/2011 $105,000,000 $1.40/€ 2011 $12,000,000 $1.20/€ 12/31/2011 90,000,000 $1.00/€ 2012 10,890,000 $.90/€ 12/31/2012 90,000,000 $1.00/€ Required: a. Calculate the return on assets for 2011 and 2012 using both translated ($) and euro data. b. Explain whether translation has distorted the Spanish subsidiary’s performance in 2012 compared with 2011. If so, explain how changes in the exchange rate contributed to the distortion. 3. Referring to WalMart’s 2012 annual report: a. What is the functional currency of their foreign subsidiaries? b. On average, did the US dollar strengthen or weaken against the currencies of WalMart’s subsidiaries from 2010 to 2011? From 2011 to 2012? c. What is WalMart’s hedging strategy and has it been successful in that same time period. d. What percent of Walmart’s income is international? e. Referring to Bayer AG’s annual report (use the interactive version online at http://www.annualreport2011.bayer.com or the pdf located in course documents) which is prepared under IFRS: Compare Bayer’s disclosure under IFRS and treatment of foreign currency and derivatives to Walmart’s under GAAP. What was the gain or loss due to differences in translation of operations outside the euro zone for 2011? What was the gain or loss from derivate hedging transactions? 4. Fine Foods Inc, a US wholesaler, buys merchandise from suppliers in Germany and pays the suppliers in euros. It also sells merchandise to customers in Italy, and receives payment in euros. Fine Foods’ accounting year ends June 30. Exchange rates are as follows: Date Spot rate ($/€) 1-Mar-11 1.55 1-Apr-11 1.6 30-Jun-11 1.62 1-Jul-11 1.63 15-Aug-11 1.65 31-Aug-11 1.68 Purchases of € 1,000,000 are made on March 1, 2011. Fine Foods pays its German suppliers on August 15, 2011, and sells the merchandise to its US customers on August 31, 2011. Sales of € 100,000 are made on April 1, 2011. Fine Foods receives payment from its Italian customers on July 15, 2011. Required: What amounts will appear on the financial statements of Fine Foods for: a. Accounts payable, on the June 30, 2011, balance sheet? b. Accounts receivable on the June 30, 2011 balance sheet? c. Exchange gain or loss, on the fiscal 2011 income statement? d. Exchange gain or loss on the fiscal 2012 income statement? e. Sales revenue, on the fiscal 2011 income statement? f. Cost of Goods Sold, on the fiscal 2012 income statement? g. What hedging strategy would you recommend for Fine Foods and why? 5. Affiliate X in Ireland sells 10,000 units to Affiliate Y located in Canada per year. The marginal corporate tax rate for Ireland is 15% and 25% for Canada. The transfer price per unit is currently set at $2,000 which is variable cost. It can be set as high as $2,450, which is full cost plus a markup. Calculate the increase in annual after-tax profits if the higher transfer price of $2,450 per unit is used. 6. How might a MNC use transfer pricing strategies? What are the various means the taxing authority of a country might use to determine if a transfer price is reasonable?