Chapter 11 Question Answer Key

Chapter 11
Translation and Consolidation of

Foreign Operations
Copyright  2016 McGraw-Hill Education. All rights reserved.

Solutions Manual, Chapter 11 1
A brief description of the major points covered in each case and problem.
CASES
Case 11-1
This case discusses how land and fair-value-through-profit or loss securities are measured
under the FCT method and PCT methods and whether these values represent the true
economic value of these assets.
Case 11-2 (prepared by Peter Secord, Saint Mary’s University)

Students are asked to assess the financial reporting implications associated with a Canadian
company’s investment in a company located in an African country known for having an
unstable currency and political environment as well as high inflation.
Case 11-3
This case, taken from a CPA exam, involves a South American subsidiary during a period of
high inflation. The client wants an explanation on how the exchange gains or losses under the
temporal and PCT methods tie in with the currency risk. Furthermore, the client wants some
guidance in assessing performance in this environment.
Case 11-4
This case, taken from a CPA exam, involves the sale of some foreign subsidiaries. The client
wants CPA to review the accounting policies related to revenue recognition, valuation of
goodwill and non-controlling interest, foreign exchange adjustments and foreign taxes.
Case 11-5
This case, taken from a CPA exam, involves a communication company that has expanded
into the United States and wants to change its reporting currency from Canadian dollars to US
dollars. The client wants CPA to review the accounting policies related to held-for-sale assets,
investment in high inflation country, business combinations and sale of receivables.
Case 11-6
This case, taken from a CPA exam, involves a consulting company involved with adopting
children from foreign countries. The partner wants CPA to review the accounting policies
2 Modern Advanced Accounting in Canada, Eighth Edition
related to revenue recognition, adopted related costs, foreign subsidiary, gross versus net
reporting and money held in trust.
PROBLEMS
Problem 11-1 (55 min.)
Comparative financial statements of a foreign subsidiary located in the United States are
presented. The problem requires that the current year's statements be translated under the
assumption that the subsidiary’s functional currency is (a) the Canadian dollar and (b) the U.S.
dollar. Separate calculations for the year's exchange gains or losses and analysis of the impact
of the translation method on selected ratios are also required.

This problem uses the same USA company as in Problem 1. Rather than buying 100%, the
investor only acquires 40%. Using the translated statements from Problem 1, journal entries
are required under the equity method to account for the investment in the associate.
Problem 11-3 (60 min.)This problem is similar in most respects to Problem 1 except that the
subsidiary's statements are presented in Libyan dinars, and the exchange rates change in the
opposite direction. In addition, this question requires the calculation and translation of the
subsidiary's goodwill.

This problem uses the same 90% owned foreign company as in Problem 3. Using the
translated statements from Problem 3, consolidated financial statements are required under
the assumption that the presentation currency is (a) the Canadian dollar and (b) the US dollar.
Also required is the preparation of consolidated financial statements using the worksheet
approach under the two scenarios for presentation currencies.

This problem requires identification of factors to determine the subsidiary’s functional currency,
the translation of selected accounts under the FCT method and explanation of reasons for
differences in exchange gains/losses between the two translation methods.

This problem is very useful for classroom illustration because it requires the translation of the
financial statements of a 90%-owned foreign subsidiary and the consolidation of these
translated statements with the statements of the Canadian parent under the assumptions that
the subsidiary’s functional currency is (a) the Canadian dollar and (b) the foreign currency. It
also requires the calculation of the balance in the investment account under the equity method.
Also required is the preparation of consolidated financial statements using the worksheet
approach under the two scenarios for functional currencies.

This relatively short problem requires the determination of the value to report for inventory for
the foreign currency financial statements, the translated financial statements and the
consolidated financial after applying the lower of cost and net realizable value principle.

This CGA-adapted problem requires the translation of a balance sheet and a calculation of
exchange losses on bonds payable when the functional currency is the Canadian dollar. It
also requires a calculation of the exchange adjustment when the functional currency is the
euro along with an explanation of whether the PCT method produces a current value figure for
equipment.

This CGA-adapted problem requires the translation of selected financial statement items under
assumptions that the subsidiary’s functional currency is (a) the Canadian dollar and (b) the
euro. It also requires a calculation of the exchange adjustment when the subsidiary’s
functional currency is the euro along with an explanation of how the FCT method is consistent
with measurement of assets and liabilities for domestic transactions.

Translated financial statements of a foreign subsidiary are required three years after formation
under the assumption that the subsidiary’s functional currency is (a) the Canadian dollar and
(b) the Indian rupee. Students are also required to determine which translation method would
be appropriate in this situation.

This problem requires the translation of a Russian associate's financial statements under the
assumptions that the associate’s functional currency is (a) the Canadian dollar and (b) the
Russian ruble along with an explanation whether the PCT method produces translated results
consistent with the normal measurement of assets and liabilities under GAAP.

This problem, taken from a CGA exam, requires an assessment of whether the subsidiary is
integrated or self-sustaining, a calculation of exchange adjustment under the assumption that
the Chinese yuan is the functional currency, a translation of income statement under the under
the assumption that the Canadian dollar is the functional currency and an explanation of the
implications of classifying a mortgage payable as a hedge of an anticipated sale.

This problem requires the translation and consolidation of selected financial statement
accounts under the assumptions that the subsidiary’s functional currency is (a) the Canadian
dollar and (b) the foreign peso.

This problem requires the preparation of the acquisition allocation and amortization schedules
both in foreign currency and then translated into Canadian dollars under the assumptions that
the subsidiary’s functional currency is (a) the Canadian dollar and (b) the US dollar. Journal
entries under the equity method to record the amortization of the acquisition differential are
also required.
SOLUTIONS TO REVIEW QUESTIONS
1. Under the FCT method, any balance sheet item that is measured at fair value is translated
using the closing rate and thus is subject to fluctuations in exchange rates. Items translated
at the historical rate are not subject to translation gains and losses because the translated
amounts are not affected by changes in rates. Under the PCT method, it is the enterprise's
net assets that are at risk. Because these amounts are usually different at any balance
sheet date, the exchange gains or losses that result from translation will be of different

amounts. In fact, it is possible to show an exchange loss using the PCT method and an
exchange gain using the PCT method on a particular balance sheet date. Note that the risk
in this context is the accounting exposure, namely, the risk of a reported gain or loss. There
is no difference in the underlying economic exposure arising from the choice of method.
2. The three major issues related to the translation of foreign currency financial statements
are: (1) what is the functional currency of the foreign operation; (2) what is the presentation
currency of the parent company; and (3) where should the resulting translation adjustment
be reported in the consolidated financial statements. The first issue relates to determining
the appropriate exchange rate (historical, closing, or average for the current period) for the
translation of foreign currency balances. Items translated at the closing rate are exposed
to translation adjustment. The second issue relates to whether the balances must be
translated again to a different reporting currency. The third issue relates to whether the
translation adjustment(s) should be reported as gains or losses in net income, or reported
in other comprehensive income.
3. Although balance sheet exposure does not result in cash inflows and outflows, it does
nevertheless affect amounts reported in consolidated financial statements. If the PCT
method is used, translation adjustments will be reported in other comprehensive income
and end up affecting shareholders’ equity. If translation adjustments are negative and
therefore reduce total shareholders’ equity, there is an adverse (inflationary) impact on the
debt to equity ratio. Companies with restrictive debt covenants requiring them to stay
below a maximum debt to equity ratio may find it necessary to hedge their balance sheet
exposure so as to avoid negative translation adjustments being reported. If the subsidiary’s
functional currency is the same as the parent’s functional currency or located in a high
inflation country, remeasurement gains and losses are reported in net income. Companies
might want to hedge their balance sheet exposure in this situation to avoid the adverse
impact remeasurement losses can have on consolidated net income and earnings per
share.
The paradox in hedging balance sheet exposure is that, by agreeing to receive or deliver
foreign currency in the future under a forward contract, a transaction exposure is created.
This transaction exposure is speculative in nature, given that there is no underlying inflow
or outflow of foreign currency that can be used to satisfy the forward contract. By hedging
balance sheet exposure, a company might incur a realized foreign exchange loss to avoid
an unrealized negative translation adjustment or unrealized remeasurement loss.
4. The gains and losses arising from financial instruments used to hedge balance sheet
exposure are treated in a similar manner as the item the hedge is intended to cover. If the
PCT method is used, gains and losses on hedging instruments will be taken to other
comprehensive income. If the subsidiary FCT method is used, gains and losses on the
hedging instruments will be offset in net income against the related remeasurement gains
and losses.
5. IAS 21 defines a foreign operation as an entity that is a subsidiary, associate, joint

arrangement or branch of a reporting entity, the activities of which are based or conducted
in a country or currency other than those of the reporting entity.
6. In such a situation, it is necessary to restate the foreign subsidiary's financial statements

using Canadian accounting principles before commencing the translation process.
7. A foreign operation whose functional currency is different than the parent’s functional
currency is financially and operationally independent of its Canadian investor. In such
cases, the investor’s exposure to exchange rate changes is limited to its net investment.
The PCT method is used to translate the statements of this foreign operation.
When the functional currency is the same as the parent’s functional currency, the foreign
operation is just the opposite, in that it is financially or operationally interdependent with its
Canadian investor. In this case, the exposure is similar to the exposure that would exist if
the Canadian investor had carried out all the transactions of its investee. The FCT method
is used to translate the statements of the foreign operation.
8. The modified PCT method should be used to translate the financial statements of a
subsidiary that is operating in a highly inflationary environment. All financial statement
items including assets, liabilities, revenues and expenses are translated using the closing
rate. However, the financial statements of the subsidiary should be adjusted for inflation
prior to the translation. Otherwise, the accounting numbers for nonmonetary assets that
would result would be distorted because high inflation nearly always leads to a decline in
exchange rates. Land that translated at $12,000 three years ago could translate at a much
smaller amount (say $3,000) if the foreign currency had weakened substantially because of
very high inflation during this period. If the land is first adjusted for inflation in the foreign
currency and then translated to dollars, the translated amount would be a meaningful
amount in dollars.
9. Assume that the functional currency of the reporting entity is the Canadian dollar. If the
functional currency of the foreign operation is also the Canadian dollar, exchange gains or
losses from translating the net monetary position are reflected immediately in net income.
If the functional currency of the foreign operation is not the Canadian dollar, gains and
losses are reported in other comprehensive income and are then shown as a separate
component of shareholders' equity. They are not reflected in the net income unless the
parent disposes of any portion of the investment in its foreign subsidiary. The above
answers would be reversed if the functional currency of the reporting entity were not the
Canadian dollar.
10. Assume that the functional currency of the reporting entity is the Canadian dollar. The FCT
method uses the functional currency of the reporting entity (i.e., the Canadian dollar) as the
unit of measure. The results from translation are basically the same as if the Canadian
parent carried out all of its foreign subsidiary's activities itself in Canadian dollars. The PCT
method uses a different foreign currency than the functional currency of the reporting entity
as the unit of measure. Transactions are recorded in the foreign currency, and then at the
end of the accounting period are translated into Canadian dollars using the PCT method.
11. The amount of the accumulated foreign exchange adjustments appearing in the
consolidated balance sheet is the parent's share of the amount appearing in the
subsidiary's translated balance sheet. If the subsidiary is less than 100% owned, this will
be a smaller amount. In addition, any exchange gain or loss resulting from the translation
of the acquisition differential is also reflected in the accumulated foreign exchange
adjustments in the consolidated balance sheet, and therefore this total could be larger than
that in the subsidiary's balance sheet.
12. Yes. Under the FCT method, it is the net monetary position that is at risk. This is normally
a net liability position because total liabilities are usually larger than monetary assets. If a
gain is recorded under the FCT method, the Canadian dollar has strengthened with respect
to the foreign currency and requires less Canadian dollars to discharge the net liability.
Under the PCT method, it is the net asset position that is at risk. Because the foreign
currency has weakened, both the assets and liabilities are worth less and this results in a
net loss. (These observations are true only when monetary liabilities are greater than
monetary assets.)
13. Assume that the functional currency of the reporting entity is the Canadian dollar. Under
the FCT method, the exchange rate is applied to produce a translated amount consistent
with the way we normally measure assets and liabilities. If an item is to be measured at
historical cost, we should apply the historical rate to the historical value in foreign currency
to derive the historical cost in Canadian dollars. If an item is to be measured at current
value, we should apply the closing rate to the current value in foreign currency to derive the
current value in Canadian dollars.
14. On the date of acquisition, when the parent takes control of the subsidiary, it is indirectly
purchasing the underlying assets and assuming the underlying liabilities of the subsidiary.
Even though the subsidiary acquired its plant assets prior to the date of acquisition, from a
consolidated perspective, the parent is acquiring the subsidiary’s plant assets on the date
of acquisition. Therefore, the historical cost of these assets from a consolidated
perspective is determined on the date of acquisition.
15. Sales should be translated at the rate in effect on the date of the sales. If the sales take
place evenly throughout the year, the average rate for the year is used to approximate the
rate for each day of the year. If all of the sales occurred on one day of the year, the sales
would be translated at the rate on the date of the sales.
SOLUTIONS TO CASES
Case 11-1
Note to the instructor:

This case represents the ongoing debate as to the proper reporting of foreign currency
balances. As a classroom exercise or written assignment, students could be required to select
a reported value for each of the two assets and then defend their position. What figure is
actually the fairest representation for each of the assets? What figure is the best conveyor of
information to an outside party? There is no single best answer to these questions. The
purpose of this type of exercise is to force students to consider the objectives of financial
reporting. Students should not just assume that the current official pronouncement is correct.
One possible approach to the case is to assign several students to represent banks or
shareholders and discuss the types of information that is most needed by these users.
Another group of students can take the position of the company responsible for preparing the
information and discuss management's preference for providing one type of information over
another. Yet another group could take a purely theoretical approach and discuss the goals
that accounting has attempted to reach. Although a final resolution may not be achieved,
some excellent class discussion is possible.
(a)
Rider invested the equivalent of C$500,000 (C$1,000,000 / 2) in each of land and equity
securities. At the end of the year, the economic value of the land was C$540,000
(US$500,000 x 1.08) and C$529,200 (US$490,000 x 1.08) for the securities.
(b)
How these assets will be reported on the consolidated balance sheet will be dependent upon
whether the functional currency of Riderville USA Ltd. is the same or different than the
functional currency of the Canadian parent.
If Riderville’s functional currency is different than the parent’s functional currency, the PCT
method must be used. The closing rate will be applied to the historical cost of the land to
produce a value of C$507,600 (US$470,000 x 1.08). The closing rate will be applied to the
current value of the securities to produce a value of C$529,200. The increase of C$7,600 for
the land will be reported in other comprehensive income on the comprehensive income
statement and end up in accumulated foreign exchange adjustments in shareholders’ equity.
The equity securities will be reported at C$529,200, the market value at the end of the year.
The increase in value of the investment is C$29,200. Part of this increase will be reported in
net income as a gain in market value of the investment and part will be reported in other
comprehensive income as the exchange gain on the investment.
If Riderville’s functional currency is the same as the parent’s functional currency, the FCT
method must be used. The land will be reported at its historical cost of C$500,000.
Accordingly, no exchange gain or loss will be reported for the land. The equity securities will
be reported at C$529,200, the market value at the end of the year. The increase in value of
the investment of C$29,200 will be reported in net income. Part of this gain will be reported as
a gain in market value of the investment and part will be reported as an exchange gain on the
investment.
Under both methods, the securities will be, but the land will not be, reported at market value or
economic value. Under the FCT method, the land is reported at historical cost. Under the
PCT method, the land is reported at an amount that is not equal to historical cost or current
value.
The FCT and PCT methods of translation differ primarily with regard to the exchange rate used
to translate those assets that are reported at historical cost — inventories, prepaids, property,
plant and equipment, and intangibles. The debate regarding the appropriate exchange rate for
translating assets exists only because some assets are reported at historical cost. If all assets
were reported at their current value, there would be no need to use the historical exchange
rate for translating assets in order to maintain the asset's historical cost in Canadian dollar
terms. All assets would be translated at the current exchange rate. The differences between
the FCT method and PCT method would disappear.
Case 11-2
Nova Mine Engineering/ Zimbabwe Platinum Management 1
Teaching Note
Nova Mine Engineering (NME) must review all the information associated with the subsidiary
Zimbabwe Platinum Management (ZPM) prior to the translation and consolidation process.
The situation is complex and is not fully reflected in this brief case. I use this case with MBA
students, who will often do additional research on the underlying issues, and refer you to the
Economist article that gave rise to this case in the first place.
It is also useful to refer to background material at www.mbendi.co.zawhich has significant
information about Zimbabwe and about the mining industry in particular.
1Peter Secord, Saint Mary’s University.

The first question that must be answered is, “Consolidate or not?” IFRS is clear in that all
subsidiaries should be consolidated.
The next question is the selection of the translation method. The choice between the FCT
method and the PCT method depends, first of all, on the functional currency of ZPM. The
secondment of staff supports the assertion that the functional currency is the same as the
parent’s functional currency. The following facts suggest that the functional currency is not the
same as the parent’s functional currency:
- there are limited flows between the firms, except for information.
- expatriate staff has been sent out for relatively long terms
Overall, it appears that the functional currency is not the same as the parent’s functional
currency. Accordingly, the PCT method should be used when translating ZPM’s financial
statements and any foreign exchange adjustments should be reported in other comprehensive
income, rather than being recognized in net income.
However, a further stage of analysis is necessary. Is Zimbabwe a highly inflationary country?

It is noted in the case that inflation was “persistent ... recently about 35%.” A conclusion,
based on the facts, that Zimbabwe was highly inflationary (note the IAS guideline of 100% over
3 years, about 25% per year compounded) would lead to the use of inflation-adjusted financial
statements for ZPM followed by translation of all financial statements items using the closing
rate. The exchange adjustments would be reported in other comprehensive income. The high
inflation, and the severe decline in the relative exchange rate, may potentially lead to losses
(associated with the investment in “working capital”), which must be recognized by Nova. As
noted in the case, these potential losses cannot be hedged because of the “stressed” state of
the Zimbabwe currency.
Regardless of the conclusion as to the translation method, the severe decline in the exchange
rates and the overall deterioration of Zimbabwe’s economy may lead to a permanent decline in
value, such that the investment should be written down. Footnote disclosure of the potential
for further difficulties would be appropriate in any case.
Case 11-3

Report to the CFO
PRIVATE AND CONFIDENTIAL
September Year 5
Chief Financial Officer

Vulcan Manufacturing Limited (VML)
Dear CFO:
The following is intended to explain the recommendations of IAS 21 and IAS 29 to help you
understand the economic and reporting implications of them.
IAS 21
IAS 21 defines two types of foreign operations: foreign operations with the same functional
currency as the parent and foreign operations with a different functional currency than the
parent. The first type has a strong interdependence between the parent company and foreign
operation. There is exposure on certain financial statement items. For the second type, the
exposure to exchange rate fluctuations is limited to the parent company's net investment.
At the present time, SAPI’s functional currency is not the same as the parent’s functional currency
because it operates almost exclusively in its own country. It sells locally, buys most of its labour
and material locally and finances its day-to-day activities from its own operations and local
borrowing. As such, SAPI would normally be translated using the PCT method. All assets and
liabilities are translated at the rate prevailing at the balance sheet date and all transactions on
the income statement are translated at the rate prevailing at the time of their occurrence. Any
foreign exchange gains or losses resulting from translation would be reported in other
comprehensive income and accumulated in a separate component of shareholders’ equity.
With the substantial devaluation of the foreign currency, the translation of SAPI’s assets and
liabilities under the PCT method would result in the reporting of substantial foreign exchange
losses. If SAPI’s assets and liabilities were not adjusted for inflation, the translated values for
these assets and liabilities would be substantially understated.

IAS 29
IAS 29 requires that a company operating in a highly inflationary environment must adjust their
financial statements for inflation. Since the country in which SAPI is located, has suffered an
inflation rate of more than 100% in the past two years, the environment would be classified as
highly inflationary and SAPI would have to prepare inflation-adjusted financial statements
using the foreign currency as the unit of measure. Then, a special translation method is
applied to translate the financial statements into Canadian dollars. Under the special
translation method, all financial statement items including assets, liabilities, equity, revenue
and expense are translated at the closing rate. Any exchange adjustments are reported in
other comprehensive income.
Communication of economic facts
You have raised some concerns about communicating to shareholders economic facts about
the effects of foreign inflation and the devaluation of the currency in SAPI's country. The
inflation-adjusted statements required by IAS 29 would report the economic effects of inflation.
These values would be translated using the closing rate to produce a current value of assets
and liabilities in Canadian dollars.
From this current value information, shareholders could determine whether the value of
physical assets has kept pace with inflation and devaluation. Historical cost statements will not
achieve this. In the final analysis, shareholders might want to assess the impact of the inflation/
devaluation on the amounts, timing, and uncertainty of remittances (dividends, etc.) from SAPI.
You could also prepare information on the financing adjustment and the purchasing power
gain/loss. If the nature of all gains/losses is properly disclosed, the semi-strong form of efficient
market hypothesis suggests that security prices will reflect the available information.
Future translation methods

Once the inflation rate subsides and the environment is no longer considered to be hyper-
inflationary, we would discontinue translating SAPI into Canadian dollars using the special
translation method. We would use either the FCT method or the PCT method depending on
SAPI’s functional currency.
The difference between the two methods is illustrated in Exhibit I using the August 31, Year 5
draft financial statements for SAPI.
Under the FCT method, an exchange gain/loss will occur when monetary items are settled or
translated at a rate different than the one used to record the transaction originally. Because the
non-monetary items are translated at the historical rate, no gain or loss is calculated. The
exchange gain/loss has to be included in net income for the period. The underlying
assumption of this method is that the transactions undertaken by the foreign operation are
deemed to be carried out by the parent.
As indicated in Exhibit I, shareholders’ equity is higher under the FCT method as compared to
the PCT method. This occurs because nonmonetary assets are translated at the historical rate
under the FCT method as opposed to the closing rate under the PCT method. Since the FC
has depreciated over time, the historical rate produces higher values than the PCT method for
the nonmonetary assets.
Management bonus plan
Finally, you mentioned that you were concerned about the manner in which the management
bonus plan was working and that you were contemplating measuring SAPI's performance in
Canadian dollars.
The decision to evaluate SAPI in Canadian dollar terms is a difficult one. In support of the idea,
Canadian dollar evaluation would force local management to set prices so as to recover local
inflation and currency devaluation. Canadian shareholders would then receive a real return in
Canadian dollars. Since the subsidiary is an autonomous investment centre, which has control
over revenues, costs, and the level of investment, it is important that local management
consider the Canadian shareholders’ perspective when making such decisions. One problem
with the idea is that exchange rate changes are due to factors beyond the control of local
management, and non-controllable factors should not enter into performance evaluation and
bonus determination. This may create motivational problems for SAPI's management.
Exhibit I
SAPI's Translated Balance Sheet
As at August 31, Year 5 (in 000s)
FCT Method PCT Method

Assets FC Rate CND $ Rate CND $
Cash 10,020 0.20 2,004 0.20 2,004
HTM investments (Note 1) 3,620 0.20 724 0.20 724
Accounts receivable 93,000 0.20 18,600 0.20 18,600
Inventory (at cost) 67,200 (Note 2) 14,000 0.20 13,440
Prepaid expenses 8,040 0.35 2,814 0.20 1,608
181,880 38,142 36,376
Plant assets 143,111 0.40 57,244 0.20 28,622

Less accum. depreciation 14,311 0.40 5,724 0.20 2,862
128,800 51,520 25,760
310,680 89,662 62,136
Liabilities and Shareholders' Equity

Current liabilities 65,640 0.20 13,128 0.20 13,128
Long-term debt 157,200 0.20 31,440 0.20 31,440
222,840 44,568 44,568
Shareholders’ equity (Note 3) 87,840 plug 45,094 plug 17,568

310,680 89,662 62,136
Notes:
1. The decline in market value is due to an increase in interest rate. Since SAPI intends to
hold the investments until maturity, the decline in value is irrelevant. Since the investments
are monetary items, they should be translated at the closing rate.
2. Under the FCT method, the inventory should be reported at the lower of cost and net
realizable based on the following translated amounts:
Cost FC67,200 x 0.22 = $14,784
Net realizable value FC700,000 x 0.20 = $14,000
3. Under the FCT method, the exchange gains or losses are included in net income, which
ends up in shareholders’ equity. Under the PCT method, the exchange gains or losses are
included in other comprehensive income, which also ends up in shareholders’ equity.
Case 11-4
Memo to: Paul Bouchard

From: CPA
Subject: Purchase by BritCo of “the Group” of TOP subsidiaries
OVERVIEW
The purchase-and-sale agreement between Top Systems and BritCo states that the price will
be adjusted for the “consolidated working capital” balance of the Group at March 31,Year 9.
Although Janis Marczynski now feels that the price paid for the Group is too high, we may be
unable to do much to help Janis reduce the purchase price at this point. The signed contract
clearly defines how to calculate the purchase price adjustment. RAD, however, clearly has a
bias towards increasing the consolidated working capital balance, thereby increasing the
purchase price for the Group. Where we find evidence of this bias, or where there is a valid
choice, we will work in the interest of BritCo, our client.
We currently do not have sufficient information to quantify the amount of any purchase price
adjustment; however, we can identify changes that can be made, or areas where further
information is required. Ms. Marczynski should clarify the meaning of the term “frivolous” in the
contract, as RAD could argue that every point brought forward is frivolous. It is difficult to
conceive that any objection could be deemed frivolous, since every dollar adjustment directly
affects the purchase price.
Non-controlling interest
There is no evidence of an adjustment for the non-controlling interest on the working capital
statement as required by clause 5.2.a of the purchase-and-sale agreement. The purchase
price adjustment is likely overstated as a result. To properly assess the amount of non-
controlling interest in the consolidated working capital balance, we need to determine whether
there are any controlling shareholders and then determine the working capital and percentage
non-controlling interest by individual company. We also need to clarify the exact nature of the

term “non-controlling interest”—does it refer to the non-controlling interest in the balance sheet
as a whole or simply in the working capital?
Intercompany receivables
An intercompany receivable included in the short-term assets of FranceCo has been included
in the long-term liabilities of a subsidiary that is not part of the Group. This inconsistent
treatment sheds some doubt on the classification of the receivable as a short-term asset,
although there are possible reasons for such a discrepancy. Perhaps the French company is
planning to factor the note, or it may be that only the current portion of the note has been
classified in short-term assets. An incorrect classification as a short-term asset, if that is the
case, would result in an overstatement of the purchase price, necessitating an adjustment.
Notwithstanding, the French company receivable should have been initially recognized at fair
value in accordance with IAS 39 (i.e., discounted to reflect French interest rates, which are
generally 4% above the rate charged on this note). The accounting subsequent to initial
recognition depends on how the company has designated the note under IFRS (i.e., at fair
value through the profit and loss, or at amortized cost using the effective interest method). In
this regard, we would require further information in order to assess what the carrying amount of
this receivable would be at March 31, Year 9.
The inconsistent classification also leads to other questions: was the note classified in long-
term assets at the time of the purchase price negotiation? If so, BritCo may be paying twice
for the same asset, once in the base purchase price and again as part of the working capital
adjustment.
To properly assess the correct treatment of this note, we need to learn what its terms are. We
also need to find out the designation and classification of the note at the time of the purchase
negotiation and management’s intent with regard to the note.
Refundable dividend tax on hand

Refundable dividend tax on hand (RDTOH) is not a receivable for accounting purposes; it is
classified as a reduction of retained earnings. As well, the RDTOH is eliminated for tax
purposes when a company is no longer a Canadian-controlled private corporation. This
happens on purchase by a foreign corporation (BritCo) or a public corporation (RAD). This
account therefore has no value, and its inclusion in working capital causes the purchase price
to be overstated.
Foreign taxes
A receivable has been accrued for tax refunds that will be received on the payment of
dividends by GermanyCo. However, no corresponding payable has been set up for the
withholding taxes, which will be due on the payment of the same dividend. The treatment of
the receivable and the liability is therefore inconsistent for the same transaction. This
treatment may demonstrate RAD’s bias towards increasing the purchase price, unless the
dividend, at the gross amount, has also been accrued in current liabilities. It appears likely,
however, that the purchase price has been overstated.
We need to know whether a dividend has been declared. If so, then both the receivable and
the liability for taxes should be accrued. Alternatively, an accrual for the gross amount of the
dividend should be made. If not, then the refund should be removed from receivables. To
assess the dollar impact of this treatment, we need to know the refund and withholding tax
rate.
Goodwill
There is no supportable argument for including goodwill as a current asset. This accounting
treatment casts doubt on the credibility of the work performed by JR, unless the amount was
immaterial on a consolidated basis to the audit. The inclusion of goodwill as a current asset
has resulted in the purchase price being overstated.
Deferred revenues
“Deferred revenues” includes payments that relate to long-term contracts. Only the portion of
the deferred revenue that relates to the current year should be included in current liabilities.
The current treatment understates the purchase price. We need to ascertain what portion of
the deferred revenue has been included as a current liability in order to quantify the possible
adjustment.
The up-front signing fees should be included in deferred revenue, with revenue allocated over
the term of the agreement. Only the portion that relates to the current year should be included
in current liabilities. The current treatment of the signing fees leads to the purchase price
being overstated. We need to know the remaining life of the contract in order to determine the
magnitude of the adjustment required.
The revenue should be amortized over the life of the contract, including the year of free
advertising. The working capital is thus reduced for the portion that relates to the current year
only. We need to know the current treatment of the year of free advertising in order to
determine any impact on the purchase price. Assuming that the deferral for the long-term
contract does not take into account the year of free advertising, the purchase price is currently
understated.
Prepaids
Prepaids include various fees for licenses ranging in length from one to ten years. Costs
associated with long-term licenses should be included in long-term assets, not as a component
of working capital. The costs associated with one-year licenses could be included in prepaids,
and these costs should be identified and segregated. An argument could be made, however,
that these costs actually represent payments to acquire intangible assets, and should not be
included in working capital at all. In either case, it is likely that the purchase price is overstated
by, at a minimum, a portion of such costs. To properly assess the impact, we need to know
the length of the licenses and whether or not the costs are being amortized over the term of
the licenses.
Printing press leases

The impact of the printing press leases entered into by SwitzerlandCo cannot be determined
from the information given and will depend on whether the leases are financing leases or
operating leases. If the leases are financing leases, then the current portion of the lease
payments should be disclosed as a short-term liability, decreasing working capital. This
treatment would likely decrease the purchase price. If the leases are operating leases
however, the lease payments are expensed as incurred, and no balance sheet accrual is
required. This type of lease would have no impact on purchase price. We need to know
further details of the leases, in order to classify the leases as financing or operating leases.
Belgian Company hedge

The Group is not hedging the current debts payable by CanadaCo, since the Belgian company
that previously hedged the debts is not being acquired. The working capital statement should
therefore reflect the fact that the debts are no longer hedged. Thus, the current debts of
CanadaCo should be restated at the closing rate. The impact on the purchase price will
depend on the change in the value of the Canadian dollar against the foreign currency in
question.
If the result of the adjustment is unfavourable (increases the purchase price), an argument
could be made against the restatement, since the hedge was effective at year-end, when both
companies were still part of the consolidated group. There would therefore be no impact on
the purchase price, although the financial statements would likely be restated immediately after
the close of the purchase transaction.
Foreign exchange losses

The inconsistent treatment of foreign exchange losses (impacting working capital) and foreign
exchange gains (no working capital impact) shows a bias towards overstating the purchase
price. IAS 21 requires recognition of a loss on the income statement; therefore, working capital
is not affected. The purchase price is therefore overstated by the amount of the reduction in
deferred revenue attributable to the foreign exchange losses. This treatment casts doubt on
the credibility of JR’s work.
Conclusion
My review of the working capital components has revealed many instances where working
capital has likely been overstated, resulting in an overstated purchase price. Given the
frequency of these upside accounting treatments, there appears to be a pervasive bias
towards overstating the purchase price. My review has also revealed a few adjustments that
cast serious doubt on the credibility of JR’s work, unless the issues were immaterial on a
consolidated basis.
RAD’s bias, as well as possible deficiencies in JR’s work, should be taken into consideration
during any future negotiations concerning the restatement of the consolidated working capital.

Case 11-5
To: Mr. R. Allen, CFO

From: CPA, Finance Director
Re: Accounting issues for fiscal Year 3
As MCI is a public company, our main objective is to present to investors the best possible
picture of profits. However, the auditors may believe that the accounting policies chosen are
too aggressive. The report that follows recommends and seeks to justify the selection of
accounting policies under IFRS. The auditors will look at the substance of each transaction
before recommending an accounting treatment and will concentrate on the unusual
transactions that have arisen this year. My report focuses on these transactions.
Change in presentation currency
In order to decide whether the change in reporting currency to U.S. dollars should be applied
prospectively or retrospectively, we must first examine the events that led to the change. Was
it necessitated by a change in events that occurred this year, or did the same circumstances
exist in prior years? Was it caused by a change in the functional currency or simply a change
in the presentation currency?
In the past, U.S. operations were probably not material and the Canadian dollar was probably
the functional currency for MCI. That would have been the reason for using the Canadian
dollar as the reporting currency in the past. If the expansion into the U.S. in Year 3 caused the
functional currency for MCI to change from the Canadian dollar to the U.S. dollar, then it was a
change in event (i.e., a change in estimate) that caused the change in functional currency. If
the change to the U.S. dollar as the presentation currency is due to the change in functional
currency to the U.S. dollar, then the new policy should be applied prospectively.
If MCI’s functional currency was and is still the Canadian dollar and MCI is simply switching the
presentation currency from the Canadian dollar to the U.S. dollar for the convenience of the
users of the financial statements, this change in presentation currency would represent a
change from one acceptable policy to another acceptable policy. A company has a free choice
to use any currency as its presentation currency. This would be viewed as a change in

accounting policy and would be applied retrospectively as per IAS 8.
I assume that the Canadian dollar remains the functional currency of MCI and that the change
in presentation currency to the U.S. dollar was a change in accounting policy.
Treatment in current and prior years' financial statements of existing cumulative gains from
foreign exchange arising from the U.S. operations
The cumulative foreign exchange gain arose in the past from translating assets and liabilities
at the closing rate at the end of each reporting periods. If the change in policy were being
applied prospectively because of a change in functional currency, the cumulative foreign
exchange gain would be retained as a separate component of shareholders’ equity. It would
be transferred to net income when this exchange gain is realized when the foreign operation to
which it pertains is sold.
If the change in policy is applied retrospectively due simply to a change in presentation
currency, all prior years’ financial statements must be restated to U.S. dollars as the reporting
currency. The cumulative exchange gain from translating to Canadian dollars in past years
would disappear and would be replaced with an exchange gain or loss from translating to U.S.
dollars for all past years. The cumulative exchange gain or loss would still be reported as a
separate component of shareholders’ equity.
Translation of Canadian operations to U.S. dollars in the current year
Since MCI uses the Canadian dollar for internal record keeping and since MCI’s financial
statements will be presented in U.S. dollars, the Canadian operations will have to be translated
into U.S. dollars. It is appropriate for MCI to use the Canadian dollar for internal record keeping
because the Canadian dollar is likely to be its functional currency i.e. MCI’s Canadian
operations are primarily carried out in Canada and most transactions would be denominated in
Canadian dollars. Since the presentation currency is different than the functional currency,
MCI’s financial statements would be translated into U.S. dollars using the PCT method as
follows as per IAS 21:
(a) assets and liabilities for each statement of financial position presented (i.e. including
comparatives) shall be translated at the closing rate at the date of that statement of
financial position;
(b) income and expenses for each statement presenting profit or loss and other
comprehensive income (i.e. including comparatives) shall be translated at exchange
rates at the dates of the transactions; and
(c) all resulting exchange differences shall be recognized in other comprehensive income.
The exchange differences referred to in (c) above result from:

(a) translating income and expenses at the exchange rates at the dates of the transactions
and assets and liabilities at the closing rate
(b) translating the opening net assets at a closing rate that differs from the previous
closing rate.
The change in accounting policy will result in a new foreign exchange exposure, and new
foreign exchange gains or losses will be created. The residual U.S. exchange gain and the
Canadian gain or loss may be combined or reported separately.
The nature of the changes in presentation and their impact on the financial statements should
be disclosed.
Investment in a high inflation country
The investment in the South American company should be consolidated since MCI appears to
have control over dividend payments and the appointment of the radio network's board
members and key executives. Even though the government may have been unstable in the
past, it appears to be stable now. The conditions imposed by the government do not impede
MCI's rights to the future economic benefits produced by the company. The restrictions are
very similar to those imposed by Canadian regulations (although perhaps more restrictive) and
do not appear to impede control. In addition, the government is democratic and wishes to open
up its borders. It is therefore unlikely the government will do anything to tarnish its image and
inhibit potential future investment.
It appears that the functional currency of the South American company would likely be the
currency of the South American country. It is likely that the sales market and labour would
come from the South American company. The subsidiary’s financial statements would be
translated to U.S. dollars for consolidation purposes. The modified PCT method would be
used. Prior to translation, the subsidiary must restate its financial statements in accordance
with IAS 29. Under IAS 29, the current year’s figures and comparative amounts must be
stated in terms of the measuring unit current at the end of the reporting period. After the
restatement, all assets and liabilities are stated at fair value or a price-level-adjusted amount,
which may approximate fair value. When these items are translated using the modified PCT
method, the translated values will approximate the fair values in terms of the reporting
currency.
Allocating acquisition cost for Cyril’s holdings (CH)
The acquisition cost of Cyril’s Holding (CH) must be allocated to the net assets acquired. The
longer the delay in making the allocation, the more likely it is that events in the intervening
period will have affected the values. Since the operations that have been sold are spread out
and are not part of MCI's core business, it is reasonable that the allocation might take some
time.
The fact that the assets were purchased with the intention of disposing of some of them affects
the method of determining the value assigned to each asset. Any assets disposed of will be
measured at their net realizable value as opposed to their value in use.
The allocation of the acquisition cost is only an estimate and therefore the auditors will accept
the fact that actual values will vary. The gain on sale of the hotel and recreational property may
have resulted from an inappropriate allocation of the acquisition cost. If that is the case, some
consideration should be given to adjusting goodwill or some other assets on the balance
sheet.
The auditors may be concerned that income is overstated. However, if there is no reasonable
basis to arrive at a more appropriate allocation of the acquisition cost, then the entire gain
should be reflected in income of the period. The assets can be segregated on the balance
sheet if there is a formal plan of disposal.
Customer lists

To increase its share of the market, MCI bought all the assets of a competing newspaper,
ceased publication, and liquidated the assets. A loss was incurred on the sale of the assets.
The accounting treatment of the loss depends on the intent of MCI management when the
competing newspaper was purchased. If the intent was to continue operating the newspaper,
then the loss on sale was not expected and the loss should be recognized on the income
statement in this period. If MCI intended to cease operations and sell the asset, then the loss
may not have been unexpected. In essence, MCI paid $5.5 million for a customer list and has
increased its share of the market by eliminating the competition. Given these facts, MCI should
capitalize the $5.5 million loss as an intangible asset called customer lists in accordance with
paragraph 21 of IAS 38 Intangible Assets. MCI is likely to prefer this treatment.
Rationalization of television and cable business
As part of MCI’s rationalization efforts, MCI has segregated a pool of assets on its balance
sheet and reported them as current assets. IFRS 5.3 allows this treatment only if the assets
meet the criteria to be classified as held for sale. The criteria are described below.
An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying
amount will be recovered principally through a sale transaction rather than through continuing
use (paragraph 6 of IFRS 5). For this to be the case, the asset (or disposal group) must be
available for immediate sale in its present condition subject only to terms that are usual and
customary for sales of such assets (or disposal groups) and its sale must be highly probable
(paragraph 7 of IFRS 5). For the sale to be highly probable, the appropriate level of
management must be committed to a plan to sell the asset (or disposal group), and an active
program to locate a buyer and complete the plan must have been initiated. Further, the asset
(or disposal group) must be actively marketed for sale at a price that is reasonable in relation
to its current fair value. In addition, the sale should be expected to qualify for recognition as a
completed sale within one year from the date of classification, except as permitted by
paragraph 9, and actions required to complete the plan should indicate that it is unlikely that
significant changes to the plan will be made or that the plan will be withdrawn (paragraph 8 of
IFRS 5).
It appears that MCI has met these criteria. Accordingly, it is appropriate that the assets be
reported as current assets. However, the measurement of these assets is inappropriate.
At present, MCI is capitalizing operating results for these assets i.e. adding the loss to or
deducting the profit from the carrying amount of these assets. Paragraph 15 of IFRS 5 requires
that an entity measure a non-current asset (or disposal group) classified as held for sale at the
lower of its carrying amount and fair value less costs to sell. The operating results should be
reported in net income as usual except that depreciation of these assets should cease once
they are classified as held for sale.
A disposal group is defined in IFRS 5 as a group of assets to be disposed of, by sale or

otherwise, together as a group in a single transaction, and liabilities directly associated with
those assets that will be transferred in the transaction. It appears that MCI is selling these
assets separately and not as a group. As such, each asset should be reported and measured
separately. If one asset has a carrying amount in excess of fair value less costs of disposal,
this asset should be written down and assets with a fair value less costs in excess of carrying
amount shall be retained at carrying amount.
Internally generated intangibles
This year, MCI has capitalized $60 million as intangibles. This is the appraised value of
internally generated intangibles, the costs of which have been expensed over the past ten
years. This action is not allowed under the revaluation option in IAS 38 because the
revaluation model does not allow the revaluation of intangible assets that have not previously
been recognized as assets as per IAS 38.76.
It appears the MCI had been expensing costs of the subscriptions drives in the past
presumably because there was uncertainty as to the future benefits of these costs. MCI cannot
go back and capitalize these costs on a retrospective basis unless errors were made in the
past.
There may be an argument for capitalizing the cost of subscription drives. The argument
hinges on whether the subscription drives are required in order to replace subscribers lost due
to normal attrition or whether such drives are a major effort undertaken only every few years. If
this cost arises annually, then it should not be capitalized as it is recurring. However, if the cost
increases the subscriber base and this increase will last for more than the current period, then
capitalization makes sense. The amortization period for these intangibles should be until the
next major subscriber drive.
The cost of intangibles includes a patented converter that was an unplanned by-product of
work being done in another area. If the development costs pertaining to the satellite
communication device were capitalized, then the portion pertaining to the patent converter
could be transferred to a separate account. If the development costs were expensed, none of
these costs can be retrospectively capitalized unless errors are being corrected.
Amortization of Intangibles
Intangible assets with finite lives must be amortized over their useful lives. If the intangible
assets have indefinite lives, then they do not have to be amortized but must be checked for
impairment on an annual basis. MCI should have amortized intangibles with finite lives in its
December 31, Year 2 financial statements as per IAS 38.
To minimize the impact of amortization, MCI can use the sinking fund method if the benefits
from using the assets increase over time. This method will result in low amortization in the
early years.
Sale of receivables
MCI sold $25 million of its accounts receivable to a financial intermediary and received half of
the consideration in cash and half in shares. Dividend payments and share redemption are
based on how much is collected.
IFRS 15 provides some guidance as to how to classify the transfer of receivables. We
must consider whether the risks and rewards of ownership have been transferred. Since half
the payments depend on the collection of the accounts receivable, the risks of ownership have
not been transferred. Furthermore, the purchaser has an option to return the receivables to
MCI at any time for 94% of their face value. Given those restrictions, it is difficult to justify
recording the transaction as a sale.
The receivables should remain on MCI's balance sheet and should be reported at net
realizable value on an annual basis. The shares received will be recorded as an investment,
and dividends will be recorded as revenue when received. To offset the debit recorded for the
cash and shares received, a liability will need to be set up that is net of the 4% discount. The
liability will be reduced as the receivables are collected.
The investment in preferred shares should be reported at cost unless there is impairment. .
The investment should be written down to fair value if there is a permanent impairment. The
impairment loss should be reported in net income.
Fibre optic cables
MCI has invested in the installation of fibre optic cable. To satisfy MCI's objectives the cost of
installation should be capitalized. The cost can be allocated evenly to all 36 cables or to the 6
cables that MCI is currently using. Allocating the cost to the 36 cables installed will increase
net income by reducing the cost of goods sold.
Purchasers of the cables must pay a monthly fee to cover their share of all maintenance
expenses. The fee can be recorded as revenue or can offset maintenance expenses. Credit
balances should be deferred.
More information is required on the cables that are being leased to determine whether they
should be accounted for as financing or operating leases depending on whether the
substantial benefits and risks have been transferred.
Case 11-6
To: Kate Horne

From: CPA
Subject: Planning memo for audit engagement
There are several potential areas of non-compliance with GAAP within the current Foreign
Infants Adoption Inc. (FIA) financial statements that need to be addressed now that CIC
requires audited financial statements. These items are discussed below.
Revenue Recognition
Currently, revenue is recorded on FIA services when payments are due. Therefore, 50% of the
adoption fees are recorded up front and 50% of the fees are recorded one month prior to
adoption finalization. We need to determine what revenue recognition method is appropriate
under IFRS. Since FIA performs multiple services as part of each adoption contract, the first
step is to determine whether the various services can be accounted for separately for revenue
recognition purposes.
Under IFRS 15, in situations with multiple deliverables, the delivered item (or items) should be
considered a separate unit of accounting if all of the following criteria are met:

(a) The delivered item has value to the customer on a stand-alone basis. That item has value
on a standalone basis if it is sold separately by any vendor or the customer could resell the
delivered item on a stand-alone basis.
(b) There is objective and reliable evidence of the fair value of the undelivered item (or items).
(c) If the arrangement includes a general right of return relative to the delivered item, delivery
or performance of the undelivered item is considered probable and substantially in the control
of the vendor.
In this case, the various services provided by FIA do not appear to represent separate units of
accounting. Each step likely does not represent value to the customer on a stand-alone basis,
since the steps do not have individual value if, in the end, an adoption is not finalized. In
addition, it may be difficult to determine the fair value of the undelivered services unless others
sell similar services on a stand-alone basis. As a result, I do not believe that the various
services can be separated for accounting purposes. Therefore, we will evaluate the services as
a single unit of accounting
Revenue should be recorded when performance has been achieved provided that at the time
of performance ultimate collection is reasonably assured. For long-term contracts, performance
would usually be measured based on the percentage of completion method. Such
performance should be regarded as having been achieved when reasonable assurance exists
regarding the measurement of the consideration that will be derived from rendering the service
or performing the long-term contract. The following factors should be used to assess
performance:
1. Persuasive evidence of an arrangement exists.
2. Services have been rendered.
3. The seller’s price to the buyer is fixed or determinable.
The first criterion is met at the time the contract is signed between FIA and the adoptive
parents. The third criterion is also met at the same time because the all-inclusive fee of
$25,000 is agreed upon. However, the timing of the second criterion may be difficult to
determine. FIA needs to establish when their services have been rendered, but it is clear that
their current timing of revenue recognition (based on payments) does not match the point at
which a significant amount of service has been performed. Given that the adoption process is
lengthy, up to two years, there are several different points in the process where revenue
recognition may be acceptable.
One alternative would be to record revenue when the Child Proposal is received from the
foreign country. At this point it is probable that the child will be adopted and the process will
continue until concluded. Recognition before this point would not seem appropriate because
FIA is dealing with foreign governments that may change rules and regulations quickly, as
evidenced by the Sudanese decision to stop allowing adoptions by Canadian families. At this
point, all that remains to be done is for the parents to travel to the foreign country to greet their
child. FIA could argue that virtually all of their services have been performed at this time
because they’ve arranged for the adoption and all the costs leading up to this point, except for
the travel costs, which they do not cover. On the other hand, FIA is still responsible for
accompanying the families to the foreign country and assisting them in finalizing the adoption.
Therefore, it appears that there are still some services to be provided by FIA.
A second alternative would be to record revenues when the child is legally adopted. At this
point, almost all of FIA’s responsibilities have been completed and the adoption process is
essentially complete. The only remaining service that FIA would need to perform would be to
complete the post-adoption report. This appears to be a minor task, and is really just a follow-
up measure to be performed once the adoption is final. This alternative is conservative as it
requires FIA to wait until virtually the end of the contract before recognizing any revenue.
However, this treatment may be appropriate given that, until the adoption is finalized, there is a
risk that it will fall through, evidenced by the cancellation of the Sudanese adoptions in
progress. It is not clear whether FIA or the adoptive parents bear the risk in the event that an
adoption falls through due to uncontrollable circumstances. If FIA bears the risk and, as a
result, there is uncertainty about the revenue, then waiting until the adoption is finalized may
be appropriate.
A third alternative would be to record revenue on some type of a percentage of completion

basis based on the amount of work that FIA performs during each stage of the adoption
process. This would be similar to the percentage of completion method used in long-term
construction projects. This alternative makes some sense since the adoption process can span
two or more years.
Based on the information we have to date, it appears that FIA should record revenue
throughout the contract using a percentage of completion approach. To do this, we will need to
determine how to measure the percentage of the contract that has been completed. For
example, since there are four steps, FIA could record 25% of revenue at the completion of
each step if the amount of effort expended is equal for each step. However, some steps may
require more work by FIA, so a better solution may involve recording revenue in proportion to
the costs incurred for each of the steps.
For now, we will assume that the percentage of work that FIA has completed to date is equal
to the percentage of costs incurred for each of the steps. As a result, the current financial
statements are misstated because FIA recognized the revenue too soon. Based on the
information supplied, 269 families are waiting for a Child Proposal at June 30, Year 8.
Therefore, under the current practice of recognizing revenue when received, FIA has
recognized $3,362,500 (269 × $25,000 × 50%) in relation to these adoptions in progress at
June 30, Year 8. However, using the costs incurred to date, FIA has only completed 20% of
the contract ($4,100 ÷ 20,000). As a result, they should only recognize 20% of the total
contract revenue; in other words, $1,345,000 ($25,000 × 20% × 269). Therefore, the Year 8
revenue is overstated by $2,017,500. This amount should be recorded as deferred revenue
until additional steps in the adoption process have been completed.
Adoption-Related Expenses
Assuming the above revenue recognition policy is chosen, expenses will be matched to
revenue as costs arise as the basis for determining FIA’s performance of the contract services.
Currently, FIA is recording expenses when it receives an invoice or when it pays an amount.
This is similar to a cash basis approach, whereas GAAP requires that accrual accounting be
followed. As a result, we will have to explain to Roger that he needs to keep better track of his
expenses and be aware of when a service is performed or goods are received, as this is when
the expense and liability should be recorded. We do not have enough information at the
current time to adjust the expenses or payables, but we will need to look into this further to
ensure the timing is appropriate.
Chinese Foreign Subsidiary

During the year, FIA set up a company in China to handle the administration of adoptions in
that country. FIA incurred various expenses related to these activities. The Chinese operation
is considered a foreign subsidiary of FIA. There are several issues that must be addressed
from an accounting perspective with respect to this foreign subsidiary.
Currently FIA records the transactions of the Chinese subsidiary in one line on the income
statement. This is not the correct accounting treatment. FIA must consolidate this Chinese
subsidiary according to IFRS 10.
For purposes of foreign currency translation, we must determine whether the subsidiary’s
functional currency is the Canadian dollar or another currency. In general, if the operation is
more of a department or extension of FIA’s regular operations, its functional currency would
likely be the Canadian dollar. If the operation is a stand-alone operation with few transactions
and little reliance on FIA, its functional currency would not likely be the Canadian dollar. While
there are a few factors that would suggest that the functional currency might be the Chinese
currency, (most of its activities are conducted in China in local currencies and its costs are
almost all incurred in China), I would suggest that its functional currency is the Canadian dollar.
My reasons are as follows: it is acting as an extension of FIA and gets all of its funding through
FIA; there are extensive transactions between FIA and the subsidiary; and the subsidiary’s
day-to-day operations are dependent on FIA.
The translation of financial statements when the functional currency is the Canadian dollar
should be done using the functional currency translation method. This would require monetary
items (cash balances, etc.) to be translated at the exchange rate in effect on the balance sheet
date. Non-monetary items (such as capital assets) should be translated at historical exchange
rates. Revenue and expense items should be translated in a manner that produces
substantially the same reporting currency amounts that would have resulted had the underlying
transaction been translated on the dates they occurred (usually the average exchange rate for
the period). Depreciation of assets would be translated at the historical rates similar to the
rates of the underlying assets. Any exchange gains and losses arising on the translation of
financial statements into the entity’s functional currency would be accounted for in the current
period.
We have also noted that the list of expenditures includes items that should be capitalized and
depreciated over their useful lives (furniture, fixtures, and computers). There will also likely be
additional assets and liabilities, such as cash in bank accounts and common shares, which
would need to be recorded. In addition, separate financial statements will probably need to be
generated for the Chinese operation.
Cancellation of the Sudanese Adoption Program

As a result of the Sudan government’s decision to stop allowing adoptions of Sudanese infants
by Canadian citizens, FIA may have additional unrecorded liabilities. It is not clear whether the
Sudanese government will provide a refund to FIA for the families who have already begun the
process of adopting a child from Sudan. Regardless of whether or not FIA receives any money
from Sudan, FIA may be required to refund the initial $12,500 deposit made by these families.
It is not clear from the case facts if this fee is refundable. It is also not clear whether some of
the steps already taken may need to be repeated if the families decide to continue to work with
FIA to adopt a child from a different country. If not already done, FIA should clearly establish in
its adoption contracts who will bear the risk in the event an adoption falls through in the future,
the client or FIA.
In this case, FIA has already incurred $155,800 in costs (38 families × $4,100) related to the
Sudanese applications and has recognized the first half of the revenue, $475,000 (38 families
× $12,500). If we assume that the deposit is refundable and the families do not wish to adopt
from another country, then retained earnings would be overstated by $319,200 ($475,000 −
$155,800). If the families decide to adopt from another country, we will need to determine
whether any of the steps performed as part of the adoption application process will have to be
repeated and, as a result, what additional expenses FIA will incur. For example, the home
assessment report may still be valid but a different adoption proposal would probably need to
be completed. Therefore, some of the initial costs of $4,100 will need to be incurred again for
the new country, thereby decreasing the amount of margin earned on these adoption
contracts. We will need to determine what the 38 families affected by the cancellation of the
Sudanese program are planning to do and what FIA’s responsibility is in terms of refunding the
initial deposit.
Money Held in Trust

CIC is now requiring all money received from families to pay for international adoption
expenses to be held in a segregated trust account until the expenses are incurred. Therefore,
FIA must physically separate a portion of the money it has received from adopting parents and
present this as restricted cash on the balance sheet. Since FIA has received $12,500 per
family and has only spent $4,100 per family on adoption related expenses to date, FIA should
segregate $2,259,600 (269 families × $8,400 per family) on its balance sheet and record these
amounts as restricted funds.
Gross versus Net Recording

FIA is recording the full amount of the money that it receives from each family as revenue and
is recording the costs that it incurs on behalf of each family as expenses.
FIA could make the argument that a portion of the revenue relating to the payment of
adoption-related expenses is simply a “flow-through” amount, and that FIA is administering

these payments on behalf of its clients but that the money does not really belong to FIA. Under
this accounting treatment, FIA would not record $20,000 of the money that it receives from
each family as revenue on the basis that it is required to pay for the families specific adoption
expenses. Instead, only the net amount of fees collected by FIA, if any, above the expenses
incurred would be recorded in income.
However, the counter argument is that FIA is exposed to the risks and rewards related to the
out-of-pocket expenses. From the information we have obtained thus far, it appears that FIA
receives $25,000 in fees per adoption contract regardless of what the actual total expenses
add up to. In other words, FIA does not provide a refund to parents if the costs amount to less
than $20,000, and the parents do not cover any additional costs if they exceed $20,000. As a
result, FIA may incur a loss on an adoption contract if the administrative and overhead costs
amount to more than $5,000. On the other hand, FIA stands to earn more than $5,000 per
contract if its out-of-pocket expenses are lower than anticipated. We will need to review the
contracts signed between FIA and the adoptive parents to confirm which party maintains the
risks associated with the payments. However, if the assumptions we have made above are
correct, the fees should be recorded on a gross basis in accordance with IFRS 15.

SOLUTIONS TO PROBLEMS
Problem 11-1
(a) (i)
Retained earnings Dec. 31, Year 1 US 7,000,000)
Profit – Year 2 1,500,000)
8,500,000)
Retained earnings Dec. 31, Year 2 7,480,000)
Dividends Year 2 US 1,020,000)
Net monetary position

US$ Cdn$
Balance Jan 1, Year 2
(4,700 + 900 – 4,800 – 2,400) (1,600,000))  1.10 (1,760,000))
Changes – Year 2
Sales 30,000,000)  1.08 32,400,000)
Purchases (23,400,000)  1.08 (25,272,000)
Other expenses (3,800,000)  1.08 (4,104,000)
Dividends (1,020,000)  1.07 (1,091,400)
Calculated monetary position 172,600)
Actual monetary position
(6,100 + 780 – 4,800 – 1,900) 180,000)  1.05 189,000)
Exchange gain – Year 2 16,400)
(a) (ii)
Income statement –Year 2
US$ Cdn$
Sales 30,000,000  1.08 32,400,000)

Cost of purchases 23,400,000 x 1.08 25,272,000
Change in inventory 600,000 calc* 888,000
Depreciation expense 700,000  1.10 770,000)
Other expenses 3,800,000  1.08 4,104,000)

Exchange gain (16,400)
28,500,000 31,017,600)
Profit 1,500,000 1,382,400
* Calc. of change in inventory

Inventory – Year 1 6,300,000  1.10 6,930,000)
Inventory – Year 2 5,700,000  1.06 6,042,000)
600,000 888,000)
Retained Earnings Statement – Year 2

Bal. Jan 1 7,000,000)  1.10 7,700,000)
Profit 1,500,000) 1,382,400
8,500,000) 9,082,400)
Dividends 1,020,000)  1.07 1,091,400)
Bal. Dec 31 7,480,000) 7,991,000)
Statement of Financial Position – December 31, Year 2

Plant and equipment (net) 6,600,000)  1.10 7,260,000)
Inventory 5,700,000)  1.06 6,042,000
Accounts receivable 6,100,000)  1.05 6,405,000)
Cash 780,000)  1.05 819,000)
19,180,000) 20,526,000)
Ordinary shares 5,000,000)  1.10 5,500,000)

Retained earnings 7,480,000) 7,991,000)
Bonds payable 4,800,000)  1.05 5,040,000
Current liabilities 1,900,000)  1.05 1,995,000)
19,180,000) 20,526,000)
(b) (i) US$ Cdn$

Net assets Year 1 12,000,000)  1.10 13,200,000)
Profit – Year 2 1,500,000)  1.08 1,620,000)
Dividends – Year 2 (1,020,000)  1.07 (1,091,400)
Calculated net assets ) 13,728,600)
Actual net assets – Year 2 12,480,000)  1.05 13,104,000)
Exchange loss – Year 2 (to be reported in other comprehensive income) 624,600)
(b) (ii)
Sales 30,000,000  1.08 32,400,000
Cost of purchases 23,400,000  1.08 25,272,000
Change in inventory 600,000 x 1.08 648,000
Depreciation expense 700,000  1.08 756,000
Other expenses 3,800,000  1.08 4,104,000
Total 28,500,000 30,780,000
Profit 1,500,000  1.08 1,620,000
Other comprehensive income (loss) – unrealized exchange gain (loss) (624,600)
Comprehensive income (loss) 995,400
Bal. January 1 7,000,000  1.10 7,700,000)

Profit 1,500,000 x 1.08 1,620,000)
8,500,000 9,320,000)
Dividends 1,020,000  1.07 1,091,400)
Bal. December 31 7,480,000 8,228,600)
Statement of Financial Position – December 31, Year 2

US$ Cdn$
Plant and equipment (net) 6,600,000  1.05 6,930,000)
Inventory 5,700,000  1.05 5,985,000
Accounts receivable 6,100,000  1.05 6,405,000)
Cash 780,000  1.05 819,000)
) 19,180,000 20,139,000)
Ordinary shares 5,000,000  1.10 5,500,000)

Retained earnings 7,480,000 8,228,600)
Accumulated foreign exchange adjustments (624,600)
Bonds payable 4,800,000  1.05 5,040,000)
Current liabilities 1,900,000  1.05 1,995,000)
19,180,000 20,139,000)
(c)
The answer to both of these questions depends on whether other comprehensive income
(OCI) and accumulated foreign exchange adjustments (AFEA) are included (B1 below) or
excluded (B2 below) from the calculations as indicated by the following:
A B1 B2
Total debt 7,035 7,035 7,035
Total equity including AFEA 13,491 13,104
Total equity excluding AFEA 13,729
Debt to equity ratio .52 .54 .51
Profit 1,382 1,620

Comprehensive income 995
Total equity including AFEA 13,491 13,104
Total equity excluding AFEA 13,729
Return on shareholders’ equity 10.2% 7.6% 11.8%
(i) The strongest solvency position is shown under B2 where the functional currency is the US
dollar and shareholders’ equity excludes the accumulated foreign exchange losses.
(ii) The best return on shareholders’ equity is shown under B2 where the functional currency is
the US dollar but the profit rather than comprehensive income is used as the numerator.
Problem 11-2
Cost of 40% investment in Sandora US$6,400,00
0
Carrying amounts of Sandora’s net assets:
Ordinary shares US$5,000,
000
Retained earnings 7,000,000
Total shareholders’ equity 12,000,000
% acquired 40% 4,800,000
Acquisition differential, December 31, Year 1 1,600,000

Allocation:
Plant (40% x 600,000) 240,000
Balance—Goodwill US$1,360,00
0
Balance Amortization Balance

Dec. 31, Year 1 Year 2 Dec. 31, Year 2
Plant US$ 240,000 US$ 15,000 US$ 225,000
Goodwill 1,360,000 500,000 860,000
US$1,600,000 US$515,000 US$1,085,000
(a) Use rate of US$1 = C$1.10 for all items in acquisition differential because all items are
measured at historical cost.
Balance Amortization Balance
Dec. 31, Year 2 Dec. 31,
Year 1 Year 2
Plant C$ 264,000 C$ 16,500 C$ 247,500
Goodwill 1,496,000 550,000 946,000
C$1,760,000 C$566,500 C$1,193,500
(b) Rates: #1 is US$1  C$1.10; #2 is US$1 = C$1.08; US$1 = C$1.05

Balance1 Amortization2 Unadjusted Exchange Adjusted
Balance3
Dec. 31, Year 2 Dec. 31, Adjustme Dec. 31, Year 2
Year 1 Year 2 nt
Plant C$ 264,000 C$ 16,200 C$ 247,800 C$11,550 C$236,250
Goodwill 1,496,000 540,000 956,000 53,000 903,000
C$1,760,00 C$556,200 C$1,203,800 C$64,550 C$1,139,250
0
Journal entries C$ as FC US$ as FC

Dec. 31, Year 1
Investment in Sandora 6,400,000 6,400,000
Cash 6,400,000 6,400,000
Sept. 30, Year 2

Cash (1) 436,560 436,560
Investment in Sandora 436,560 436,560
Dec. 31, Year 2

OCI – exchange adjustment (4) 249,840
Equity method income (2) 552,960
Equity method income (3) 648,000
Equity method income 566,500 556,200

OCI – exchange adjustment 64,550
Report amortization/impairment of acquisition differential
Notes:
1) .4 x 1,091,400 = 436,560
2) .4 x 1,382,400 = 552,960
3) .4 x 1,620,000 = 648,000
4) .4 x 624,600 = 249,840
Problem 11-3
(a) Arkenu’s functional currency is the Canadian dollar
(i) Current monetary position LD Dollars
Balance Jan. 1, Yr. 1 $2,367,000)  0.52 $1,230,840)
(9,670K – 2,433K – 4,870K)
Changes – Year 2
Sales 16,206,000  0.58 9,399,480
Purchases (10,938,000)  0.58 (6,344,040)
Other expenses (1,598,000)  0.58 (926,840)
Dividends (7,081K + 2,741K – 8,271K) (1,551,000)  0.62 (961,620)
2,119,000 1,166,980
Calculated monetary position 2,397,820
Actual position – Dec. 31/ Year 2
(11,361K – 2,005K – 4,870K) $4,486,000)  0.65 2,915,900

Exchange gain – Year 2 $518,080

(ii)
LD Dollars
Income Statement – Year 2:
Sales $16,206,000)  0.58 $9,399,480)
Cost of goods sold 11,461,000 Note 1 6,407,220
Depreciation expense 406,000)  0.52 211,120)
Other expenses 1,598,000)  0.58 926,840)
Exchange gain ) (518,080)
13,465,000) 7,027,100)
Net income $2,741,000) $2,372,380)
Note 1:
Inventory Jan. 1 $2,421,000)  0.52 $1,258,920)
Purchases 10,938,000)  0.58 6,344,040)
Inventory Dec. 31 (1,898,000)  0.63 (1,195,740)
$11,461,000 $6,407,220

Bal. Jan. 1 $7,081,000)  0.52 $3,682,120)
Net income 2,741,000) 2,372,380)
9,822,000) 6,054,500)
Dividends 1,551,000)  0.62 961,620)
$8,271,000) $5,092,880)
Balance Sheet – December 31, Year 2

Current monetary assets $11,361,000)  0.65 $7,384,650)
Inventory 1,898,000)  0.63 1,195,740)
Plant and equipment (net) 6,957,000)  0.52 3,617,640)
$20,216,000) $12,198,030)
Current liabilities $2,005,000)  0.65 $1,303,250)

Bonds payable 4,870,000)  0.65 3,165,500)
Ordinary shares 5,070,000)  0.52 2,636,400)
Retained earnings 8,271,000) 5,092,880)
$20,216,000) $12,198,030)
(b) Arkenu’s functional currency is the Libyan dinar

(i)
LD Dollars
Net assets Dec. 31, Year 1 $12,151,000)  0.52 $6,318,520)

Net Income – Year 2 2,741,000)  0.58 1,589,780)
Dividends – Year 2 (1,551,000)  0.62 (961,620)
Calculated net assets – Dec. 31, Year 2 6,946,680)
Actual net assets – Dec. 31, Year 2 13,341,000)  0.65 8,671,650)
Exchange gain – Year 2 (to be reported in other comprehensive income) $1,724,970)
(ii)
Income Statement – Year 2
Sales $16,206,000)  0.58 $9,399,480
Cost of goods sold 11,461,000 x 0.58 6,647,380

Depreciation expense 406,000)  0.58 235,480
Other expenses 1,598,000)  0.58 926,840
13,465,000)  0.58 7,809,700
Net income $2,741,000)  0.58 1,589,780
Other comprehensive income – unrealized exchange gain 1,724,970
Comprehensive income $3,314,750

Bal. Jan. 1 $7,081,000  0.52 $3,682,120
Net income 2,741,000  0.58 1,589,780
9,822,000 5,271,900
Dividends 1,551,000  0.62 961,620
$8,271,000 $4,310,280

Current monetary assets $11,361,000  0.65 $7,384,650

Inventory 1,898,000  0.65 1,233,700
Plant and equipment (net) 6,957,000  0.65 4,522,050
$20,216,000 $13,140,400
Current liabilities 2,005,000  0.65 1,303,250

Bonds payable 4,870,000  0.65 3,165,500
Ordinary shares 5,070,000  0.52 2,636,400
Retained earnings 8,271,000 4,310,280
Accumulated foreign exchange adjustments 1,724,970
$20,216,000 $13,140,400
(iii)
Investment cost LD 13,700,000
Carrying amount of Arkenu’s net assets 12,151,000
Acquisition differential 1,549,000
Allocated (FV – CA)  100% –0–
Goodwill Dec. 31/ Year 1 LD 1,549,000  0.52 805,480
Impairment loss Year 2 50,000  0.58 29,000
December 31, Year 2
Calculated goodwill 776,480
Actual goodwill LD 1,499,000  0.65 974,350
Exchange gain $197,870
Consolidated goodwill – Dec. 31/ Yr. 2 $974,350
(iv)
Translation of financial statements $1,724,970
Translation of goodwill 197,870
Total Year 2 exchange gains $1,922,840

This will appear as a separate component in consolidated shareholders' equity as accumulated
foreign exchange adjustments.
(c)
The answer to both of these questions depends on whether other comprehensive income
(OCI) and accumulated foreign exchange adjustments (AFEA) are included (B1 below) or
excluded (B2 below) from the calculations as indicated by the following:
A B1 B2
Total debt 4,468,750 4,468,750 4,468,750
Total equity including AFEA 7,729,280 8,671,650
Total equity excluding AFEA 6,946,680
Debt to equity ratio 0.58 0.52 0.64
Net income 2,372,380 1,589,780

Comprehensive income 3,314,750
Total equity including AFEA 7,729,280 8,671,650
Total equity excluding AFEA 6,946,680
Return on shareholders’ equity 30.69% 38.23% 22.89%
(i) The strongest solvency position is shown under B1 where the functional currency is the
Libyan dinar and shareholders’ equity includes the accumulated foreign exchange gains.
(ii) The best return on shareholders’ equity is also shown under B1 where the functional
currency is the Libyan dinar and comprehensive income, which includes the substantial
foreign exchange gain, is used as the numerator.
Problem 11-4
(a)
Consolidated Statement of Profit
for the Year Ended December 31, Year 2
Sales (46,317,000 + 9,399,480) $55,716,480

Dividend income from Arkenu (961,620 – 961,620) 0

55,716,480
Inventory, Jan. 1 (3,532,000 + 1,258,920) 4,790,920

Purchases (30,817,000 + 6,344,040) 37,161,040
Inventory, Dec. 31 (-2,909,000 + -1,195,740) (4,104,740)
Depreciation expense (717,000 + 211,120) 928,120
Other expenses (12,887,000 + 926,840) 13,813,840
Exchange loss (gain) (0 + -518,080) (518,080)
Total expenses 52,071,100
Profit $ 3,645,380
Attributable to:
NCI $ 0
Shareholders of Kelly Corporation 3,645,380
Retained Earnings Statements

for Year Ended December 31, Year 2
Balance, January 1 $ 12,813,000
Profit - 3,645,380
16,458,380
Dividends 1,884,620
Balance, December 31 $14,573,760
Total
$ 961,620
$ 961,620

Consolidated Statement of Financial Position
at December 31, Year 2
Current monetary assets (27,472,000 + 7,384,650) $34,856,650
Inventory (2,909,000 + 1,195,740) 4,104,740
Investment in Arkenu – at cost (7,124,000 – 7,124,000) 0
Plant and equipment (net) (13,644,000 + 3,617,640) 17,261,640
Goodwill (0 + 0 + 805,480) 805,480
$57,028,510
Current monetary liabilities (12,006,000 + 1,303,250) 13,309,250

Bonds payable, due Dec. 31, Year 7 (15,980,000 + 3,165,500) 19,145,500
Common shares 10,000,000
$57,028,510

(b)
Goodwill, at date of acquisition as per Problem 11-3 LD1,549,000

Rate from LD to C$ at Dec. 31, Year 1 x .52
Goodwill, at date of acquisition in C$ 805,480
Rate from C$ to US$ at Dec. 31, Year 1 x .84
Goodwill, at date of acquisition in US$ US$676,603
Goodwill, Dec. 31, Year 2 in US$ (805,480 x .80) 644,384
OCI – Exchange loss US$ 32,219
Calculation of exchange adjustments at end of Year 2:
Kelly C$ Rate Kelly US$
Shareholders’ equity, beginning of year 22,813,000 0.84 19,162,920

Net income excluding dividend income 1,273,000 0.83 1,056,590
Dividend income from Arkenu 961,620 0.82 788,528
Dividends paid (1,884,620) 0.82 (1,545,388)
Shareholders’ equity, end of year 19,462,650
Restate 23,163,000 0.8 18,530,400
OCI - Exchange loss 932,250
Arkenu (C$) Arkenu (UC$)

Shareholders’ equity, beginning of year 6,318,520 0.84 5,307,557
Net income 2,372,380 0.83 1,969,075
Dividends (961,620) 0.82 (788,528)
Restate 7,729,280 0.8 6,183,424
OCI - Exchange loss 304,680

Eliminations
Arkenu Arkenu Consolidate
Kelly (C$) Rate Kelly (US$) (C$) Rate (US$) Dr. Cr. d
$46,317,0 $38,443,1 $ $ $
Sales 00 0.83 10 9,399,480 0.83 7,801,568 $ - $ - 46,244,678
Dividend income Arkenu 961,620 0.82 788,528 0.00 0 2 788,528 0
47,278,620 39,231,638 9,399,480 7,801,568 46,244,678
Inventory, Jan. 1 3,532,000 0.83 2,931,560 1,258,920 0.83 1,044,904 3,976,464

Purchases 30,817,000 0.83 25,578,110 6,344,040 0.83 5,265,553 30,843,663
Inventory, Dec. 31 -2,909,000 0.83 -2,414,470 -1,195,740 0.83 -992,464 -3,406,934
Depreciation expense 717,000 0.83 595,110 211,120 0.83 175,230 770,340
Other expenses 12,887,000 0.83 10,696,210 926,840 0.83 769,277 11,465,487
Exchange loss (gain) -518,080 0.83 -430,006 -430,006
Total expenses 45,044,000 37,386,520 7,027,100 5,832,494 0 43,219,014
$ $
Profit 2,234,620 1,845,118 2,372,380 1,969,074 Total 788,528 0 3,025,664
OCI (932,250) (304,680) 3 32,219 -1,269,149
$ $ $
Comprehensive Income 912,868 1,664,394 2,577,265
Attributable to:
$
NCI 0 0 0 0 -
Shareholders of Kelly Corporation 912,868 1,664,395 3,025,664
$
Total 820,747 $ -
Retained Earnings Statements — for Year 2

$12,813,0 $10,762,9 $ $ $3,092,98 $ $10,762,92
Balance, January 1 00 0.84 20 3,682,120 0.84 3,092,981 1 1 - 0
Abov
Profit 2,234,620 1,845,118 2,372,380 1,969,074 e 788,528 - 3,025,664

15,047,620 12,608,038 6,054,500 5,062,055 13,788,584
Dividends 1,884,620 0.82 1,545,388 961,620 0.82 788,528 0 2 788,528 1,545,388
$13,163,00 $11,062,65 $ $
Balance, December 31 0 0 5,092,880 4,273,527 $12,243,196
$3,881,50 $
Total 9 788,528
Consolidated Statement of Financial Position — at December 31, Year 2

$27,472,0 $21,977,6 $ $ $27,885,32
Current monetary assets
00 0.80 00 7,384,650 0.80 5,907,720 0
Inventory 2,909,000 0.80 2,327,200 1,195,740 0.80 956,592 3,283,792
Investment in Arkenu – at
cost 7,124,000 0.80 5,699,200 0 0.80 0 4 284,960 1 5,984,160 0
Plant and equipment (net) 13,644,000 0.80 10,915,200 3,617,640 0.80 2,894,112 13,809,312
Goodwill 0 0.80 0 0 0.80 0 1 676,603 3 32,219 644,384
$51,149,00 $40,919,20 $12,198,03 $

0 0 0 9,758,424 $45,622,808
$12,006,0 $ $ $ $10,647,40
Current monetary liabilities
00 0.80 9,604,800 1,303,250 0.80 1,042,600 0 0 0
Bonds payable 15,980,000 0.80 12,784,000 3,165,500 0.80 2,532,400 15,316,400
Common shares 10,000,000 0.84 8,400,000 2,636,400 0.84 2,214,576 1 2,214,576 0 8,400,000
Abov Abov Abov Abov
Retained earnings
13,163,000 e 11,062,650 5,092,880 e 4,273,528 e 3,881,509 e 788,528 12,243,197
Abov
Accumulated OCI
(932,250) (304,680) e 32,219 4 284,960 -984,189
$51,149,00 $40,919,20 $12,198,03 $

0 0 0 9,758,424 $45,622,808
$7,089,86 $7,089,86
7 7

JOURNAL ENTRIES
#1 Common shares 2,214,576

Goodwill 676,603
Investment in Arkenu 5,984,160
To eliminate subsidiary's shareholders' equity and allocate acquisition differential at beginning of year
#2 Dividend revenue 788,528

Dividends paid 788,528
To eliminate dividend revenue from S Company
#3 OCI- exchange adjustment 32,219

Goodwill 32,219
To remeasure goodwill at closing rate
#4 Investment in Arkenu 284,960

OCI - exchange adjustment 284,960
To reverse OCI pertaining to investment account
(c)
Notes: See below for summary of journal entries.
Canadian dollar is presentation currency (FCT method)

Eliminations
Kelly Arkenu Dr. Cr. Consolidated
Sales $ 46,317,000 $ 9,399,480 $ - $ - $55,716,480

Dividend income from Arkenu 961,620 2 961,620 0
47,278,620 9,399,480 55,716,480
Inventory, Jan. 1 3,532,000 1,258,920 4,790,920

Purchases 30,817,000 6,344,040 37,161,040
Inventory, Dec. 31 -2,909,000 -1,195,740 -4,104,740
Depreciation expense 717,000 211,120 928,120
Other expenses 12,887,000 926,840 13,813,840
Exchange loss (gain) -518,080 -518,080
Total expenses 45,044,000 7,027,100 52,071,100
Profit $ 2,234,620 $ 2,372,380 $ 3,645,380
Attributable to:
NCI 0 0 $ -
Shareholders of Kelly Corporation 3,645,380
Total $ 961,620 $ -

Balance, January 1 $ 12,813,000 $ 3,682,120 1 3,682,120 $ - 12,813,000
Profit 2,234,620 2,372,380 Above 961,620 - 3,645,380
15,047,620 6,054,500 16,458,380
Dividends 1,884,620 961,620 0 2 961,620 1,884,620
Balance, December 31 $ 13,163,000 $ 5,092,880 $14,573,760

Total $ 4,643,740 $ 961,620

Current monetary assets $ 27,472,000 $ 7,384,650 $34,856,650
Inventory 2,909,000 1,195,740 4,104,740
Investment in Arkenu – at cost 7,124,000 0 0 1 7,124,000 0
Plant and equipment (net) 13,644,000 3,617,640 17,261,640
Goodwill 1 805,480 805,480

$ 51,149,000 $ 12,198,030 $57,028,510
Current monetary liabilities $ 12,006,000 $ 1,303,250 0 0 13,309,250

Bonds payable, due Dec. 31, Year
7 15,980,000 3,165,500 19,145,500
Common shares 10,000,000 2,636,400 1 2,636,400 0 10,000,000
Retained earnings 13,163,000 5,092,880 Above 4,643,740 Above 961,620 14,573,760
$ 51,149,000 $ 12,198,030 $57,028,510
Total $ 8,085,620 $ 8,085,620
JOURNAL ENTRIES
1 Common shares 2,636,400

Goodwill 805,480
Investment in Arkenu 7,124,000
2 Dividend revenue 961,620

For US dollar as presentation currency (PCT method), see part (b) above.

Problem 11-5
a)
The following factors indicate that the Canadian dollar is the functional currency:
 EVA sells and distributes equipment manufactured by the parent company, PAL.
 PAL finances EVA’s purchases of PAL’s equipment because PAL allows 90 days for EVA
to pay and EVA will have sold the equipment and received the money from their customers
by then.
The following factors indicate that the Euro is the functional currency:
 EVA continues to sell its equipment in Europe
 EVA will construct a new distribution centre and finance it with EVA’s own retained
earnings
b)
i) Cost of goods sold
Euro Rate $
Beginning inventory 280,000 1.32 369,600
Purchases (Note) 2,045,000 1.28 2,617,600
Available for sale 2,325,000 2,987,200
Ending inventory before write down 325,000 1.26 409,500
Cost of goods sold 2,000,000 2,577,700
Note: 2,000,000 + 325,000 – 280,000 = 2,045,000
ii) Depreciation expense 150,000 1.44 216,000

iii) Inventory 300,000 1.25 375,000*
iv) Unearned revenue 295,000 1.27 374,650
v) Ordinary shares 100,000 1.44 144,000
* The closing rate is used to derive the market value in Canadian dollars under the lower-of-
cost-and-market principle.
c)
The main factors causing the difference in the foreign exchange gains/losses are as follows:

1) the decline in foreign currency reduces the Canadian dollar amount of assets and
liabilities after they are translated at the closing rate
2) under the FCT method, there are more liabilities than assets translated at the
closing rate; this will result in exchange gains
3) under the PCT method, there are more liabilities than assets translated at the
closing rate; this will result in exchange losses
Problem 11-6
(a) FCs Dollars
Cost of 90% of S Company $15,580)  1.10 $17,138

Implied value of 100% 17,311 x 1.10 19,042)
Carrying amount of S Company’s net assets 13,650  1.10 15,015)
Acquisition differential 3,661)  1.10 4,027)
Allocated:
Plant and equipment 2,000)  1.10 2,200)
Goodwill $1,661)  1.10 $1,827)
(i) The Canadian dollar is the functional currency

C = closing rate Dec. 31/4 Av = average rate year 4 H = historical rate
FCs Dollars
Net monetary position – Jan. 1/4 * $(15,450))  1.10H $(16,995)

Sales 210,000)  1.16Av 243,600)
Purchases (132,600 + 12,100 – 9,100) (135,600)  1.16Av (157,296)
Other monetary expenses ** (65,200)  1.16Av (75,632)
Dividends (4,100)  1.22C (5,002)
Calculated position Dec. 31/4 (11,325))
Actual monetary position Dec. 31/4 *** $(10,350)  1.22C (12,627))
Exchange loss – Dec. 31/4 $(1,302))
*$11,100 – $10,550 – $16,000

**$67,200 – depreciation expense of $20,000 / 10

***$19,200 – $13,550 – $16,000

S Company – December 31/4
FCs Dollars
Plant and equipment (net) $18,000)  1.10H $19,800)
Inventory 12,100)  1.19H 14,399)
Monetary assets 19,200)  1.22C 23,424)
$49,300) $57,623)
Ordinary shares $10,000)  1.10H $11,000)

Retained earnings 9,750) see below 10,572)
Bonds payable 16,000)  1.22C 19,520)
Current liabilities 13,550)  1.22C 16,531)
$49,300) $57,623)
Sales $210,000)  1.16Av $243,600)

Cost of sales (132,600) calc. (152,907)
Other expenses (67,200) calc. (77,832)
Exchange loss ) (1,302))
Profit 10,200 11,559
Retained earnings, Jan. 1 3,650)  1.10H 4,015)
Dividends (4,100)  1.22C (5,002)
Retained earnings, Dec. 31 $9,750 $10,572 (a)
Cost of sales
Inventory Jan. 1 $9,100)  1.10H $10,010)
Purchases 135,600)  1.16Av 157,296)
144,700) 167,306)
Inventory Dec. 31 (12,100))  1.19H (14,399))
Cost of sales – calc. $132,600) $152,907)
Other expenses
Depreciation (20,000 / 10 years) $(2,000)  1.10H $(2,200)
Other expenses (65,200)  1.16Av (75,632)
$(67,200) $(77,832)

Acquisition differential amortization schedule
Balance Jan. 1 Amort. Balance
FCs Dollars Dollars Dec. 31/4
Plant and equipment (net) $2,000  1.10 $2,200 $220 $1,980

Goodwill 1,661  1.10 1,827 * 110 1,717
$3,661  1.10 $4,027 $330 $3,697
* Translation of impairment loss
FCs100 x 1.10 = $110
Calculation of consolidated profit – Year 4

P Company – profit $31,802
Less: Dividends from S Company (as recorded) (4,502)
27,300
S Company – profit 11,559
Less: Acquisition diff. amort. (330)
11,229
Profit $38,529
Attributable to:
Shareholders of P Company ((27,300 + (90% x 11,229)) 37,406
Non-controlling interest (10% x 11,229) 1,123
Consolidated Income Statement - Year 4

Sales (411,800 + 243,600) $655,400
Cost of sales (206,400 + 152,907) (359,307)
Other expenses (178,100 + 77,832 + 220) (256,152)
Goodwill impairment loss (110)
Exchange loss (1,302)
(616,871)
Profit $38,529
Attributable to:
Shareholders of P Company 37,406
Non-controlling interest 1,123

Consolidated Retained Earnings Statement – Year 4
Balance Jan. 1 $39,298
Profit 37,406
76,704
Dividends (23,200)
Bal. Dec. 31 $53,504
Calculation of non-controlling interest – Dec. 31, Year 4

Dollars
Ordinary shares (FC10,000  1.10) $11,000)
Retained earnings (a) 10,572)
21,572
Add: unamortized acquisition differential 3,697
25,269
10%)
$2,527

At Dec. 31, Year 4
Plant and equipment (net) (68,800 + 19,800 + 1,980) $90,580)
Goodwill 1,717 )
Inventory (34,400 + 14,399) 48,799)
Monetary assets (31,552 + 23,424) 54,976)
$196,072)
Ordinary shares $34,400)

Retained earnings 53,504)
Bonds payable (46,500 + 19,520) 66,020)
Current liabilities (23,090 + 16,531) 39,621)
) $196,072)

(ii) The foreign-currency unit is the functional currency
FCs Dollars
Net assets – Jan. 1 $13,650)  1.10H $15,015)
Profit – Year 1 10,200)  1.16Av 11,832)
Dividends – Year 1 (4,100)  1.22C (5,002)
Calculated net assets ) 21,845)
Actual net assets – Dec. 31/4 $19,750)  1.22C 24,095)
Exchange gain – Year 1 (to be reported in other comprehensive income) $2,250)
S Company – December 31/4

FCs Dollars
Plant and equipment (net) $18,000)  1.22C $21,960)
Inventory 12,100)  1.22C 14,762)
Monetary assets 19,200)  1.22C 23,424)
$49,300) $60,146)
Ordinary shares 10,000)  1.10H 11,000)

Retained earnings 9,750) calc 10,845)
Accumulated foreign exchange adjustments ) 2,250)
Bonds payable 16,000)  1.22C 19,520)
Current liabilities 13,550)  1.22C 16,531)
49,300) $60,146)
Sales 210,000)  1.16Av 243,600)

Cost of sales (132,600)  1.16Av (153,816)
Other expenses (67,200)  1.16Av (77,952)
Profit $10,200)  1.16Av 11,832
Other comprehensive income – unrealized exchange gain 2,250

Comprehensive income $14,082
Retained earnings, Jan 1 $3,650 x 1.1 $4,015

Profit 10,200 calc 11,832
Dividends (4,100) x 1.22 (5,002)
Retained earnings, Dec 31 $9,750 $10,845
Acquisition differential amortization schedule

Bal. Jan. 1 Amort. Bal. Dec. 31 Rate Dollars
FCs FCs FCs
Plant and equipment (net) $2,000) $200 $1,800 x 1.22 $2,196
Goodwill 1,661) 100) 1,561 x 1.22 1,904
$3,661 $300 $3,361 $4,100
Translated amortization schedule

FCs Dollars
Balance January 1 $3,661 x 1.10H $4,027)
Amortization – Plant and equip. (200)  1.16Av (232)
Goodwill impairment loss (100)  1.16Av (116)
Calculated acquisition differential ) 3,679)
Actual acquisition differential $3,361)  1.22C 4,100)
Exchange gain $421)
Calculation of consolidated accumulated foreign exchange adjustments

Exch. Consolidated
gain 10%** bal. sheet
From translation of S Company $2,250 $225 $2,025
From translation of acquisition differential 421 42 379
Total – Year 4 $2,671 $267 $2,404
**10% non-controlling interest
Calculation of consolidated profit – Year 4

P Company – profit $31,802
Less: Dividends from S Company (4,502)
27,300
S Company – profit 11,832
Less: Acquisition diff. amort
Plant and equipment (232)
Goodwill (116)
11,484
Consolidated profit $38,784
Profit attributable to:
Non-controlling interest (10% x 11,484) 1,148
Consolidated Income Statement – Year 4

Sales (411,800 + 243,600) $655,400
Cost of sales (206,400 + 153,816) (360,216)
Goodwill impairment loss (116)
Other expenses (178,100 + 77,952 + 232) (256,284)
(616,616)
Profit 38,784
Other comprehensive income – unrealized exchange gain (2,250 + 421) 2,671
Comprehensive income $41,455

Non-controlling interest (10% × 11,484) 1,148
Comprehensive income attributable to:

Non-controlling interest (10% × [11,484 + 2,671]) 1,415
Consolidated Retained Earnings Statement – Year 4

Balance Jan. 1 $39,298
Profit 37,636
76,934
Dividends (23,200)
Balance Dec. 31 $53,734
Calculation of non-controlling interest – Dec. 31, Year 4

Common shares (FC10,000  1.10) 11,000
Retained earnings (4,015 + 11,832 – 5,002) 10,845
Unamortized acquisition differential 4,100
Accumulated foreign exchange adjustments from translation of S Company (**) 2,250
28,195
10%
$2,819
**The NCI’s share of the OCI relating to the translation of the acquisition differential is included
in the unamortized acquisition differential.

At Dec. 31, Year 4
Plant and equipment (net) (68,800 + 21,960 + 2,196) $92,956
Goodwill 1,904
Inventory (34,400 + 14,762) 49,162
Monetary assets (31,552 + 23,424) 54,976
$198,998
Common shares $34,400

Retained earnings 53,734
Accumulated foreign exchange adjustments 2,404
Bonds payable (46,500 + 19,520) 66,020
Current liabilities (23,090 + 16,531) 39,621
$198,998
(b) Assuming P Company is a private company, uses ASPE and the equity method.
Method 1
Investment in S Company, beginning of year $17,138
Share of S’s income for Year 4 from consolidated perspective (90% x 11,484) 10,336
Share of dividends paid by S (90% x 5,002) (4,502)
Investment in S Company, end of year, equity method $22,972

Method 2
P Company’s consolidated retained earnings, end of year $53,734
P Company’s retained earnings, end of year under cost method 47,900
Difference between cost method and equity method 5,834
Investment in S Company, cost method 17,138
Investment in S Company, end of year, equity method $22,972

(c)
(c) (i) Canadian dollar as functional currency (FCT method)

Eliminations
P Company S Company Dr. Cr. Consolidated
$
Sales 411,800 $ 243,600 $ - $ - $ 655,400
Dividend income 4,502 3 4,502 0
416,302 243,600 655,400
Cost of sales 206,400 152,907 359,307

Other expenses 178,100 77,832 4 220 256,152
Goodwill impairment loss 4 110 110
Exchange loss 1,302 1,302
Total expenses 384,500 232,041 616,871
$
Profit 31,802 $ 11,559 $ 38,529
Attributable to:
NCI 0 0 5 1,123 $ 1,123
Total $ 5,955 $ -

$
Balance, January 1 39,298 $ 4,015 2 $ 4,015 $ - $ 39,298
Profit 31,802 11,559 Above 5,955 - 37,406
71,100 15,574 76,704
Dividends 23,200 5,002 0 3 4,502 23,200

6 500
$
Balance, December 31 47,900 $ 10,572 $ 53,504
Total $ 9,970 $ 5,002

Plant and equipment (net) $
68,800 $ 19,800 2 $ 2,200 4 $ 220 $ 90,580
Goodwill 0 0 2 1,827 4 110 1,717
Investment in S Company (at cost) 17,138 0 1 1,904 2 19,042 0
Inventory 34,400 14,399 48,799
Monetary assets (current) 31,552 23,424 54,976
$
151,890 $ 57,623 $ 196,072
Ordinary shares $
34,400 $ 11,000 2 11,000 $ 34,400
Retained earnings 47,900 10,572 Above 9,970 Above 5,002 53,504
Non-controlling interest 0 0 6 500 1 1,904 2,527
5 1,123
Bonds payable 46,500 19,520 66,020
Current monetary liabilities 23,090 16,531 39,621
$
151,890 $ 57,623 $ 196,072
Total $ 27,401 $ 27,401
JOURNAL ENTRIES
$
1 Investment in S Company 1,904
Non-controlling interest $ 1,904
To establish non-controlling interest at beginning of year (See Note a)

2 Ordinary shares 11,000
Plant and equipment 2,200
Goodwill 1,827
Investment in S Company 19,042

4 Other expenses 220

Goodwill impairment loss 110
Plant and equipment 220
Goodwill 110
To record amortization and impairment of acquisition differential
5 Non-controlling interest-P&L 1,123

Non-controlling interest-SFP 1,123
To record NCI's share of income for the year
6 Non-controlling interest-SFP 500

Dividends paid 500
To record NCI's share of dividends paid
$
27,401 $ 27,401
Notes:
a) NCI, end of Year 4 $ 2,527
Less: NCI's share of consolidated net income for Year 4 -1,123
Add: NCI's share of S Company's dividends for Year 4 500

$
NCI, beginning of Year 4 1,904

See schedules at start of question to support the numbers used in the journal entries below.
c) Foreign currency as functional currency (PCT method)

Eliminations
P Company S Company Dr. Cr. Consolidated
$
Sales 411,800 $ 243,600 $ 655,400
Dividend income 4,502 3 4,502 0
Gross profit 416,302 243,600 655,400
Cost of sales 206,400 153,816 360,216
Goodwill impairment loss 0 0 4 116 116
Other expenses 178,100 77,952 4 232 256,284
Total expenses 384,500 231,768 616,616
$
Profit 31,802 $ 11,832 $ 38,784

NCI 0 0 6 1,148 1,148
Total $ 5,998 $ -
Other comprehensive income -
Unrealized exchange gain
$ - $ 2,250 5 421 $ 2,671
OCI attributable to:
NCI 0 0 6 267 267

Total $ 267 $ 421
Comprehensive income attributable to:

NCI 1,415
$ 41,455
Retained Earnings Statements — Year 4
$
Balance, January 1 39,298 $ 4,015 2 4,015 $ 39,298
Profit 31,802 11,832 Above 5,998 37,636
71,100 15,847 76,934
Dividends 23,200 5,002 0 3 4502 23,200
7 500
$
Balance, December 31 47,900 $ 10,845 $ 53,734
Total $ 10,013 $ 5,002
Accumulated Foreign Exchange Adjustment — Year 4

$
Balance, January 1 - $ - $ -
OCI for year 0 2,250 Above $ 267 Above $ 421 2,404
Balance, December 31 $ - $ 2,250 2,404
Total $ 267 $ 421
Plant and equipment (net) $

68,800 $ 21,960 2 2,200 4 232 $ 92,956
5 228
Goodwill 0 0 2 1,827 4 116 1,904

5 193
Investment in S Company (at cost) 17,138 0 1 1,904 2 19,042 -
Inventory 34,400 14,762 49,162
Monetary assets (current) 31,552 23,424 54,976
$
151,890 $ 60,146 $ 198,998
Ordinary shares $
34,400 $ 11,000 2 11,000 $ 34,400
Retained earnings 47,900 10,845 Above 10,013 Above 5,002 53,734
Accumulated foreign exchange
adjustments 0 2,250 Above 267 421 2,404
Bonds payable 46,500 19,520 66,020
Current monetary liabilities 23,090 16,531 39,621
Non-controlling interest 0 0 7 500 1 1,904 2,819
6 1,415
$
151,890 $ 60,146 $ 198,998
Total $ 28,132 $ 28,132
JOURNAL ENTRIES
$
1 Investment in S Company 1,904
Non-controlling interest (note a) $ 1,904
To establish non-controlling interest at beginning of year
2 Ordinary shares 11,000

Plant and equipment 2,200
Goodwill 1,827
Investment in S Company 19,042

4 Other expenses 232

Goodwill impairment loss 116
Plant and equipment 232
Goodwill 116
To record amortization and impairment of acquisition differential
5 Plant and equipment 228

Goodwill 193
Exchange gain 421
To recognize exchange adjustment on acquisition differential
6 Non-controlling interest-P&L 1,148

Non-controlling interest-OCI 267
Non-controlling interest-SFP 1,415
To record NCI's share of income for the year
7 Non-controlling interest-SFP 500

Dividends paid 500
To record NCI's share of dividends paid
$
28,132 $ 28,132
Notes:
a) NCI, end of Year 4 $ 2,820
Less: NCI's share of consolidated comprehensive income for Year 4 -1,416
Add: NCI's share of S Company's dividends for Year 4 500
NCI, beginning of Year 4 $ 1,904

Problem 11-7
The inventory must be reported at the lower of cost and net realizable (LC&NRV) value for all
situations.
(a) The inventory would be reported at €20,000 on Athena’s balance sheet before translation
(b) After translation, the inventory would be reported on Athena’s balance sheet at
i. carrying amount in euros x closing rate: €20,000 x 1.20 = $24,000;
ii. cost in $ = €20,000 x 1.27 = $25,400; NRV in $ = €21,000 x 1.20 = $25,200; (LC&NRV)
= $25,200
(c) The parent’s own inventory would have to be carried at LC & NRV = $44,000
i. $44,000 + $24,000 = $68,000
ii. $44,000 + $25,200 = $69,200
Problem 11-8
(a) MAPLE LIMITED
Balance Sheet
December 31, Year 10
€ Rate C$
Cash 100,000 1.66 166,000
Accounts receivable 200,000 1.66 332,000
Inventory 180,000 1.63 293,400
120,000 1.60 192,000
Equipment — net 1,100,000 1.42 1,562,000
1,700,000 2,545,400
Accounts payable 250,000 1.66 415,000

Bonds payable 700,000 1.66 1,162,000
Common shares 100,000 1.42 142,000
Retained earnings (to balance) 650,000 826,400
1,700,000 2,545,400
(b)
Bonds payable, end of year 700,000 1.66 1,162,000
Bonds payable, beginning of year 700,000 1.56 1,092,000
Exchange loss 70,000
The exchange loss would be reported as a foreign exchange loss on the income statement for
the year ended December 31, Year 10.
(c) Items subject to exchange rate exposure (= shareholders’ equity):

Beginning 710,000 1.56 1,107,600
Net income 200,000 1.59 318,000
Dividends (160,000) 1.61 (257,600)
Calculated 1,168,000
Actual 750,000 1.66 1,245,000
Exchange gain (to be reported in other comprehensive income) 77,000
(d)
No, this is not a valid statement. The equipment is reported at historical cost less accumulated
amortization in the euro balance sheet. When a historical cost in euros is multiplied by a
closing rate, the resulting amount is not a current value of the equipment in Canadian dollars.
To get a current value in Canadian dollars, the current value in euros of the equipment is
multiplied by the closing rate.
Problem 11-9
(a)
€ Rate C$
(i) Accounts receivable 197,000 / 0.80 246,250
(ii) Inventory 255,000 / 0.79 322,785
(iii) Equipment 150,000 / 0.60 250,000
200,000 / 0.70 285,714
(iv) Accumulated amortization
200,000 (1/8 × 2) 50,000 / 0.70 71,429
(420,000 – 50,000) 370,000 / 0.60 616,667
(v) Common shares 600,000 / 0.60 1,000,000
(b)

€ Rate C$
(i) Cost of goods purchased 1,080,000 / 0.76 1,421,053
(ii) Amortization expense 130,000 / 0.76 171,053
(iii) Inventory 255,000 / 0.80 318,750
(iv) Common shares 600,000 / 0.60 1,000,000
(c) Gioco’s only working capital item that is translated at different rates under the two
translation methods is inventory. Since inventory is higher in part a), Gioco’s translated
financial statements would show the highest current ratio if the Canadian dollar is Gioco’s
functional currency.
(d)
Shareholders’ equity, beginning of year 900,000 / 0.70 1,285,714
Net income 450,000 / 0.76 592,105
Dividends paid (300,000) / 0.70 (428,571)
Actual shareholders’ equity, end of year 1,050,000 / 0.80 1,312,500
Exchange adjustment to be reported in other comprehensive income 136,748
Problem 11-10
(a) VICTORIA TEXTILES (India) Limited
INCOME STATEMENT
($000s)
(i) (ii)
Temporal Current rate
method method
Sales (20,200 x .031) $626 $626

Cost of sales
Opening inventory (3,500 x .045) 158
Purchases (12,600 x .031) 391
549
Closing inventory (4,800 x .027) 130
419 (11,300 x .031) 350
Gross profit 207 276
Operating expenses excluding depreciation

(3,400 x .031) 105 105
Depreciation (400 x .075 = 30)
(600 x .062 = 37) 67 (1,000 x .031) 31
Interest (700 x .031) 22 (700 x .031) 22
Taxes (600 x .031) 19 19
Net income (loss) before foreign
Exchange gains (losses) (6) 99
Foreign exchange gains (losses) (2)
Net income (loss) (8)) 99
BALANCE SHEET
December 31, Year 4
($000s)
Temporal Current rate

method method
Cash (4,100 x .025) 102 102
Accounts receivable (2,900 x .025) 72 72
Inventories (4,800 x .027) 130 (4,800 x .025) 120
Prepaid expenses (1,900 x .03) 57 (1,900 x .025) 48
Plant assets (net) (2,800 x .075 = 210)
(5,100 x .062 = 316)
7,900 526 526 (7,900 x .025) 198
887 540

Current liabilities (2,400 x .025) 60 60
Unearned revenue (800 x .028) 22 (800 x .025) 20
Long-term debt (6,000 x .025) 150 150
232 230
Common shares (10,000 x .075) 750 750
Retained earnings (deficit) plug (95) (440)*
887 540
* Includes accumulated foreign exchange adjustments. Separate details would have to be

disclosed under IAS 21.
Foreign exchange gain/loss - Year 4 (FCT method) Rupee Rate $

Net monetary position, opening (900) .041 (37)
(3,900 + 2,100 – 900 – 6,000)
Inflows: sales (20,200 + 800 – 500) 20,500 .031 636
19,600 599
Outflows:
Purchases (11,300 + 4,800 – 3,500) 12,600 .031
391
Operating expenses (4,400 – 1,000 + 1,900 – 1,700) 3,600 .031 112
Interest 700 .031 22
Taxes 600 .031 19
Dividends 3,500 .025 88
21,000 632
Expected net monetary position (33)
Actual net current monetary assets
(4,100 + 2,900 –2,400 – 6,000) (1,400) .025 (35)
Foreign exchange Loss (2)
Note: A loss because the actual net monetary liability is larger than the expected net
monetary liability.
(b)
IAS 21 requires the FCT method for any company operating directly in a foreign country (i.e.,
importing, borrowing, exporting) because this method better reflects the risk of exposure to
currency fluctuations. Under the FCT method, the translation gain or loss is charged to
income. The same method is prescribed for a foreign operation whose functional currency is
the Canadian dollar as the risk (economic exposure) associated with such an operation is very
similar to that undertaken had the parent company operated directly in the foreign jurisdiction.
The PCT method is prescribed for a foreign operation whose functional currency is a foreign
currency as the risk associated with those operations is limited to the net investment in the
foreign operation. By definition, there is no further risk because there is no integration of
operations, product flows, or cash flows. Under the PCT method, the translation gain or loss is
reported as other comprehensive income and then accumulated as a separate component of
shareholders' equity, as the true economic exposure may not be related to the apparent
accounting exposure. Such an operation would not be dependent on the parent for funds to
finance current operations, and as it is difficult to estimate the likelihood of eventual loss, the
treatment of the translation adjustment as a separate component of shareholders' equity
without income consequences is justified.
With regard to the underlying rationale, the selection of an accounting treatment that reflects
the true economic exposure can be a difficult concept to apply in practice. It may roughly be
defined as the possible affect on the long-run profitability of the firm as a result of the change
in exchange rates. The economic exposure is not necessarily in the same "direction" as the
accounting exposure. For example, economic factors may be such that a decline in the
exchange rate may actually enhance the competitive position of the subsidiary by increasing
the demand for products, as the price is now lower. This would tend to counteract the initial
assessment of apparent accounting exposure in many cases. As a result, economic exposure
must be assessed carefully and should be considered in the selection of the appropriate
translation method and in the determination of necessary disclosure. Further, steps to manage
the accounting translation exposure may have a detrimental effect on the true economic
exposure that the firm faces.
Accounting exposure and economic exposure are separate yet related concepts. Accounting
exposure has two distinct categories — transaction exposure and translation exposure.
Transaction exposure arises from outstanding monetary items, and may often be readily
hedged. Translation exposure, related to the net amount translated at the current (rather than
historical) rate, is more complex and may be somewhat more difficult to guard against.
Further, actions to manage translation exposure may have adverse effects on the economic
exposure of the firm. However, many firms will take action to alter accounting exposure
because of the adverse effect translation exposure may have on reported income, in spite of
this risk, perhaps because of a lack of understanding of economic exposure. Alternatively, a
firm may choose to take no action (perhaps when a translation gain is anticipated) or to cover
all or part of the net exposure through hedging. The income effect recognized as a result of
translation of financial statements may be eliminated entirely by management action, through a
"rearrangement" of the monetary assets and liabilities of the subsidiary, or by careful hedging.
Economic exposure may be more narrowly defined as the change in the earnings ability of the
firm (i.e., the net present value of cash flows) caused by unexpected changes in exchange
rates. That is, management may take action to guard against expected changes, but may not
be able to guard effectively against unexpected changes, which may be random in frequency
or direction.
The method to be used depends on the outcome of an analysis of the above factors. VTIL
does not have a choice in the matter of selection of an accounting method. The selection is
effectively dictated by an assessment of the underlying economic reality of the relationship
between the parent and the subsidiary. Is the parent exposed to the risk of the subsidiary
environment, including currency risks? If the extent of integration indicates that this is the case,
the FCT method must be used.
In this case, VTIL was established for the purpose of serving as a product and supplier
conduit. It appears that the integration between VTIL and the operations of the parent are
extensive and that the FCT method should be used. Should VTIL begin to operate on a more
autonomous basis, matching Asian product with Asian customers, the argument might be
raised that VTIL’s functional currency is different than the parent’s functional currency.
However, the information provided in the case leads to the conclusion that VTIL’s functional
currency is the same as the parent’s functional currency (involved in the selling of Victoria's
current product lines, and also expected to establish supplier contacts).
(Solution prepared by Peter Secord, Saint Mary’s University.)

Problem 11-11
PART A Functional currency is the Canadian dollar
RR Rate Dollars
Cost of sales:
Inventory Jan. 1/ yr. 11 525,000 28.00 18,750
Purchases* 1,512,000 28.09 53,827
2,037,000 72,577
Inventory Dec. 31/ yr. 11 357,000 28.04 12,732
1,680,000 59,845
RR
* Inventory Jan. 1/ yr.11 525,000
Inventory Dec. 31/ yr.11 357,000
Decrease in inventory 168,000
Cost of sales 1,680,000
Purchases, yr. 11 1,512,000
Equipment
Purchased yr. 11 125,000 28.18 4,436
On hand Jan. 1/ yr. 11 358,000 28.00 12,786
Equipment balance, Dec. 31/ yr. 11 483,000 17,222
Year 11 equipment depreciation

Year 11 purchase 25,000 28.18 887
On hand Jan. 1/ yr. 11 38,000 28.00 1,357
63,000 2,244
Accumulated depreciation
Year 11 purchase 25,000) 28.18 887
On hand Jan. 1/ yr.11 143,000) 28.00 5,107
168,000) 5,994
Net monetary position RR Dollars

Balance Jan. 1/ yr.11 (1,033,000) 28.00 (36,893)
Changes Year 11
Sales 3,150,000) 28.09 112,139)
Purchases – inventory (1,512,000) 28.09 (53,827)
– equipment (125,000) 28.18 (4,436)
Other expenses (840 – 105 – 63) (672,000) 28.09 (23,923)
Dividends (450,000) 28.20 (15,957)
391,000) 13,996)
Calculated position Dec. 31/ yr. 11 (22,897)

Actual position Dec. 31/ yr. 11
Cash 105,000)
Accounts receivable 168,000)
273,000)
Accounts payable (210,000)
Bonds payable (600,000)
Misc. payables (105,000) (642,000) 28.20 (22,766)
Exchange gain 131)
Income Statement – Year 11

Sales 3,150,000 28.09 112,139)
Cost of sales 1,680,000 calc. 59,845)
Depreciation – building 105,000 28.00 3,750)
– equipment 63,000 calc. 2,244)
Other expenses 672,000 28.09 23,923)
Exchange gain ) (131))
2,520,000 89,631)
Net income 630,000 22,508)
Retained Earnings Statement – Year 11 RR Dollars

Balance Jan. 1 470,000) 28.00 16,786)
Net Income 630,000) 22,508)
1,100,000) 39,294)
Dividends 450,000) 28.20 15,957)
Balance Dec. 31 650,000) 23,337)

Cash 105,000) 28.20 3,724)
Accounts receivable 168,000) 28.20 5,957)
Inventories 357,000) 28.04 12,732)
Land 430,000) 28.00 15,357)
Buildings 1,460,000) 28.00 52,143)
Accumulated depreciation (420,000) 28.00 (15,000)
Equipment 483,000) calc. 17,222)
Accumulated depreciation (168,000) calc. (5,994)
2,415,000) 86,141)
Accounts payable 210,000) 28.20 7,447)

Miscellaneous payables 105,000) 28.20 3,723)
Bonds payable 600,000) 28.20 21,277)
Common shares 850,000) 28.00 30,357)
Retained earnings 650,000) 23,337)
2,415,000) 86,141)
PART B Functional currency is the Russian ruble
RR Dollars
Net assets – Jan. 1/ yr. 11 (850 + 470) 1,320,000) 28.00 47,143
Net income – Year 11 630,000) 28.09 22,428
Dividends (450,000) 28.20 (15,957)
Calculated net assets – Dec. 31/ yr. 11 53,614
Actual net assets – Dec. 31/ yr. 11 1,500,000) 28.20 53,192
Exchange loss – Year 11(to be reported in other comprehensive income) 422
Retained Earnings – Dec. 31/ yr. 11

Bal. Jan. 1 470,000) 28.00 16,786
Net income 630,000) 28.09 22,428
Dividends (450,000) 28.20 (15,957)
Bal. Dec. 31 650,000) 23,257

Cash 105,000 28.20 3,723
Accounts receivable 168,000 28.20 5,957
Inventories 357,000 28.20 12,660
Land 430,000 28.20 15,248
Buildings 1,460,000 28.20 51,773
Equipment 483,000 28.20 17,128)
2,415,000 85,639)
Accounts payable 210,000 28.20 7,447)

Miscellaneous payables 105,000) 28.20 3,723)
Bonds payable 600,000) 28.20 21,277)
Shareholders' equity
Common shares 850,000) 28.00 30,357)
Retained earnings 650,000) 23,257)
Accumulated foreign exchange adjustments (loss) ) (422))
2,415,000) 85,639)
PART C
PART C
The PCT method does not produce a translated amount consistent with the way we normally
measure assets and liabilities. When the closing rate is applied to the historical cost in foreign
currency, the translated amount is not historical cost or current value in Canadian dollars. This
is a problem for inventory and property, plant and equipment, which are supposed to be
measured at historical cost.
Problem 11-12
(a)

CHIN’s functional currency is the Chinese yuan because it is financially and operationally
independent of SPEC. CHIN’s revenues, expenses, cash flows, and financing are all
determined by conditions in China and are not affected by conditions in Canada.
(b)
Yuan Rate Dollars
Net assets, beginning of year 20,000,000 6.92 2,890,173
Profit (loss) (2,000,000) 7.20 (277,778)
Calculated net assets, end of year 2,612,395
Actual net assets, end of year 18,000,000 7.50 (2,400,000)
Exchange loss from translation 212,395
The exchange loss is reported in other comprehensive income in the statement of

comprehensive income and is included in accumulated foreign exchange adjustments as a
separate component of shareholders’ equity.
(c)
Yuan Rate Dollars
Rent revenue 6,000,000 7.20 833,333
Interest expense (5,000,000) 7.20 (694,444)
Amortization expense (2,000,000) 6.92 (289,017)
Other expenses (1,000,000) 7.20 (138,889)
Profit (loss) (2,000,000) (289,017)
(d)
If the mortgage payable were an effective hedge of the anticipated sale of the land and was
accounted for as a cash flow hedge, the annual exchange adjustment on the mortgage
payable would be reported in other comprehensive income. When the land is sold the
amounts that had been recognized in other comprehensive income would be removed from
accumulated foreign exchange adjustments and reported in net income as an adjustment to
the gain or loss on the sale of the land.
If the mortgage payable is not an effective hedge of the anticipated sale of the land or if the

hedge is classified as a fair value hedge, the annual exchange adjustment on the mortgage
payable would be reported in profit.
Problem 11-13
Calculation, allocation, and amortization of acquisition differential
Cost of 70% investment, Jan. 2, Year 1 FP1,330,000
Implied value of 100% investment FP1,900,000
Carrying amounts of White’s net assets:
Common shares 199,000
Total shareholders' equity 1,098,000
Acquisition differential 802,000
Allocation: FV – CA
Building 99,000
99,000
Balance – goodwill $703,000
Balance Amortization/ Balance

Dec. 31 Impairment Dec. 31
Year 5 Year 6 Year 6
Building (10 years) $99,000 $9,900 $89,100
Goodwill 703,000 0 703,000
$802,000 $9,900 $792,100
Goodwill – carrying amount FP703,000 x 0.20 = $140,600
(a)
(i) Building – net Canadian $
Black’s building $2,999,000
White’s building (FP2,699,000 × 0.20) 539,800
Unamortized acquisition differential (FP89,100 × 0.20) 17,820
$3,556,620

(ii) Goodwill
Carrying amount (FP703,000 x 0.20) $140,600
(iii) Depreciation expense – buildings

Black’s depreciation expense $199,000
White’s depreciation expense (FP299,000 x 0.20) 59,800
Amortization of acquisition differential (FP9,900 x 0.20) 1,980
$260,780
(iv) Net income (excluding other comprehensive income)
Black’s income before foreign exchange $149,000
Less: dividend income (FP99,000 × 70% × 0.17) (11,781)
137,219
White’s income before foreign exchange (given) 29,000
Foreign exchange gains on White’s separate F/S 49,000
Amortization of acquisition differential (FP9,900 × 0.20) (1,980)
76,020
Net income $213,239
Attributable to:
Shareholders of Black ($137,219 + 70% × $76,020) 190,433
Non-controlling interest (30% × $76,020) 22,806
(v) Other comprehensive income

Not applicable under FCT method $0
(vi) Non-controlling interest on income statement

White’s adjusted net income $76,020
NCI’s share 30% $22,806
(vii) Non-controlling interest on balance sheet

White’s common shares (FP199,000 x 0.20) $39,800
White’s retained earnings, beginning (FP899,000 x 0.20) 179,800
White’s net income ($29,000 + $49,000) 78,000
White’s dividends (FP99,000 x 0.17) (16,830)
280,770
Unamortized acquisition differential
- building (FP89,100 x 0.20) 17,820
- goodwill 140,600
439,190
NCI’s share 30% $131,757
(b)
(i) Building – net Canadian $
Black’s building $2,999,000
White’s building (FP2,699,000 x 0.15) 404,850
Unamortized acquisition differential (FP89,100 x 0.15) 13,365
$3,417,215
(ii) Goodwill
Unamortized acquisition differential (FP703,000 x 0.15) $105,450
(iii) Depreciation expense – buildings

Black’s depreciation expense $199,000
White’s depreciation expense (FP299,000 x 0.18) 53,820
Amortization of acquisition differential (FP9,900 x 0.18) 1,782
$254,602
(iv) Net income (excluding other comprehensive income)
Black’s income before foreign exchange 149,000
Less: dividend income (FP99,000 x 70% x 0.17) (11,781)
137,219
White’s income before foreign exchange (FP159,000 x 0.18) 28,620
Amortization of acquisition differential (FP9,900 x 0.18) (1,782)
26,838
$164,057
Attributable to:
Shareholders of Black ($137,219 + 70% × $26,838) 156,006
Non-controlling interest (30% x $26,838) 8,051
(v) Other comprehensive income

FP Rate Dollars
Net assets, beginning of year 1,098,000 0.20 $219,600
Net income 159,000 0.18 28,620
Dividends paid (99,000) 0.17 (16,830)
Calculated net assets, end of year 231,390
Actual net assets, end of year 1,158,000 0.15 (173,700)
Exchange loss from translation of White’s financial statements (57,690)
Acquisition differential, beginning of year 802,000 0.20 160,400

Amortization for year 9,900 0.18 (1,782)
Calculated acquisition differential, end of year 158,618
Actual acquisition differential, end of year 792,100 0.15 (118,815)
Exchange loss from translation of acquisition differential (39,803)
Total other comprehensive income (loss) $(97,493)
Attributable to:
Shareholders of Black (70% x $97,493) (68,245)
Non-controlling interest (30% x $97,493) (29,248)
(vi) Non-controlling interest on income statement

White’s adjusted net income $26,838
NCI’s share 30% 8,051
White’s other comprehensive income (loss) (97,493)
NCI’s share 30% (29,248)
$(21,197)
(vii) Non-controlling interest on balance sheet

White’s common shares (FP199,000 x 0.20) $39,800
White’s retained earnings, beginning (FP899,000 x 0.20) 179,800
White’s net income (FP159,000 x 0.18) 28,620
White’s dividends (FP99,000 x 0.17) (16,830)
Exchange loss from translation of White’s financial statements (57,690)
Unamortized acquisition differential (FP792,100 x 0.15) 118,815
292,515NCI’s share 30%
$87,755
Problem 11-14
(a) i)
Note: All amounts are translated at the historical rate of US$1 = C$0.99
US$ C$ US$ C$ US$ C$

At date of acquisition
Cost of acquisition $260,000 $257,400
NBV of net assets 202,000 199,980
Acquisition differential $58,000 $57,420 Amortization in Year 4 Balance, end of year
Allocated to:
Plant & equipment 24,000 23,760 2,400 2,376 21,600 21,384
Trademarks 34,000 33,660 3,400 3,366 30,600 30,294
Total allocated $58,000 $57,420 $5,800 $5,742 $52,200 $51,678
a) ii)
Equity method income 5,742
Investment in Bayshore 5,742
To record Par’s share of amortization of acquisition differential for Year 4
(b) i)
Note: All US$ amounts are the same as in part a). The following schedule indicates the rates
used to translate in Canadian dollars
Rate C$ Rate C$ Rate C$

At date of acquisition
Cost of acquisition $0.99 $257,400
NBV of net assets 0.99 199,980
Acquisition differential 0.99 57,420 Amortization in Year 4 Balance, end of year
Allocated to:
Plant & equipment 0.99 23,760 0.97 2,328 0.95 20,520
Trademarks 0.99 33,660 0.97 3,298 0.95 29,070
Total allocated 0.99 $57,420 $5,626 $49,590

b) ii)
Equity method income 5,626
To record Par’s share of amortization of acquisition differential for Year 4
Other comprehensive income – exchange loss 2,204

To record Par’s share of exchange loss from translating at closing rate (57,420 − 5,626 − 49,590)


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Chapter 11

Translation and Consolidation of

Copyright  2016 McGraw-Hill Education. All rights reserved.

Case 11-2 (prepared by Peter Secord, Saint Mary’s University)

Problem 11-2 (30 min.)

Problem 11-4 (60 min.)

Problem 11-5 (30 min.)

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Problem 11-7 (20 min.)

Problem 11-8 (30 min.)

Problem 11-9 (30 min.)

Problem 11-10 (70 min.)

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Problem 11-12 (35 min.)

Problem 11-13 (40 min.)

Problem 11-14 (25 min.)

SOLUTIONS TO REVIEW QUESTIONS

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5. IAS 21 defines a foreign operation as an entity that is a subsidiary, associate, joint

6. In such a situation, it is necessary to restate the foreign subsidiary's financial statements

Note to the instructor:

1Peter Secord, Saint Mary’s University.

However, a further stage of analysis is necessary. Is Zimbabwe a highly inflationary country?

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PRIVATE AND CONFIDENTIAL

Chief Financial Officer

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Communication of economic facts

Future translation methods

Management bonus plan

FCT Method PCT Method

Plant assets 143,111 0.40 57,244 0.20 28,622

Liabilities and Shareholders' Equity

Shareholders’ equity (Note 3) 87,840 plug 45,094 plug 17,568

Memo to: Paul Bouchard

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Refundable dividend tax on hand

Printing press leases

Belgian Company hedge

Foreign exchange losses

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To: Mr. R. Allen, CFO

Change in presentation currency

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Translation of Canadian operations to U.S. dollars in the current year

The exchange differences referred to in (c) above result from:

Investment in a high inflation country

Allocating acquisition cost for Cyril’s holdings (CH)

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Rationalization of television and cable business

A disposal group is defined in IFRS 5 as a group of assets to be disposed of, by sale or

Internally generated intangibles

Fibre optic cables

To: Kate Horne

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A third alternative would be to record revenue on some type of a percentage of completion

Chinese Foreign Subsidiary

Cancellation of the Sudanese Adoption Program

Money Held in Trust

Gross versus Net Recording

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Net monetary position