Chapter 08 - Additional Financial Reporting Issues

CHAPTER 8 ADDITIONAL FINANCIAL REPORTING ISSUES

Solutions to Exercises and Problems
1. Sorocaba Company December 31, Year 1 Purchase Date Item 1/15/Y1 3/20/Y1 10/10/Y1 Cost Machine X Machine Y Machine Z Original Historical Ratio $ 20,000 55,000 130,000 $205,000 Restatement Cost 140/100 140/110 140/130 Restated Historical $ 28,000 70,000 140,000

$238,000 December 31, Year 2 Purchase Date Item 3/20/Y1 10/10/Y1 Cost Machine Y Machine Z Original Historical Ratio $ 55,000 130,000 $185,000 Restatement Cost 180/110 180/130 Restated Historical $ 90,000 180,000

$270,000 Alternatively, the restated historical cost at December 31, Year 2 could be determined as follows: December 31, Year 2 Restated Historical Purchase Date Item (12/31/Y1) 3/20/Y1 Machine Y 10/10/Y1 Machine Z $270,000 Ignoring depreciation, machinery and equipment would be reported on the balance sheet at: 12/31/Y1 $238,000 12/31/Y2 $270,000 2. Antalya Company Cost Ratio $ 70,000 140,000 $210,000 Historical Restatement (12/31/Y2) 180/140 180/140 Restated Cost $ 90,000 180,000

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3. Doner Company Calculation of Purchasing Power Loss Net monetary assets, 1/1/Y1 Plus: Increase in net monetary assets Net monetary assts, 12/31/Y1 Purchasing power loss GPP Income Statement Year 1 Revenues $50,000 Depreciation (5,000) Other expenses (incl. income taxes) (35,000) Purchasing power loss Net income 4. Petrodat Company Subsidiary in Mexico GPI 1/1/Y1 Average 12/31/Y1 a. Balance Sheet, 1/1/Y1 Machinery and equipment Total assets Contributed capital Total stockholders equity Income Statement, Year 1 Historical Restatement Cost Factor 400,000.00 110/105 (200,000.00) 110/100 (150,000.00) 110/105 Restated to 12/31/Y1 GPP 419,047.62 (220,000.00) (157,142.86) (11,904.76) Historical Cost 1,000,000.00 1,000,000.00 1,000,000.00 1,000,000.00 110/100 Restatement Factor 110/100 Restated to 12/31/Y1 GPP 1,100,000.00 1,100,000.00 1,100,000.00 1,100,000.00 $5,000 15,000 $20,000 x 150/100 = x 150/120 = $ 7,500 18,750 $26,250 20,000 $ 6,250

x 150/120 = x 150/100 = x 150/120 =

$ 62,500 (7,500) (43,750) (6,250) $ 5,000

100 105 110

Revenues Depreciation expense Other expenses Purchasing power loss

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Income

50,000.00

30,000.00

Calculation of Purchasing Power Loss Net monetary assets, 1/1 0.00 plus: Increase in NMA, Y1* 250,000.00 Net monetary assets, 12/31 250,000.00 Net monetary assets, 12/31 Purchasing power loss * Revenues less other expenses

110/100 110/105

0.00 261,904.76 261,904.76 250,000.00 11,904.76

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Balance Sheet, 12/31/Y1 Cash Machinery and equipment Less: accumulated depreciation Total assets Contributed capital Retained earnings Total stockholders' equity

Historical Restatement Cost Factor 250,000.00 none 1,000,000.00 110/100 (200,000.00) 110/100 1,050,000.00 1,000,000.00 50,000.00 1,050,000.00 110/100 above

Restated to 12/31/Y1 GPP 250,000.00 1,100,000.00 (220,000.00) 1,130,000.00 1,100,000.00 30,000.00 1,130,000.00

Calculation of Average Stockholders' Equity January 1, Year 1 (restated) December 31, Year 1

Average stockholders equity

1,100,000.00 1,130,000.00 2,230,000.00 /2 1,115,000.00

b. Calculation of profit margin and return on equity on an inflation-adjusted basis Profit margin 30,000.00 7.16% 419,047.62 Return on Equity 30,000.00 1,115,000.00 2.69%

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Subsidiary in Venezuela GPI 1/1/Y1 Average 12/31/Y1 a. Balance Sheet, 1/1/Y1 Machinery and equipment Total assets Contributed capital Total stockholders equity Income Statement, Year 1 Historical Restatement Cost Factor 60,000,000.00 120/110 (30,000,000.00) 120/100 (22,500,000.00) 120/110 7,500,000.00 Restated to 12/31/Y1 GPP 65,454,545.45 (36,000,000.00) (24,545,454,55) (3,409,090.91) 1,500,000.00 Historical Cost 150,000,000.00 150,000,000.00 150,000,000.00 150,000,000.00 120/100 Restatement Factor 120/100 Restated to 12/31/Y1 GPP 180,000,000.00 180,000,000.00 180,000,000.00 180,000,000.00

100 110 120

Revenues Depreciation expense Other expenses Purchasing power loss Income

Calculation of Purchasing Power Loss Net monetary assets, 1/1 plus: Increase in NMA, Y1* Net monetary assets, 12/31 Net monetary assets, 12/31 Purchasing power loss * Revenues less other expenses

0.00 120/100 37,500,000.00 120/110 37,500,000.00

0.00 40,909.090.91 40,909,090.91 37,500,000.00 3,409,090.91

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Balance Sheet, 12/31/Y1 Cash Machinery and equipment Less: accumulated deprec Total assets Contributed capital Retained earnings Total stockholders' equity

Historical Restatement Cost Factor 37,500,000.00 none 150,000,000.00 120/100 (30,000,000.00) 120/100 157,500,000.00 150,000,000.00 7,500,000.00 157,500,000.00 120/100 above

Restated to 12/31/Y1 GPP 37,500,000.00 180,000,000.00 (36,000,000.00) 181,500,000.00 180,000,000.00 1,500,000.00 181,500,000.00

Calculation of Average Stockholders' Equity January 1, Year 1 (restated) December 31, Year 1 Average stockholders equity

180,000,000.00 181,500,000.00 361,500,000.00 180,750,000.00

b. Calculation of profit margin and return on equity on an inflation-adjusted basis Profit margin 1,500,000.00 2.29% 65,454,545.45 Return on Equity 1,500,000.00 180,750,000.00 0.83%

c. Both subsidiaries had the same profit margin and return on equity when these ratios were calculated from unadjusted historical cost information. After adjusting for inflation, the Mexican subsidiary appears to be substantially more profitable than the Venezuelan subsidiary.

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5. Auroral Company Name of Company Accurcast Bonello Cromos Fidelis Jenna Marek Phenix Regulus Synkron Tiksed Ypsilon % Voting Rights 100% 45% 30% 100% 100% 40% 90% 50% 15% 70% 51% IFRS Full consolidation Equity method unless there is evidence that Auroral exercises effective control Equity method Do not consolidate fair value method Full consolidation Full consolidation Full consolidation Proportional consolidation or equity method Fair value method Full consolidation Full consolidation U.S. GAAP Full consolidation Equity method Equity method Do not consolidate fair value method Full consolidation Equity method Full consolidation Equity method Fair value method Full consolidation Full consolidation

9. IBM, Johnson & Johnson, and General Motors a. A commonly used measure of multinationality is the percentage of total sales that are generated in countries other than the United States: Foreign Sales/Total Sales. This ratio can be calculated for each company by subtracting U.S. sales from total sales and then dividing by total sales: IBM ($91,424 - $35,917) / $91,424 = 60.7% Johnson & Johnson ($53,324 - $29,775)/ $53,324 = 44.2% General Motors ($207,349 - $129,041) / $129,041 = 37.8% Based on this measure, IBM is the most multinational company among the three in Exhibit 8.9. b. International diversification refers to the extent to which a companys operations are spread across different countries and regions of the world. General Motors appears to be concentrated in a relatively small number of countries, and is therefore not very diversified internationally. 88% of GMs sales are generated from operations in only ten countries (U.S., Canada and Mexico, France, Germany, Spain, U.K., Brazil, Australia, and South Korea). From Johnson & Johnsons segment disclosure, it is impossible to know the number of countries in which the company has operations. For example, Europe could imply operations in anywhere from one to 30+ countries. One can determine that about 50% of IBMs revenues are generated in only two countries (U.S. and Japan), but it is impossible to know where in the world the remaining 50% of its sales are generated. We do know that there are no other countries in which IBM has a material amount (defined by the company as 10%) of total revenues, because it would be required to disclose this country separately. (Note that if GM had used a 10% materiality criterion, it would have provided separate disclosures for no country other than the United States.) This exercise demonstrates the difficulty in assessing

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international diversification given current segment reporting practices that allow companies to define materiality in different ways. CASE 10. BMW and Volkswagen a. A commonly used measure of multinationality is the percentage of total sales that are generated in countries other than the home country: Foreign Sales/Total Sales. This ratio can be calculated for each company by subtracting sales in Germany from total sales and then dividing by total sales: BMW (44,335 11,961) / 44,335 = 73.0% Volkswagen (88,963 24,504) / 88,963 = 72.5% Based on this measure, BMW is slightly more multinational than Volkswagen. Both companies rely very heavily on sales made outside of Germany. Note that the internationality of the two companies can be directly compared by collapsing VWs North America and South America segments into one region America and by collapsing its Africa and Asia/Oceania segments into one region Africa, Asia, Oceania. b. One way to measure international diversification is the extent to which sales are spread out over different regions of the world. Column B in the table below shows that BMWs sales are more evenly spread over the four segments than are VWs. Whereas VW generates 72% of its sales in Europe including Germany, BMW generates only 63% of its sale in Europe. External Sales BMW Germany Rest of Europe America Africa, Asia, Oceania Volkswagen Germany Rest of Europe America Africa, Asia, Oceania Col. A 2004 11,961 15,823 10,648 5,903 44,335 24,504 39,755 17,257 7,447 88,963 Col. B % 27.0% 35.7% 24.0% 13.3% 100.0% 27.5% 44.7% 19.4% 8.4% 100.0% Col. C 2003 10,590 13,389 11,620 5,926 41,525 23,298 35,723 18,084 7,708 84,813 Col. D % 25.5% 32.2% 28.0% 14.3% 100.0% 27.5% 42.1% 21.3% 9.1% 100.0% Col. E Year-to-year % change 12.9% 18.2% -8.4% -0.4% 6.8% 5.2% 11.3% -4.6% -3.4% 4.9%

c. BMW experienced a growth in 2004 revenues of 6.8% (Col. E in table above). Revenues grew in Germany and the Rest of Europe only. The greatest decrease in revenues incurred in America.

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Volkswagen experienced an overall increase in sales in 2004 of 4.9% (Col. E). The pattern of revenue growth for Volkswagen is similar to that for BMW. Sales for VW also grew in Germany and the Rest of Europe, with a decline in America and Africa/Asia/Oceania. The largest year-to-year % decline was in America (Col. E).

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