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Chapter 8
Investing Activities
8-21
in whole or in part.
rate. It also results in a smaller shareholders’ equity because of inclusion of the
translation adjustment. Therefore, the all-current method produces higher rates
of return on both assets and shareholders’ equity.
8.26 Translating the Financial Statements of a Foreign Subsidiary; Second Year of
Operations.
a. Translation of the Accounts of Canadian Subsidiary
for Year 2 (All-Current Translation Method)
Canadian Exchange U.S.
Dollars Rate Dollars
Balance Sheet:
Assets
Cash..................................... C$ 116,555 0.84 US$ 97,906
Rent receivable ................... 30,000 0.84 25,200
Retained Earnings Statement:
Balance, January 1, Year 2 . C$ 12,000 See Prob. 8.25 US$ 13,200
Chapter 8
Investing Activities
8-22
in whole or in part.
Computation of Translation Adjustment for Year 2
Canadian Exchange U.S.
Dollars Rate Dollars
Net asset position,
January 1, Year 2 ............ C$ 567,555 0.80 US$ 454,044
Change in Translation Adjustment during Year 2
for Year 2 (Monetary/Nonmonetary Translation Method)
Canadian Exchange U.S.
Dollars Rate Dollars
Balance Sheet:
Assets
Liabilities and Equity
Income Statement:
Chapter 8
Investing Activities
8-23
in whole or in part.
Retained Earnings Statement:
Computation of Translation Gain for Year 2
Canadian Exchange U.S.
Dollars Rate Dollars
Net monetary asset
position, January 1,
Less:
Cash disbursed and
liabilities assumed
for operating
differ, causing the dollar amounts to differ.
d. The monetary/nonmonetary translation method results in larger earnings than
for the all-current method. Two offsetting factors explain this result: (1)
management’s preference.
Chapter 8
Investing Activities
8-24
in whole or in part.
8.27 Identifying the Functional Currency. The following discussion applies the five
Cash Flows of Foreign Entity. The use of forward exchange contracts suggests
foreign subsidiaries to retain earnings for growth rather than remitting it to the U.S.
Sales Prices. ECS sets transfer prices to mirror free market prices. Given the signif-
icant amount of intersegment transfer, this suggests a worldwide influence on pric-
ing. The use of foreign exchange contracts indicates that exchange rate changes
likely affect pricing. These facts point to the U.S. dollar as the functional currency.
Financing. Computer firms experience significant technological risks (short
product life cycles, high research and development costs) and tend not to assume
major financing risks as well. Thus, the foreign subsidiaries probably do not engage
in heavy borrowing. The financing for those foreign subsidiaries appears to come
currency.
Relations between Parent and Foreign Unit. The segment data indicate a high
volume of intercompany operations, particularly from the United States Although
the path is not fully evident, it appears that ECS sources components in the Canada,
the functional currency.
Mixed signals emerge regarding ECS’s functional currency. Three characteristics
Chapter 8
Investing Activities
8-25
in whole or in part.
The application of these criteria to ECS demonstrates a possible flaw in Statement
identifiable functional currency use the U.S. dollar as the functional currency.
The solution attempts to identify the functional currency for all of ECS’s opera-
tions. It is likely that ECS will use the local currency for some activities and the
U.S. dollar for others. This problem uses data from Digital Equipment Corporation
Integrative Case 8.1: Starbucks
Part I.
a. Leasehold improvements meet the definition of an asset. The improvements
process.
Starbucks’ useful life policy appears to be one that will generate high-quality
accounting numbers (assuming that the underlying assets used to improve the
leased property will have a useful life that is at least as long as the lease). At the
time the lease is signed, Starbucks equates the useful life with the lease term un-
back periods for leasehold improvements, and other moving costs might cause
Starbucks to expect to lease the properties for longer periods than the original
lease term. [Also, if leasehold improvement assets are likely to need replacement
before the end of the lease (for example, carpeting that will be replaced every
an asset for capitalized leasehold improvements while showing no leased asset
under an operating lease.)
Chapter 8
Investing Activities
8-26
in whole or in part.
If Starbucks estimates that it will renew a lease and does not, it will have an
b. Starbucks estimates how much cost it will incur to remove the leasehold improve-
ments at the end of the lease and records an ARO at its fair value. It is unlikely that
AROs are traded in organized markets to the extent that Starbucks could use a
Level 1 or Level 2 valuation. Thus, Starbucks takes the Level 3 approach to fair
than the ARO liability. This situation occurs because the ARO-related asset is
amortized with the leasehold improvements asset and reported as amortization
expense on each year’s income statement. The ARO liability, on the other hand,
accretes (that is, becomes larger) over time. Recall that the ARO liability is
ARO liability.
Income is not affected by the act of reclaiming the property to satisfy the
ARO liability. Cash is decreased, and the ARO liability is decreased. However, if
the cash paid to satisfy the ARO liability is different than expected, a loss is
c. If Starbucks used IFRS, the carrying value of the asset would be compared to the
larger of its fair value in use (discounted future cash flows) and fair value from
sale (fair value in the market – disposal costs). IFRS impairment testing appears
to better estimate the economic decline in the fair value of the asset.
is that managers might be inclined to over-allocate expenses to line items they an-
ticipate might be ignored or underweighted by investors.
Chapter 8
Investing Activities
8-27
in whole or in part.
Part II.
records are reported at fair value in the consolidated statements. Goodwill also is
reported at fair value. Finally, as required under U.S. GAAP and an option under
IFRS, the full fair value of the acquisition is allocated on a pro rata basis to non-
controlling interests. Recording noncontrolling interests at fair value is a major
b. Starbucks states that international operations generally use their local currency as
their functional currency. Therefore, Starbucks uses the all current translation
method. Under the all current translation method, Starbucks translates revenues
and expenses at the average exchange rate during the period and balance sheet
c. Bay Bread continues to produce its own financial statements using pre-acquisition
book values. Therefore, its own financial statements continue to report all three
items at or near $0. When preparing consolidated financial statements, Starbucks
will add on the differences between book value and fair value for these three
Trade name: $9.7 million
Goodwill: $58.7 million
Starbucks will also be preparing a consolidated income statement. Bay Bread
reports no amortization for proprietary recipes and processes. In consolidation,
Starbucks will add the $1.46 million of amortization expense.
Chapter 8
Investing Activities
8-28
in whole or in part.
Part III.
Sept. 30, Oct. 2,
2012 2011
Average depreciable assets acquisition cost = 0.5($6,592.8 + $5,990.9) = $6,291.8
b. Analysts can track this number over time to see if companies are changing esti-
mated useful lives (for strategic or earnings management purposes) or changing
the mix of PP&E. Analysts also can explain differences in earnings and asset
book values among competitors by comparing useful life estimates. The differ-
accounting quality.
c. Because the amount of accumulated depreciation depends on the number of years
for which depreciation has been taken, the average age of depreciable assets
equals the amount of accumulated depreciation divided by depreciation expense,
as follows:
The remaining useful life can be obtained by dividing net depreciable PP&E by
annual depreciation expense, as follows:
Chapter 8
Investing Activities
8-29
in whole or in part.
for growth in capacity. Although the analyst must rely on knowledge of industry
and high proportion consumed provides an indication that the firm is in a later
stage of average product life-cycle.
Case 8.2: Disney Acquisition of Marvel Entertainment
“As DVD sales sink, Hollywood has been scrambling for new sources of ancillary
revenue, such as toys, videogames, clothing and roller coasters. Marvel, with its
roster of 5,000 characters, could provide several years of fodder for Disney’s en-
tertainment and marketing empire.”
to acquire Marvel Entertainment.
In a less than 100% acquisition, the premium does matter. Disney’s willingness
to pay the premium indicates its belief that Marvel is worth more under Disney’s
control (and not under the control of a competitor such as Paramount). In a less
than 100% acquisition, the noncontrolling shares of Marvel trade at prices that are
fair value of the noncontrolling shares.
Chapter 8
Investing Activities
8-30
in whole or in part.
eliminated, and Disney will replace the account by adding goodwill and Marvel’s
identifiable assets and liabilities at fair value to the consolidated totals. The
financial statements issued by Disney will be exactly the same regardless of
whether the business combination is a merger or an acquisition.
less reduced for impairment). Also, Marvel likely has a number of identifiable in-
tangible assets such as the artistic-related intangible assets: video and audiovisual
material, including motion pictures, music videos, and television programs, and
character brand names, and the contract-based intangible assets: licensing, royal-
tion of the large excess consideration given to goodwill, Disney will allocate
amounts to the aforementioned differences between fair and book values. The re-
mainder will be classified as goodwill.
