Question

Chapter 7 Exercise

Hamilton Company (a U.S. based company) acquired 100% of a Swiss company, Franco AG, for 8.2 million Swiss francs on December 30, Year 1. At the date of acquisition, the exchange rate was $0.70 per franc.   The acquisition price is attributable to the flowing assets and liabilities denominated in Swiss francs:

Cash	1,000,000	à	Common Stock	8,200,000
Inventory (@ cost)	2,000,000
Fixed Assets	7,000,000
Notes Payable	(1,800,000)

Hamilton Corporate prepares consolidated financial statements on December 31, Year 1. By that date, the Swiss franc appreciated to $0.75. Because of the year-end holidays, no transactions took place between the date of acquisition and the end of the year.

Assignment:

1. Determine the translation adjustment to be reported on Hamilton’s December 31, Year 1 consolidated financial statements, assuming that the Swiss franc is the Swiss subsidiary’s functional currency. Where would the adjustment be located in the financial statements?
   
2. Determine the translation adjustment to be reported on Hamilton’s December 31, Year 1 consolidated financial statements, assuming that the U.S. dollar is the Swiss subsidiary’s functional currency. Where would the adjustment be located in the financial statements?

Answer 1

SOLUTION

a.	Swiss franc is functional currency (Current rate method)
		Swiss	Exchange	U.S.
		Francs	Rate	Dollars
	Net assets, 12/20/Y1	8,200,000	0.70	5,740,000
	Change in net assets	-		-
	Net assets, 12/31/Y1	8,200,000		5,740,000
	Net assets, 12/31/Y1 at
	the current exchange rate	8,200,000	0.75	6,150,000
	Translation adjustment (positive)			(410,000)

b.	U.S. dollar is functional currency (Temporal method)
		Swiss	Exchange	U.S.
		Francs	Rate	Dollars
	Net monetary liabilities, 12/20/Y1	(800,000)	0.70	(560,000)
	Change in net monetary liabilities	-		-
	Net monetary liabilities, 12/31/Y1	(800,000)		(560,000)
	Net monetary liabilities, 12/31/Y1
	at the current exchange rate	(800,000)	0.75	(600,000)
	Remeasurement loss			40,000

Economic Relevance of Translation Adjustment

The translation adjustment increases stockholders’ equity by $410,000. The positive translation adjustment arises because the Swiss subsidiary has a net asset position of CHF8,200,000 and the Swiss franc appreciates by $.05 [CHF8,200,000 x $.05 = $410,000]. The positive translation adjustment is not realized in terms of U.S. dollar cash flow. It would be a realized gain only if Hamilton sold this operation on December 31 for exactly CHF8,200,000 and converted the sales proceeds into dollars at the current exchange rate of $.75 per Swiss franc.

Economic Relevance of Remeasurement Loss

The remeasurement loss arises because the Swiss subsidiary has a net monetary liability position of CHF800,000 (Cash of CHF1,000,000 less Notes payable of CHF1,800,000) and the Swiss franc has appreciated by $.05 [CHF800,000 x $.05 = $40,000]. The loss is unrealized. It would be realized only if the Swiss subsidiary used its Swiss franc cash to pay off Swiss franc notes payable to the extent possible (CHF1,000,000), and the parent paid off the remaining Swiss franc notes payable using U.S. dollars, thereby realizing a transaction loss of $40,000 [CHF800,000 x ($.75-$.70)]. (A CHF 800,000 note payable could have been paid off at December 1 with $560,000 [CHF800,000 x $.70]. At December 31, it takes $600,000 to pay off the same amount of CHF note payable [CHF800,000 x $.75].)