Question

Tuxedo Company (a U.S. based company) acquired 100% of a Swiss company, Roche AG, for 8.2 million Swiss francs on December 30, Year 1.  At the date of acquisition, the exchange rate was $0.60 per franc.   The acquisition price is attributable to the flowing assets and liabilities denominated in Swiss francs:

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

Tuxedo Corporate prepares consolidated financial statements on December 31, Year 1.  By that date, the Swiss franc appreciated to $0.65.  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 Tuxedo’s December 31, Year 1 consolidated financial statements, assuming that the Swiss franc is used to pay local wages, set sales price, and is borrowed locally.  Where would the adjustment be located in the financial statements?
   
2. Determine the translation adjustment to be reported on Tuxedo’s December 31, Year 1 consolidated financial statements, assuming that the U.S. dollar is used to pay local wages, set sales price, and there is a high volume of transactions between Tuxedo and Roche.  Where would the adjustment be located in the financial statements?

Answer 1

For consolidation, the books of Roche AG need to be translated into the currency of the parent entity, Tuxedo Company in USD. Before consolidation, Roche AGs financial statements must be prepared in accordance with US GAAP rules.

For translation in parent company's functional currency (USD), following exchange rates should be used:

• Assets & Liabilities - Exchange rate between the functional currency and reporting currency at the end of the period.
• Income Statement - Exchange rate on the date that income or expense was recognized, weighted average for the period is also acceptable.
• Shareholder's Equity - Historical exchange rate at the date of entry to shareholder equity, the change in retained earnings applies historical exchange rates of each period's income statement.

As on date of acquisition Dec 30, the value of Swiss Francs was 0.60 $ per Franc. On Dec 31, the exchange rate is 0.65 per Franc.

The consolidated financial statements are prepared a day after acquisition, i.e., post-acquisition.

For acquisition of assets & liabilities, the rate applicable at the end of period, i.e, Dec 31 will be applicable

For shareholder's equity, the rate applicable on the date of entry in the shareholder's register, i.e. Dec 30 will be applicable.

For income/expenses, each transaction will be recorded individually with the rate applicable on the date of transaction.

If Swiss Franc is used to pay local wages, set sales price and is borrowed locally, the value would remain at 8.2 Million Francs and the acquisition would not be impacted with the foreign exchange rate fluctuation. Hence, value of investment in Roche AG in the books of Tuxedo Company would be at 8.2 Million Francs and the change post-acquisition would be recorded as "Other Comprehensive Income", presented in consolidated financial statements of shareholder's equity.Accumulated "Other Comprehensive Income" includes unrealized gains and losses reported in equity section of the Balance Sheet below Retained Earnings.  

If US Dollars is used to pay local wages, set sales price and there is a high volume of transactions between Tuxedo & Roche, the financials on Dec 31 will be based on the rate applied for US Dollars (0.65). The transactions for up-stream & down-stram sales between Tuxedo & Roche will need to be eliminated during consolidation. Since, there're no transactions during year end due to holidays, there's no impact in P&L.