Dr. M. D.

Chase Long Beach State University

Advanced Accounting 1010-85B SFAS-52 Illustrative Example Page 1

Consolidated Foreign Exchange Transactions

Durango Corporation is a consolidated foreign Subsidiary of Parent, a U.S. Corporation. Durango conducts operations in Mexico and uses the
peso for all business activities. Durango's financial statements (before foreign exchange gains and losses and before income taxes) for the
year ended December 31, Year 2, are as follows:

Balance Sheet: Pesos Income Statement:

Cash.............................................. 1,000,000 Sales ............................................ 8,500,000
Accounts receivable, net ......................... 3,000,000 Cost of goods sold:
Note receivable .................................. 4,000,000 Beginning inventory .......... 2,000,000
Inventory (FIFO) ................................. 2,500,000 Purchases ............................... 6,000,000
Property, plant, and equipment ................... 5,000,000 8,000,000
Accumulated depreciation ......................... (1,000,000) Less ending inventory...... (2,500,000)
Total assets 14,500,000 Cost of goods sold .......................... 5,500,000
Depreciation expense ............................. 250,000
Accounts payable ................................. 750,000 Operating expenses ............................... 1,250,000
Income taxes payable............................. -0-. Exchange gains - foreign currency transactions ?
Intercompany notes payable to parent company ..... 5,000,000 Exchange losses - foreign currency transactions ?
Long-term debt ................................... 1,000,000 Income before income taxes ....................... 1,500,000
Common stock ..................................... 6,000,000 Income taxes (60%)................................ ?
Retained earnings ................................ 1,750,000 Net Income ………………………………………………….. 1,500,000
Total equities 14,500,000

Additional Information:
(1) CONFORMITY WITH U.S. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES: Assume the financial statements in pesos are presented
in accordance with U.S. generally accepted accounting principles; thus, no adjustments are necessary to the financial statements prior to
translation in this respect.

(2) EXCHANGE RATES: Current rate at December 31, Year 2 = $ 0.04

Historical rate (prior to Jan. 1, Year 2 = 0.05
Average rate for Year 2 = 0.045

(3) NOTE RECEIVABLE: The note receivable is from a nonaffiliated customer of the foreign subsidiary and arose as a result of a sale, the
collection of which has been delayed - the billing was in dollars when the direct exchange rate was $0.05. No adjustment has been made on
the general ledger of the subsidiary for the weakening of the peso. If and as necessary, you should adjust the appropriate accounts in the
peso financial statements before translating the financial statements.
(4) INVENTORY: The inventory was acquired when the exchange rates were as follows:
Pesos Direct Rate Replacement cost 2,500,000
600,000 $0.05 Net realizable value 4,000,000
1,900,000 0.04 NRV less normal gross margin 2,600,000
2,500,000

NOTE: You should determine if a write-down to market in dollars is necessary. (The beginning inventory was reported in
the December 31, Year 1, translated balance sheet at $100,000.)

(5) PROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment were acquired when the exchange rates were as
follows: Pesos Direct Rate
4,500,000 $0.05
500,000 0.04
5,000,000
Dr. M. D. Chase Long Beach State University
Advanced Accounting 1010-85B SFAS-52 Illustrative Example Page 2

(6) INTERCOMPANY NOTES PAYABLE TO PARENT COMPANY: This note is repayable in dollars. The balance in the general ledger
account arose from the following intercompany borrowings: Date Pesos Direct Rate
February 28, Year 2 1,000,000 $0.05
March 31, Year 2 1,000,000 0.05
May 31, Year 2 1,000,000 0.05
October 31, Year 2 1,000,000 0.04
December 31, Year 2 1,000,000 0.04
5,000,000

(7) LONG-TERM DEBT: This debt is repayable to the Mexican National Bank in pesos. The borrowing all arose prior to the
devaluation. No adjustments have been made in the general ledger of the subsidiary for the weakening of the peso.
If and as necessary, you should adjust the appropriate accounts in the peso financial statements before translating
the financial statements.

(8) RETAINED EARNINGS - BEGINNING OF THE YEAR: The amount of retained earnings in dollars at December 31, Year 1, was
$12,500. No dividends were declared during Year 2.

(9) SALES AND OPERATING EXPENSES. All occurred evenly throughout the year.

(10) PURCHASES: Use an average exchange rate of $0.048 to translate purchases.

--Required:
A) Make Appropriate adjustments to the financial statements in connection with items (3), (6) and (7) above;
B) Provide for income tax expense at 60% after making the adjustments in requirement (A) above.
C) Translate the financial statements into dollars as required under FASB Statement 52. Assume that there were no
unrecognized exchange adjustments at December 31, Year 1 and that management deems the weakening of the peso
during Year 2 to be temporary.
Dr. M. D. Chase Long Beach State University
Advanced Accounting 1010-85B SFAS-52 Illustrative Example Page 3

Durango Example: Solution

Requirement A: Make Appropriate adjustments to the financial statements in connection with items (3), (6) and (7)

Item 3 Adjustment:
Note receivable ................................ 1,000,000
Exchange gain - transactions ....... 1,000,000
To adjust note receivable to reflect the current exchange rate.

--Explanation: The receivable must be reported in U.S. dollars on the Parents financial statements. That dollar amount has remained unchanged,
however, the value of the peso against the dollar has fluctuated. Therefore, the number of pesos required to achieve the equivolent of
$200,000 has changed. When the receivable was created in pesos, the U.S. dollar equivalent was $200,000 (4,000,000 x $0.05). At todays
exchange rate, this $200,000 receivable will require 5,000,000 pesos ($200,000 / $0.04). Therefore, the adjustment is computed as follows:

Desired balance in note receivable, expressed in pesos to equal $200,000.......... 5,000,000

Current balance in note receivable, expressed in pesos ........................... 4,000,000
Required adjustment .............................................................. 1,000,000 pesos

Item 6 adjustment:
Deferred exchange loss - Intercompany transactions . 750,000
Intercompany note payable ........................ 750,000
To adjust intercompany notes payable to reflect the current exchange rate.

--Explanation: The intercompany liability is due in U.S. dollars. When the liability was created, the dollar equivalent was $150,000 (3,000,000
x $0.05). Based on the current exchange rate, the liability, expressed in pesos, would be 3,750,000 ($150,000 / $0.04).

Desired balance in intercompany notes payable 3,750,000

Current balance in intercompany notes payable 3,000,000
Required adjustment 750,000

The exchange loss is deferred because it is an intercompany transaction, and therefore not "at arms length".

Item 7 adjustment:
No adjustment is required because the liability is to be repaid in pesos; there is no need to convert it to $.

Requirement B: Provide for income tax expense at 60% after making the adjustments in requirement (A) above

Income tax expense .................................. 1,500,000

Income taxes payable .............................. 1,500,000
To provide income taxes for 1982.

Income before taxes (before adjustments) 1,500,000

Exchange gain - transactions 1,000,000
Exchange loss - transactions (deferred) -0-
Income before taxes, adjusted 2,500,000
Income taxes @ 60% 1,500,000
Net income 1,000,000
Dr. M. D. Chase Long Beach State University
Advanced Accounting 1010-85B SFAS-52 Illustrative Example Page 4

Requirement C: Translate the financial statements into dollars as required under FASB Statement 52. Assume that there were no
unrecognized exchange adjustments at December 31, Year 1 and that management deems the weakening of the peso during Year 2 to be
temporary. Exchange
Trial Balance Pesos Rate Dollars
Cash 1,000,000 $ 0.04 $ 40,000
Note: Real Accounts: Current Rate
Accounts receivable, net 3,000,000 0.04 120,000 Nominal Accounts: Historical or Wtd Avg if
Note receivable 5,000,000 0.04 200,000 Historical rate is not practical
Inventory (at lower of FIFO cost or market) 2,500,000 0.04 100,000 PIC Accounts: Historical Rate
Property, plant and equipment 5,000,000 0.04 200,000
Accumulated depreciation (1,000,000) 0.04 (40,000)
Accounts payable (750,000) 0.04 (30,000)
Application of LCM Rule for Inventory:
Income taxes payable (1,500,000) 0.04 (60,000)
Cieling: = NRV.(Sales $-Selling Exp) 4,000,000
Intercompany notes payable 5,750,000) 0.04 (230,000) Replacement Cost..(Market)............ 2,500,000
Long-term debt (1,000,000) 0.04 (40,000) Cost:.................... 2,600,000
Common stock (6,000,000) 0.05 (300,000) Floor (NRV-normal profit) 2,500,000
Retained earnings, beginning (250,000) ---- (12,500) LCM Value: 2,500,000
(.04)
Sales (8,500,000) 0.045 (382,500)
$ 100,000
Cost of goods sold 5,500,000 0.045 247,500
Depreciation expense 250,000 0.045 11,250
Operating expenses 1,250,000 0.045 56,250
Exchange gain - transactions (1,000,000) 0.04 (40,000)
Deferred exchange loss - transactions 750,000 0.04 30,000
Income tax expense 1,500,000 0.045 67,500
Subtotal -0- $ (62,500)
Translation loss 62,500
Total $ -0-

Durango Company Durango Company

Income Statement Balance Sheet
For Period from January 1, 19x2 to December 31, 19x2 For the Year Ended December 31, 19X2
Sales $ 382,500 Cash..................................... $ 40,000
Cost of goods sold 247,500 Accounts receivable, net............ 120,000
Gross profit $ 135,000 Note receivable.......................... 200,000
Depreciation expense 11,250 Inventory................................ 100,000
Operating expenses 56,250 Property, plant and equipment..... 200,000
Exchange gain, transactions 40,000 A/D.................................... (40,000)
Income before taxes $ 107,500 Total Assets........................... $ 620,000
Income taxes 67,500
Net income $ 40,000 Accounts payable................... $ 30,000
Income tax payable.................... 60,000
Intercompany notes payable....... 230,000
Long-term debt........................... 40,000
Common Stock............................. 300,000
Retained earnings ($12,500 + $40,000) 52,500
Deferred exchange losses:
Transactions: $(30,000)
Translation (62,500) (92,500)
Total Liabilities and SHE................ $ 620,000