Question

On December 18, 2017, Stephanie Corporation acquired 100 percent of a Swiss company for 4.0 million Swiss francs (CHF), which is indicative of book and fair value. At the acquisition date, the exchange rate was $1.00 = CHF 1. On December 18, 2017, the book and fair values of the subsidiary’s assets and liabilities were:
Cash CHF 814,000
Inventory 1,314,000
Property, plant & equipment 4,014,000
Notes payable 2,128,000

Stephanie prepares consolidated financial statements on December 31, 2017. By that date, the Swiss franc has appreciated to $1.10 = CHF 1. Because of the year-end holidays, no transactions took place prior to consolidation.

Required:
a. Determine the translation adjustment to be reported on Stephanie’s December 31, 2017, consolidated balance sheet, assuming that the Swiss franc is the Swiss subsidiary’s functional currency. What is the economic relevance of this translation adjustment?

b. Determine the remeasurement gain or loss to be reported in Stephanie’s 2017 consolidated net income, assuming that the U.S. dollar is the functional currency. What is the economic relevance of this remeasurement gain or loss?

Answer 1

Answer:

a. Translation adjustment = $401,400

b. Remeasurement loss = –$131,400

Explanation:

a. Determine the translation adjustment to be reported on Stephanie’s December 31, 2017, consolidated balance sheet, assuming that the Swiss franc is the Swiss subsidiary’s functional currency. What is the economic relevance of this translation adjustment?

This can determined as follows:

Step 1: Calculation of beginning net asset in

Particular                                         Amount (CHF)    

Cash CHF                                             814,000

Inventory                                             1,314,000

Property, plant & equipment            4,014,000

Notes payable                                (2,128,000)  

Beginning net asset                        4,014,000  

Beginning net asset in USD = Beginning net asset in Swiss francs (CHF) * Beginning exchange rate = CHF4.014,000 * $1 = $4,014,000

Step 2: Calculation of ending net asset

Ending net asset in USD = Beginning net asset  in Swiss francs (CHF) * Ending exchange rate = CHF4.014,000 * $1.10 = $4,415,400

Step 3: Calculation translation adjustment

Translation adjustment = Ending net asset in USD - Beginning net asset in USD = $4,415,400 - $4,014,000 = $401,400

Economic relevance of this translation adjustment

The positive translation adjustment implies that the equity of stockholders has increased by $401,000.

We obtained a positive value because the net position of the subsidiary in Switzerland is CHF4,014,000 and there was a Swiss franc appreciation of $0.10 (i.e. $1.10 - $1.00 = $0.10).

The translation adjustment of $401,000 does not however implies that it was made as a dollar cash flow. The only condition that can make to turn to a profit is if this operation is sold at CHF4,014,000 on December 31 and the amount realized as a proceed is changed to dollars at ruling exchange rate of $1.10 to a Swiss franc on December 31, 2017.

b. Determine the remeasurement gain or loss to be reported in Stephanie’s 2017 consolidated net income, assuming that the U.S. dollar is the functional currency. What is the economic relevance of this remeasurement gain or loss?

This can be determined as follows:

Beginning net liabilities in Swiss franc = Cash - Note payable = CHF814,000 - CHF2,128,000 = –CHF1,314,000

Beginning net liabilities in USD = Beginning net liabilities in Swiss franc * Beginning exchange rate = –CHF1,314,000  * $1.00 = –$1,314,000

Ending net liabilities in USD = Beginning net liabilities in Swiss franc * Ending exchange rate = –CHF1,314,000  * $1.10 = –$1,445,400

Remeasurement loss = Ending net liabilities in USD – Beginning net liabilities in USD = [–$1,445,400] – [–$1,314,000] = –$131,400

Economic relevance of this remeasurement gain or loss

There is a negative remeasurement or remeasurement lost because the net monetary liability position of the Swiss subsidiary is CHF 1,314,000. The appreciation of the Swiss franc by $0.10 results in a loss of $131,400] that not is unrealized.

The readjustment loss of $131,400 does not however implies that it was a dollar cash outflow. The only condition that can make it to turn to a loss is if this operation is sold on December 31. This will lead to the realization of a transaction gain of $81,400 [i.e. CHF814,000 x ($1.10 - $1.00)].

Also, the Swiss franc note payable will be paid off by using the US dollar. This will bring about the realization of a truncation loss of $212,800 [i.e. CHF2,128,000 x ($1.10 - $1.00)].