2. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-1 CHAPTER 10 Part B Accounting for Long-Term Investments and International Operations

3. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-2 ACCOUNTING FOR INTERNATIONAL OPERATIONS

4. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-3 ACCOUNTING FOR INTERNATIONAL OPERATONS The exhibit below shows the percentages of international sales for three large U. S. companies: CompanyPercent of International Sales Coca-Cola 62% IBM 57 Intel 56 CompanyPercent of International Sales Coca-Cola 62% IBM 57 Intel 56

5. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-4 Accounting for business activities across national boundaries makes up the field of international accounting ACCOUNTING FOR INTERNATIONAL OPERATONS

6. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-5 FOREIGN CURRENCIES AND EXCHANGE RATES The measure of one currency against another is called the foreign-currency exchange rate Using an exchange rate to convert the cost of an item given in one currency to its cost in a second currency is called a translation

7. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-6 Foreign-Currency Exchange Rates at One Point in Time Canada European Common Market France Germany Great Britain Italy Japan Mexico Dollar Euro Franc Mark Pound Lira Yen Peso $0.66 1.06 0.16 0.54 1.59 0.0005 0.0086 0.107 Country Monetary Unit Dollar Value

8. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-7 If an item costs 200 French francs,its translation to dollars is found by multiplying the amount in francs by the conversion rate: 200 French francs x $0.16 = 32 FOREIGN CURRENCIES AND EXCHANGE RATES

9. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-8 Two main factors determine the supply and demand for a particular currency –The ratio of a country’s imports to its exports When exports exceed imports, customers must buy the unit of currency in the international currency market to pay for their purchases FOREIGN CURRENCIES AND EXCHANGE RATES

10. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-9 This demand drives up the price (the foreign exchange rate) of a currency Conversely, as the supply of a currency increases, its price decreases –The rate of return available in the country’s capital market The rate of return available in a country’s capital markets affects the amount of investment funds flowing into the country FOREIGN CURRENCIES AND EXCHANGE RATES

11. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-10 When rates of return are high, international investors buy stocks, bonds, and real estate in that country This activity increases the demand for the nation’s currency and drives up its exchange rate The exchange rate of a strong currency is rising relative to other nations’ currencies The exchange rate of a weak currency is falling relative to other currencies FOREIGN CURRENCIES AND EXCHANGE RATES

12. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-11 Shipp Belting sells goods to Artes de Mexico for a price of 1 million pesos on July 28. On that date, a peso was worth $0.107. On August 28, when the peso is worth only $0.104, Shipp receives 1 million pesos from Artes, but the dollar value of Shipp’s cash receipt is $3,000 less than expected. The following journal entries show how Shipp would account for these transactions: July 28 Accounts Receivable - Artes (1,000,000 pesos x $0.107)107,000 Sales Revenue 107,000 Sale on account July 28 Accounts Receivable - Artes (1,000,000 pesos x $0.107)107,000 Sales Revenue 107,000 Sale on account Aug. 28 Cash (1,000,000 pesos x $0.104)104,000 Foreign Currency Transaction Loss 3,000 Accounts Receivable - Artes 107,000 Collection on account Aug. 28 Cash (1,000,000 pesos x $0.104)104,000 Foreign Currency Transaction Loss 3,000 Accounts Receivable - Artes 107,000 Collection on account

13. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-12 Shipp exposed itself to foreign-currency exchange risk and experienced a $3,000 foreign-currency transaction loss If the peso had increased in value, Shipp would have experienced a foreign-currency transaction gain FOREIGN CURRENCIES AND EXCHANGE RATES

14. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-13 Assume Shipp Belting buys inventory from Gesellschaft Ltd., a Swiss company. The two companies decide on a price of 20,000 Swiss francs. On September 15, when Shipp receives the goods, the Swiss franc is quoted at $0.7999. When Shipp pays on September 29, the Swiss franc has decreased in value to $0.7810. Shipp would record the purchase and payment as follows: Sept. 15 Inventory ( 20,000 Swiss francs x $0.7999 ) 15,980 Accounts Payable - Gesellschaft Ltd. 15,980 Purchase on account Sept. 15 Inventory ( 20,000 Swiss francs x $0.7999 ) 15,980 Accounts Payable - Gesellschaft Ltd. 15,980 Purchase on account Sept. 29 Accounts Payable - Gesellschaft Ltd. 15,980 Cash (20,000 Swiss francs x $0.781) 15,620 Foreign Currency Transaction Gain 360 Payment on account Sept. 29 Accounts Payable - Gesellschaft Ltd. 15,980 Cash (20,000 Swiss francs x $0.781) 15,620 Foreign Currency Transaction Gain 360 Payment on account If the Swiss franc had strengthened against the dollar, Shipp would have had a foreign-currency transaction loss

15. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-14 The company reports the net amount of foreign currency transaction gains and losses on the income statement as Other Revenues and Gains, or Other Expenses and Losses FOREIGN CURRENCIES AND EXCHANGE RATES Other

16. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-15 Shipp Belting would combine the $3,000 foreign-currency loss and the $360 gain and report the net loss of $2,640 on the income statement as follows: Other Expenses and Losses: Foreign-currency transaction loss, net $2,640 Other Expenses and Losses: Foreign-currency transaction loss, net $2,640

17. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-16 One way for U. S. companies to avoid foreign-currency transaction losses is to insist that international transactions be settled in dollars Another way for a company to protect itself is by hedging –Protection from transaction losses by engaging in a counterbalancing transaction FOREIGN CURRENCIES AND EXCHANGE RATES

18. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-17 Some companies buy futures contracts which are contracts for foreign currencies to be received in the future Futures contracts can effectively create a payable to exactly offset a receivable, and vice versa FOREIGN CURRENCIES AND EXCHANGE RATES

19. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-18 CONSOLIDATION OF FOREIGN SUBSIDIARIES The consolidation of a foreign subsidiary poses two special challenges –Accountants must first bring the subsidiary’s statements into conformity with American GAAP –When the subsidiary statements are expressed in foreign currency, they must be translated into dollars

20. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-19 The process of translating a foreign subsidiary’s financial statements into dollars usually creates a foreign- currency translation adjustment –Assets and liabilities in the foreign subsidiaries’ financial statements are translated into dollars at the exchange rate in effect on the date of the statements –Stockholders’ equity is translated into dollars at the historical exchange rates CONSOLIDATION OF FOREIGN SUBSIDIARIES

21. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-20 The foreign-currency translation adjustment is the balancing amount that brings the dollar amount of the total liabilities and stockholders’ equity of a foreign subsidiary into agreement with the dollar amount of its total assets CONSOLIDATION OF FOREIGN SUBSIDIARIES

22. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-21 U. S. Express Corporation owns Italian Imports, Inc., whose financial statements are expressed in lire When U. S. Express acquired Italian Imports in 20X1, a lira was worth $0.00070 When Italian Imports earned its retained income during 20X1 - 20X6, the average exchange rate was $0.00067 On the balance sheet date in 20X6, a lira is worth only $0.00060 The following exhibit shows how to translate Italian Imports’ balance sheet into dollars and shows how the translation adjustment arises:

23. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-22 Assets Liabilities Stockholders’ Equity Common stock Retained earnings Accumulated other comprehensive income: Foreign currency translation adjustment translation adjustment 800,000,000 500,000,000 100,000,000 200,000,000 800,000,000 $0.00060 0.00060 0.00070 0.00067 $480,000 $300,000 70,000 134,000 (24,000) $480,000 Exchange Italian Imports, Inc., Amounts Lire Rate Dollars Translation of Foreign-Currency Balance Sheet into Dollars

24. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-23 United States Germany Japan United Kingdom Specific unit cost, FIFO, LIFO, weighted average Similar to U.S. LIFO is unacceptable for tax purposes and is not widely used Amortized over period not to exceed 40 years Amortized over 5 years Amortized over useful life or not amortized if life is indefinite Expensed as incurred May be capitalized and amortized over 5 years Expense research cost Some development costs may be capitalized CountryInventoriesGoodwill Research and Development Costs Differences in accounting principles exist among countries around the world as shown below:

25. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-24 INTERNATIONAL ACCOUNTING STANDARDS A company that sells its stock through a foreign stock exchange must follow the accounting principles of the foreign country The globalization of business enterprises and capital markets is creating much interest in establishing common, worldwide accounting standards

26. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-25 The primary organization working to achieve worldwide harmony of accounting standards is the International Accounting Standards Committee (IASC) INTERNATIONAL ACCOUNTING STANDARDS

27. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-26 USING THE SCF TO INTERPRET INVESTING ACTIVITIES The purchase and sale of investments in the stocks and bonds of other companies are investing activities that are reported on the cash-flow statement Investing activities are on the statement of cash flows as the second category, as shown in the following exhibit:

28. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-27 Cash Flows from Operating Activities 1. Net cash provided by operating activities $ 1,185 Cash Flows from Investing Activities 2. Purchases of plant assets (391) 2. Purchases of plant assets (391) 3. Sales of plant assets 21 3. Sales of plant assets 21 4. Businesses acquired (1,255) 4. Businesses acquired (1,255) 5. Sales of businesses 12 5. Sales of businesses 12 6. Other (45) 6. Other (45) 7. Net cash used in investing activities (1,658) 7. Net cash used in investing activities (1,658) Cash Flows from Financing Activities 8. Long-term borrowings 312 9. Repayments of long-term borrowings (29) 10. Short-term borrowings 1,087 11. Repayments of short-term borrowings (662) 12. Dividends paid (295) 13. Other 13 14. Net cash provided (used in) financing activities 426 CAMPBELL SOUP CO. Consolidated Statement of Cash Flows (In millions)19X5

29. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-28 Campbell Soup spent $1.255 billion to acquire other companies (line 4) It sold other companies for a total of $12 million (line 5) Campbell Soup financed acquisitions of other businesses through operating activities (line 1) USING THE SCF TO INTERPRET INVESTING ACTIVITIES

30. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-29 Long-term borrowing (line 8) and short- term borrowing (line 10) far exceeded repayments of borrowings (lines 9 and 11) –This means that the company had the cash to expand USING THE SCF TO INTERPRET INVESTING ACTIVITIES

31. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10B-30 END OF CHAPTER 10 Harrison & Horngren