Advanced Accounting ACCT 400
Popular in Course
Popular in Accounting
This 39 page Class Notes was uploaded by Mrs. Antoinette Kiehn on Monday October 5, 2015. The Class Notes belongs to ACCT 400 at California State University - Long Beach taught by Michael Constas in Fall. Since its upload, it has received 7 views. For similar materials see /class/218772/acct-400-california-state-university-long-beach in Accounting at California State University - Long Beach.
Reviews for Advanced Accounting
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 10/05/15
1 Forming Partnerships Heading Chapter 13 Forming Partnerships 2 Relationship Between Partners Heading Legal Relationship Between Partners 3 Relationship Between Partners 1 Some basic legal concepts Partnership Pp 9 People get together to conduct a business Regular Pps are General Pps Law governing GPps is Uniform Partnership Act UPA 4 Relationship Between Partners 1 UPA also provides basic agreement between Prs in the absence of a Pp Agreement Pp Agreement can overide these provisions Eg UPA says Prs get equal share of Pp income but Pp agreement can provide differently Pp Agreement can treat Prs differently Prs can get different shares of Pp incomewithdrawals of capital 5 Relationship Between Partners 1 Partners Prs have fiduciary relationship with each other amp Pp Eg Pp property cannot be used by any Prs for personal purposes wo consent of all other Prs 6 Relationship Between Partners 3 Prs have mutual agency Each Pr is agent for other GPs and Pp One GP can bind entire Pp Even though not authorized Apparent Authorityquot Doctrine Pp is bound 9 If other party did not know GP not authorized Pp not bound 9 If other party knew GP not authorize Pp can sue GP for unauthorized action 7 Relationship Between Partners 4 Prs have Jointly amp Severally Liabiliy for Pp debts All Prs are personally liable amp Creditor can collect entire debt from any 1 Pr Pr then has to collect respective shares of debt from other Prs 8 Relationship Between Partners 5 Limitation of liability for newly admitted Prs Unlimited liability for Pp debts incurred after admission For Ereexisting obligations 9 Can only lose capital contributions Limited Liability like corp shareholder 9 Admission of Partner 1 W All existing Prs must agree to admission of a new Pr If 1 Pr sells Pp interest 9 transferee is not automatically new Pr If old Prs do not consent transferee is an assignee Assignee gets economic benefits of Pp but does not participate in the management 10 Limited Partnerships Heading Limited Partnerships Limited Partnerships 1 ln limited partnership LPp there are 2 classes of Prs GPs and Limited Prs LPs GPs run LPp GPs have rights amp obligations of Prs described above LPs Don t participate in Pp management Have Limited Liability LPps are governed by the Uniform Limited Partnership Act ULPA 12 Limited Partnerships 3 LPs can only lose capital contributions Limited liability If LP involved in management of LPp LP loses limited liability LP has unlimited liability Despite being called a LP State law usually lets LPs vote on certain things amp still remain LPs Eg admitting a new GP or selling LPp property 13 LLCs amp LLPs Heading Limited Liability Companies LLCs amp Limited Liability Partnerships LLPs 14 LLCs amp LLPs 1 Pps have advantages that investors like 91 Flexibility in management Avoidance of double taxation Corps also have advantages that investors want Eg Limited liability Publisher39s web site says in theory partnerships are more able to attract capital than corpora ions This is not true capital markets are geared towards selling stock For years investors tried structuring LPps similar to corps Big tax litigation for around 30 years Finally states developed 2 types of new orgs Give investors best of Corp amp Pp worlds 15 LLCs amp LLPs 2 Limited Liability Company LLC is used for most businesses All LLC members can engage in management amp they have limited liability 16 LLCs amp LLPs 3 Limited Liability Partnership LLP is used for professions Eg doctors lawyers amp accountants Professionals may engage in management Professionals generally have limited liability BUT they have unlimited liability for their own actions Eg malpractice 17 Legal Theories Heading Conflicting Legal Theories Concerning Essence of Partnerships 18 Legal Theories 1 1St 9 law viewed Pps as a group of individuals Not an entity Called Proprietary Theoryquot amp Aggregate Theoryquot Later 9 law began to view Pps as entities Called Entity Theoryquot Law today is mixture of both theories Sometimes Pp viewed as group of individuals Sometimes Pp viewed as an entity 19 Legal Theories 2 Egs of Aggregate Theory Unlimited liability GPs liable for Pp debt as if their own debt Pps do not pay taxes Pps file informational tax return Pp does not pay taxes Pr receives a Form K1 Pr pays taxes on share of Pp income Pp legal termination on death withdrawal or bankruptcy of 1 GP Pp may dissolve but Prs can agree to continue the business in a new Pp It is a different group of prs Pps don39t have continuity of lifequot Different than corps 20 Legal Theories 3 Egs of Entity Theory Pp may enter contracts in its own name In CA Pp may own real estate in its own name A Pp may declare bankruptcy N Legal Theories 5 A GPp doesn t need a written GPp agreement Still is a GPp A LPp LPps needs a written LPp agreement States require that certain forms must be filed or recorded If you don t do everything required 9 then LPp is treated as GPp 22 Methods of Accounting Heading Different Methods of Accounting Used By Partnerships N w Methods of Accounting 1 Pps are usually small businesses Many small businesses don t use GAAP Not worried about certified FS Use other methods of accounting The American Institute of Certified Public Accountants AICPA notes that the following methods are popular with small businesses Eg Cash method amp tax basis of accounting 24 Methods of Accounting 2 TaX basis of accounting Keep books same way as required for Pp tax return Eg depreciation MACRS rules amp immediate write offs This way have all information ready to prepare Pp tax return 25 GAAP Partnership Accounting Heading GAAP Partnership Accounting 26 GAAP Partnership Accounting 1 Pps amp Sole Proprietorships have different capital set up from corps Corp has 2 types of capital Paidin capital eg common stock amp Each account applies to entire corp Pp each Pr has hisher own capital account that contains both Capital contributions amp Prs share of Pp RE 27 GAAP Partnership Accounting 2 Capital account Normally has credit balance Credited for capital contributions Credited forthe GPLP s share income Debited for Pr s share of losses Debited for Pr s withdrawals John Doe Capital Account Share of Partnership Losses Capital Contributions Withdrawals Share of Partnership Income 28 GAAP Partnership Accounting 6 Pp are diff than Corps with respect to capital With corps 9 When corp liquidates each stkholder gets same amount per share With Pps 9 Pp BV is already divided up between the Prs Need this because income can be allocated differently to Prs Cash can be withdrawn by Prs are different rates Prs cap acct bal says this amount of Pp s BV belongs to this Pr 29 GAAP Partnership Accounting 6 On liquidation Pr gets hisher cap acct bal Pr s share of total Pp capital sometimes called Pr s interest in Ppquot Pr s interest in Pp can be different from Pr s share of Pp39s incomelosses Eg Pr can have 90 of Pp capital but receive only 50 of Pp income 31 GAAP Partnership Accounting 4 Pp39s payment of Pr39s personal debt obligation is treated as a draw withdrawal of capital Eg paying a Pr s insurance premium Payment treated as paid to Pr amp then Pr takes cash amp pays debt 30 GAAP Partnership Accounting 3 Also each Pr has drawing acct Temporary acct Records Pr s withdrawals Has a debit acct balance Draws are not Salary More like Divs paid by corps The name draw is for withdrawal of capital Draws are not payments for services Drawing acct is closed to Pr39s capital account periodically Eg at end of year 393 2 GAAP Partnership Accounting 5 Contribution of property to Pp Use FMV of contributed assets This is GAAP This would not be the case if Pp were using tax basis accounting Same rule we learned for corps 33 GAAP Partnership Accounting 7 Pr may loan funds to Pp Mainly treated as loan not capital contribution 34 Journal Entries Heading Journal Entries 35 Journal Entries 1 When Pr A contributes 10K cash to Pp D Cash 10000 0 PrA Capital Account 10000 36 Journal Entries 2 When Pr B contributes inv worth 5K amp equip worth 4K to Pp amp Pp assume Pr s debt of 2K D Inventory 5000 Equipment 4000 0 Note Payable 2000 Pr B Capital Account 7000 37 Journal Entries 3 When Pr C makes 3K loan to Pp D Cash 3000 0 Pr 0 loan 3000 38 Journal Entries 4 When a Pr D withdraws 5K cash from Pp D Pr D Drawing 5000 0 Cash 5000 39 Journal Entries 5 Income of Pp goes into capital accounts No RE account in Pps Eg Pp earns 10K income amp allocates income between Prs E amp F 5050 D IncomeSummary 10000 0 PrECapita 5000 Pr F Capital 5000 40 Journal Entries 6 Pr s drawing account is closed to Pr s capital account Eg Pr G has 1K balance in drawing acct at end of year D Pr G Capital 1000 0 Pr G Drawing 1000 41 Income Allocations Heading Income Allocations 42 Income Allocations 1 UPA 18 If the Pp agreement is silent 9 profits and losses allocated equally among Prs 43 Income Allocations 2 Pps have flexibility in allocating profits Prs can share profits any way they want Can use capital ratio Can use different ratio Eg Able gets profits from Long Beach store where Able is manager amp Betty gets profits from Torrance store where Betty is manager Not like corps 9 RE shared according to stock ownership ratio 44 Income Allocations 4 Pp may pay interest on capital account balances amp Allocate remaining Pp profits using another ratio When Pp pays interest to a Pr It isn t an expense It is an allocation of income 45 Income Allocations 5 If Pp pays interest on capital acct 9 of issues Will drawings be netted against capital acct balances How does Pp calculate capital acct balance on which interest paid Can use capital acct balances at the end of the period Can use capital acct balances at the beginning of the period 0 Can use the weighted average of the capital accts balances of the partners during the year 46 Income Allocations 6 Eg Pp has 20000 net income Prs get interest on capital accounts Any remaining profits shared equally among Prs Able Betty Total Interest on Beginning Capital Able 10 X 100000 10000 10000 Betty 10 X 60000 6000 6 000 16000 Balance per profit ratio equally 2000 2000 4000 Allocation of profit 12000 8000 20000 47 Journal Entries 5 This calculation provides the numbers for the following journal entry D Income Summary 20000 0 Able Capital 12000 Betty Capital 8000 48 Income Allocations 7 Pp can paym to Prs Salaries to Prs are an allocation of P9 profits Pr salaries are not treated as expenses Remember 9 don t confuse a drawing with a salary A bonus is also an allocation of profits Often the bonus is a of Pp net income Bonus may be of Pp income reduced by interest on capital Pr salary andorthe Pr bonus 49 Income Allocations 8 50 Income Allocations 9 Eg Pr gets 10 bonus on Pp income 120K alter Pr salaries 60K amp Interest on capital accounts 5K amp the Bonus itself Eg Pr gets 10 bonus on Pp income 120K alter Pr salaries 60K amp interest on capital accounts 5K X Net Income Salaries Interest Bonus X Net Income Pr Salaries Interest on Capital Bonus Bonus 10 120000 60000 5000 101201000 39 601000 5000 Bonus Bonus Bonus 10 55000 B 5 500 Bonus 10 55000 10 Bonus onus Bonus 10 Bonus 5500 110 Bonus 5500 Bonus 5500110 Bonus 5000 51 Income Aocations 10 52 Income Allocations 11 Pps often combines several allocation Profit Allocation Multiple Bases Example techniques m m m m E39gquot Pp may use Int on Capital Balances 3000 600 3600 Interest on capital balances Bonus 3000 3000 Salaries Salaries 13000 12000 25000 Bonuses amp Subtotal 13000 3000 15600 31600 Remaining Profit 700 350 350 1400 Allocation Ratios IncomeAllocation 13700 3350 15950 33000 53 Allocation De ciencies Heading Allocation Deficiencies 54 Allocation De ciencies 1 Pp income may not be sufficient to cover all of the interest salaries andor bonuses or a Pp loss may occur There are 2 alternatives for Pp to handle deficiency Satisfy all allocation provisions Create deficiency loss Allocate deficiency using profit amp loss ratio Satisfy each allocation provisions to extent possible Need to know allocation priorities 55 Allocation De ciencies 2 Eg Pp had net income of 22000 13 alternative do all allocations amp allocate resulting deficiency ProfitAllocation First Alternative 22000 Net Income Able Betty Cain Total Int on Capital BaI 3000 600 3600 Bonus 2000 2000 Salaries 13000 12000 25000 Subtotal 13000 3000 14600 30600 Remaining Profit 4300 2150 2150 8600 Income Allocation 8700 850 12450 22000 56 Allocation De ciencies 3 Eg Pp had net income of 22000 2nd alternative do as much as Pp can Profit Allocation Second Alternative 22000 Net Income Able Betty Cain Total Int on Capital BaI 3000 600 3600 Bonus 2000 2000 Salaries 8528 7872 16400 Income Allocation 8528 3000 10472 22000 57 Special Allocations Heading Special Allocations 58 Special Allocations 1 Different items of Pp income may be allocated using different ratios Called special allocations Special allocations were abused to give tax advantages Tax rules require that allocations must have substantial economic effect Allocation must affect way in which assets are distributed in liquidation to have sub econ effect 1 Topic Heading Chapter 5 INTERCOMPANY BONDS amp LEASES Intercompany Bonds Are Common Ps often provide financing for Ss Ps can borrow at better rates Ps want to control access to capital markets We do the same type of WS entries that we already talked about with intercompany debt Get Rid of Bond RecBond Pay Get Rid of Int RevInt Exp Get Rid of Int RecInt Pay 2 Intercompany Bonds Heading Intercompany Bonds Issued to Affiliate 4 Issuer s Accrual Entn on Its Books Assume 8 issues 100K of bonds amp P buys bonds Assume that pay 8 interest On S s books Bond Issuer in the 1St Year D Cash C Bonds Payable 100000 100000 D Interest Expense 8000 C Interest Payable 8000 5 Issuer s Accrual Entn on Its Books Assume 8 issues 100K of bonds amp P buys bonds Assume that Bonds pay 8 interest On P s books Bond Investor in the 1st Year D InvestmentinSubsidiary Bonds 100000 C Cash 100000 D InterestReceivabIe 8000 C InterestRevenue 8000 6 Issuer s Accrual Entn on Its Books On S s books Bond Issuer in later years 9 S accrues interest expense on intercompany bonds D Interest Expense 8000 C Interest Payable 8000 7 Issuer s Accrual Entn on Its Books On P s books Bond Investor in later years 9 P accrues interest revenue on intercompany bonds D Interest Receivable 8000 C Interest Revenue 8000 8 Intercompany Bonds Worksheet Entn 2 The WS entries are BI D Bonds Payable 100000 BI C Investmentin Sub Bonds 100000 BI D Interest Revenue 8000 BI C Interest Expense 8000 B2 D Interest Payable Amt Unpaid B2 C Interest Receivable Amt Unpaid 9 Intercompany Bonds Heading Bonds Originally Issued to Others Purchased by Affiliate afterwards 10 Creditor s Accrual Entn on Its Books Bonds issued to nonaffiliated buyers are legitimate debt Shows up on Consolidated FS If these bonds are later purchased by affiliated Cos 9 They become intercompany debt No longer show up on Consolidated FS We treat bonds as being redeemed Bond issuer recognizes gainloss on retirement 11 Creditors Accrual Entn on Its Books When P buys 8 bonds 9 on P s books P creates Investment in Subsidiary Bonds for purchase price Purchase price includes de facto premiumdiscount No actual premiumdiscount acct is created by investor in bonds P amortizes defacto premiumdiscount P writes downup Investment in Bonds account directly 12 Creditor s Accrual Entn on Its Books Assume P purchases S s 100K 8 bonds for 103600 Premium amortized over 3 year remaining term In the 1st year D Investment in Bonds 103600 Cash 103600 D Interest Receivable 8000 Investment in Bonds 1200 Interest Revenue 6800 13 Issuer s Accrual Entn on Its Books On S s books Bond Issuer in the 1st Year D Interest Expense 8000 C Interest Payable 8000 14 Intercompany Bonds 1 On the WS We want nothing to survive Get rid of Assets amp Liabilities Get rid of Rev amp Exp When you eliminate Rev amp Exp There is a net reduction of exp 1200 8000 6800 This is income 9 Who gets it Issuer of bonds gets interest savings income 1200 15 Intercompany Bonds Worksheet Entn 2 Also recognize lossgain on retirement Difference between Price paid for bonds 103600 Issuer s BV 100000 Loss of 3600 Issuer of Bonds 8 is allocated both LossGain from Retirement Interest savingsexpenditure Over years they offset amp no effect 16 Intercompany Bonds Worksheet Entry 2 In our Eg 9 following WS entry made in 1St year Remember that P amortized 1200 of its Inv in Sub Bonds Reduces Inv in Sub Bonds from 103600 to 102400 B1 D Bonds Payable 100000 B1 C Investmentin Subsidiary Bonds 102400 B1 D Interest Revenue 6800 B1 C Interest Expense 8000 B1 D Loss on Bond Retirement 3600 17 Intercompany Bonds Worksheet Entn 3 If interest is unpaid 9 eliminate interest receivable amp a ab p y Ie B2 D Interest Payable 8000 B2 C Interest Receivable 8000 19 Intercompany Bonds Worksheet Entn 5 Parent Income Distribution Internally generated net income including interest revenue 36800 90 of Sub39s 9600 income 8640 Controlling Interest 45440 18 Intercompany Bonds 4 Subsidiary Inc me Distribution Internally generated net Loss on bond retirement 3600 income 12000 Interest adjustment bond prem 1200 Adjusted income 9600 NCI share 10 NCI 960 20 Intercompany Bonds Year 1 B1 B1 B1 B1 B1 Last year15t Year Issuer S allocated 3600 loss on retirement Issuer S allocated 1200 interest savings Issuer 8 had a net loss of 2400 This reduced Consolidated RE by 2400 last year Not done on PampS books 9 must be done in WS This year 2nd Year P amortized its Inv in Sub Bonds by another 1200 Reduced Inv in Sub Bonds from 102400 to 101 200 D Bonds Payable 100000 C Investmentin Subsidiary Bonds 101200 D Interest Revenue 6800 C Interest Expense 8000 D Retained Earnings January 1 2004 P90 2160 Retained Earnings January 1 2004 S10 240 21 Intercompany Bonds Worksheet Entn 2quotd Year 2 It interest is unpaid need to eliminate intercompany accounts 82 D InterestPayabIe 8000 82 C Interest Receivable 8000 22 Intercompany Bonds Worksheet Entry 2quotd Year 3 Subsiciary Income Distribution Internally generated net income 12000 Interest adjustment bond prem 1200 Adjusted income 13200 NCI share 10 NCI 1 320 23 Intercompany Bonds Worksheet Entry 2quotd Year 4 Parent Income Distribution Internally generated net income including interest revenue 36800 90 of Sub s 13200 income 11 700 Controlling Interest 48500 24 Other Intercompany Bond Issues Heading Other Intercompany Bond Issues 25 Part of Bond Issue Owned By Af liates Onlv Part of Bond Issue Owned by Affiliate If P purchased only portion of bond issue eliminate only portion purchased along with its interest revenue amp expense Bonds owned by nonrelated parties are valid debt Not eliminated Interest accrued is valid expense 27 Operating Leases Heading Operating Leases 26 Effective Interest Amortization lf interest method of amortization effective interest amortization is used Entries are unchanged but Dollar amounts will be different 28 Operating Leases 1 If operating lease OL between affiliates eliminate Rent revenue amp Rent expense Rent receivable amp Rent payable Assume 1 200 a month OL with 1 month unpaid rent OL1 D Rent Revenue 14400 OL1 C Rent Expense 14400 0L2 D Rent Payable 0L2 C Rent Receivable 1200 1200 29 Capital Leases Heading Capital Leases 0 Capital Leases 1 What about capital leases Asset amp liability are created on PampS books On Consolidated FS 9 only asset survives Liability is intercompany liability Same as before get rid of intercompany accts int rev amp exp int pay amp rec lf profit taken in capital lease by affiliate Undo profit Names reflect capital leases Need to change names to reflect outright ownership of asset 31 Capital Leases 2 Capital Lease with no profit On Lessee s books on lease signing 1120X1 D Assets Under Capital Lease On Lessor s books on lease signing 1120X1 D Accounts Payable Owed to 3d Party for asset 5851 If we were to close the year right after signing Capital Lease LESSEE S BOOKS LESSOR S BOOKS Oblig Under Lease 3851 Min Lease Pay Rec Unearn Int Inc M 3851 D Unearned Interest Income 1149 Obligations Under Capital Lease 3851 C Minimum Lease Payments Receivable q 33 Capital Leases 3 Asset Under Capital Lease needs to have name changed To Property Plant amp Equipmentquot D Property Plant amp Equipment 5851 C Assets Under Capital Lease 5851 347 El Enin E g 711204 D Assets Under Capital Lease 5851 Lessee Books 0 Obligations Under Capital Lease 3851 2000 D Minimum Lease Payments Receivable 5000 Lessor39s Books Cash 2000 O Unearned Interest Income 1149 Owed to 3rd Party ior asset 5851 D Unearnedlnterest Income 1149 WS CLZ Obligations Under Capital Lease 3851 Minimum Lease Payments Receivable 5000 D Property Plant amp Equipment 5851 WS CL 3 C lAssets Under Capital Lease 5851 After the WS entries Left with only asset PropPlnt amp Equipquot Left with only liability Accts Pay 35 Capital Leases 4 During 1St year 9 Int accrued amp Depr Exp taken On Lessee s books end of 1st year D Depreciation Expense 1170 C Accumulated Depreciation Leased Asset 1170 D Interest Expense 616 C Interest Payable 616 On Lessor s books D Unearned Interest Revenue 616 C Interest Revenue 616 Notice that there is no Int Receivable Instead there is reduction in Unearned Int Rev 36 Capital Leases Worksheet Entries 1 WS needs to eliminate Revenue to Lender Interest Revenue Need to eliminate Expense to Borrower Interest Expense 1st year WS entry CL1 D Interest Income 616 CL1 C Interest Expense 616 37 Capital Leases Worksheet Entries 2 We want to eliminate the Lease RecPay and Interest RecPay The Problem is that there is no Interest Rec It was added to the Lease Rec Because of this Lease Rec Lease Pay We want to see the following Lessee Lessor LPay 3851 LRec 5K 1149 3851 lPay 616 lRec 616 IExp 616 lRev 616 39 Capital Leases Worksheet Entries 2 Since you combined the LRec amp lRec you need to combine the LPay and to get this to work 38 Capital Leases Worksheet Entries 2 Unfortunately we see Lessee Lessor LPay 3851 LReC 5K 1149 3851 lRec 616 lPay 616 IExp 616 lRev 616 Not this Lessee Lessor LPay 3851 LReC 5K 1149 3851 lPay 616 lRec 616 IExp 616 lRev 616 LESSEE S BOOKS LESSOR S BOOKS BEFORE Oblig Under Lease 3851 Min Lease Pay Rec 5000 Unearn Int Inc M 3851 Lessee Lessor LPay 3851 LRec 5K 1149 3851 lPay m lRec m 4467 LReC 4467 Remember I Rec reduced Unearned Interest IExp 616 llRev 616 AFTER Oblig Under Lease Min Lease Pay Rec Interest Payable V m Unearn Int Inc V 1 4467 4467 No Interest Receivable CL2 D Unearnedlnterestlncome D Interest Payable D Obligation Under Capital Lease C Minimum Lease Payment Rec 41 Capital Leases Worksheet Entries 3 In 1st year also need to change name of asset from Asset Under Capital Lease to PPampE you can t lease from yourself CL3 D Accumulated Depreciation Leased Asset 1170 CL3 Cr Accumulated Depreciation PPampE 1170 CL3 D Property Plant and Equipment 5851 CL3 Cr Assets Under Capital Lease 5851 o smug m 43 Capital Leases Profit on Capital Lease 1 lf lessor has profit sales type lease Need to eliminate profit Lessor made following entry at signing of lease All of the other journal entries of lessor and lessee do not c ange 112001 D Minimum Lease Payments Receivable 5000 Cash 2000 C Unearned Interest Income 1149 Accounts Payable for asset 4951 Profit 900 W D Assets Under Lease 5851 D Min Lease Pay Rec 5000 C Dblig Under Lease D Cash 2000 C Unearn Int Inc 1149 AP 3rd Party 35351 D Depreciation Expense 1170 D Unearnedlnt Rev 616 Acc Depreciation C Interest Rev 616 D Interest Expense 616 C Interest Payable womnm 8le D Interest Revenue 616 WS CL 1 C Interest Expense 616 D Unearned Interest Income WS CL 2 D Interest Payable D Obligation Under Capital Lease C Minimum Lease Payment Rec 5000 D Accumulated Depreciation Leased Asset WS CL 3 C Accumulated Depreciation Prop Plant amp Equip 1170 D Property Plant amp Equipment 5851 WS CL 3 C Asset Under Capital Lease 5851 44 Capital Leases Pro t on Capital Lease 2 In addition to the other WS entries discussed earlier must Write down asset s cost to original cost Defer profit on Capital Lease Eliminate depreciation exp on markup F1 D Sales Profit on Lease 900 F1 C Property Plant and Equipment 900 F2 D Accumulated Depreciation PP amp E 300 F2 C Depreciation Expense 300 45 Prior Transactions 39 T 39 Prior To Business Combination lf affiliates did business before becoming affiliated Profitslosses andor incomeexpenses accrued prior to affiliation stay in Consolidated FS Any profitslosses andor incomeexpenses accrued after acquisition eliminated CHAPTER 11 Translation 0f Foreign Financial Statements Introduction This chapter deals with the situation where a subsidiary keeps its books using a foreign currency The foreign currency in which the subsidiary s book are kept is called the book of recordquot currency or the subsidiary s domestic currency Functional Currency The functional currency of a company is the currency of the primary economic environment in which the entity generates and expends cash The functional currency may be the subsidiary s domestic currency For example A US parent may establish a Italian subsidiary to manufacture and sell goods in Italy The subsidiary s financing comes from Italian banks and its suppliers are in Italy as well In this case the functional currency is probably the Euro The functional currency may be the parent s domestic currency For example a US parent may establish a Mexican subsidiary to manufacture goods The financing comes from US banks US suppliers provides parts and the manufactured goods are sold to US customers In this case the functional currency is probably the US dollar The functional currency does not have to be either the domestic currency of the parent or the subsidiary If you have an American parent with a Irish subsidiary The Irish subsidiary uses suppliers in United Kingdom and sells all of the goods that it produces in the United Kingdom The functional currency of the subsidiary is probably neither the US dollar nor the Euro but the UK Pound Remember that the determination of the functional currency is a subjective one Basic Translation Process The first thing that you have to do is to make sure that the financial statements of the foreign subsidiary reflect GAAP Next you have to identify the functional currency of the foreign subsidiary If the functional currency of the foreign subsidiary is its domestic or local currency then the functional currency accounts must be translated into the parent s domestic currency using the current rate methodquot This is also known as the functional methodquot or the translation methodquot We will discuss this first REMEMBER WHEN YOU CONVERT FROM THE FUNCTIONAL CURRENCY TO THE US DOLLAR YOU FOLLOW THE TRANSLATION RULES IF THE SUBSIDIARY S DOMESTIC CURRENCY IS ITS FUNCTIONAL CURRENCY THEN ALL YOU DO IS A TRANSLATION If the books of record are not kept using the functional currency the functional currency is not the domestic currency of the foreign subsidiary then you must first remeasure the account balances of the subsidiary and then translate them from the functional currency to the Parent s domestic currency When remeasuring you use the historical rate methodquot also known as the temporal methodquot or the remeasurement methodquot We will discuss this later REMEMBER WHEN YOU CONVERT FROM THE DOMESTIC CURRENCY TO THE FUNCTIONAL CURRENCY YOU FOLLOW THE TRANSLATION RULES IF THE US DOLLAR IS THE SUBSIDIARY S FUNCTIONAL CURRENCY THEN ALL YOU DO IS A REMEASUREMENT WHEN THE FUNCTIONAL CURRENCY IS NEITHER THE SUBSIDIARY S DOMESTIC CURRENCY NOR THE US DOLLAR THEN YOU NEED TO DO A REMEASUREMENT AND A TRANSLATION Translation The Current Rate Method With translation you follow the following steps 1 All assets and liabilities are translated at the current exchange rate at the date of translation 2 Although the rule in translation is that elements of income are translated at the current exchange rates that existed at the time the revenues and expense were recognized As a practical matter your book always translates income elements normally at a weighted average exchange rate for the period 3 Equity accounts other than retained earnings eg common stock are translated at the historical rate on the date of investment 4 Retained earnings are translated in layers a Retained earnings that exist on the date of investment are translated at the historical rate on the date of investment lncome additions to retained earnings that have occurred since the parent s acquisition of the subsidiary are included at the amounts translated in item 2 above Reductions for dividends are translated at the historical exchange rates at the date of the declaration 039 O The basic translation process is applied to a company s trial balance prior to its inclusion in consolidated financial statements With respect to consolidated financial statements recall that one of the primary criteria to determine if consolidation is appropriate deals with the extent of control the parent entity exercises over the subsidiary For foreign subsidiaries effective control is determined in part by currency restrictions and the possibility of nationalization of the operations by foreign governments Example 1 Sori Corporation began operations on January 1 2000 On January 1 2001 when net assets totaled 100000FC 90 of Sori stock was acquired by Pome Corporation Sori s functional currency is the foreign currency and it maintains its records in the functional currency Sales to Pome are billed in the foreign currency and all receivables from Pome have been collected except for the amount shown in the account Due from Pomequot All other sales are billed in the foreign currency as well The level of sales and purchases was constant over the year None of the inventory purchased from Sori remains in Pome s ending inventory Selected exchange rates between the functional currency and the dollar are as follows m January 1 2000 1 FC 098 January 1 2001 1 FC 100 December 31 2001 1 FC 105 2001 Average 1 FC 103 All assets are translated at the current exchange rate at the date of translation Trial Balance Translation Balance In Relevant Functional Exchange Balance in Account Currency Rate Dollars Cash FC 10000 105 10500 Accounts Receivable 21000 105 22050 Allowance for Doubtful Accounts 1000 105 1050 Due from Pome 14000 105 14700 lnventory 30000 105 31500 Prepaid lnsurance 3000 105 3150 Land 18000 105 18900 Depreciable Assets 120000 105 126000 Accumulated Depreciation 15000 105 15750 Expenses are translated at the weightedaverage exchange rate for the period Trial Balance Translation con t Balance in Relevant Functional Exchange Balance in Account Currency Rate Dollars Cost of Goods Sold FC 180000 103 185400 Depreciation Expense 10000 103 10300 Income Tax Expense 30000 103 30900 Other Expenses 23 000 103 23 690 Total Debits FC 443 000 460 290 All liabilities are translated at the current exchange rate at the date of translation Trial Balance Translation con t Balance in Relevant Functional Exchange Balance in Account Currency Rate Dollars Accounts Payable FC 20000 105 21000 Taxes Payable 30000 105 31500 Accrued lnterest Payable 1000 105 1050 Mortgage Payable Land 10000 105 10500 Equity and retained earnings balances on the date of investment are translated at the historical exchange rate on that date Trial Balance Translation con t Balance in Relevant Functional Exchange Balance in Account Currency Rate Dollars Common Stock FC 80000 100 80000 Retained Earnings 20000 100 20000 Note on Retained Earnings The beginning balance of retained earnings normally is equal to the translated value of the previous period s retained earnings However since 2001 is the first year Pome has owned Sori the beginning balance is set equal to the January 1 2001 acquisition date balance of retained earnings in foreign currency translated at the January 1 2001 spot rate in this case 100 The balance sheet for 2001 would show a translated value for retained earnings equal to the translated beginning balance of retained earnings plus the translated value of net income less dividends translated at the rate existing on the declaration date Income is generally translated at the weightedaverage exchange rate for the period Trial Balance Translation con t Balance in Relevant Functional Exchange Balance in Account Currency Rate Dollars Sales Pome FC 80000 103 82400 Sales Other 200000 103 206000 Gain on Sale of Depreciable Assets 2000 103 2060 Cumulative Translation Adjustment to balance 5 780 Total Credits FC443 000 46 290 When you arrange the accounts in balance sheet and income statement order the following totals would be calculated Trial Balance Translation Balance in Functional Balance in Currency Dollars Total revenues and gains FC 282000 290460 Total expenses 243 000 250 290 Net Income FC 39 000 40 170 Total Assets FC 200 000 210 000 Total Liabilities FC 61000 64050 Total Equity including Net Income 139 000 140 170 Total Liabilities amp Equity FC 200000 204220 Cumulative translation adjustment OCI amount needed to balance 5 780 Total Liabilites amp Equity FC 200 000 210 000 Accounting for the Cumulative Translation Adjustment Because various exchange rates current historical and weightedaverage are used in the translation process the basic equality of the balance sheet equation is not preserved Therefore from a mechanical viewpoint the translation adjustment is an amount necessary to balance a translated entity s trial balance The translation adjustment should be included as a component of Other Comprehensive lncome OCI in the equity section of the balance sheet of the parent Subsequent Recognition of the Translation Adjustment Although translation adjustments have no immediate effect on reported earnings they may ultimately affect income when there is a partial or complete sale or complete or substantially complete liquidation of the investment in the foreign entity Example 2 Assume a company owns 100 of a foreign entity its investment account has a balance of 4200000 and its owners equity includes Other Comprehensive Income containing a M of 320000 representing the accumulated translation adjustment If the entire investment in the subsidiary is sold for 4750000 the translation adjustment affects the gain on sale as follows Proceeds from sale of investment 4750000 Book Value of investment account 4 200 000 550000 Balance in accumulated translation adjustment 320 000 Gain on sale of investment 230000 Foreign Currency Transactions as Hedges of a Net Investment in a Foreign Entity The translation adjustment has the effect of either increasing or decreasing the parent s net investment in the foreign subsidiary The parent may decide to hedge against the effect of translation on their net investment in the subsidiary Example 3 Go back to Example 1 where the translation adjustment of 5780 was included in OCI This time we are going to hedge our investment with a nonderivative instrument a loan rather than a derivative instrument eg a Forward Contract The hedge could be accomplished with a derivative instrument as well Assume that the parent takes out a loan from a foreign bank denominated in the foreign currency Now you have an asset and a liability being translated from the same foreign currency The effect of the exchange rate changes for the asset and the liability will tend to offset each other Assume the loan was for 200000 FC at a time when the spot rate was 1FC 1022 Ignore the interest rate payments The value of the loan changes with the exchange rates changes Value of loan payable at December 31 2001 200000 FC X 1050 210000 Value of loan payable at inception 200000 FC X 1022 204 400 Change in value of Loan Payable 5 600 The entry to record the change in the value of the Loan Payable is as follows D Translation Adjustment Hedge OCI 5600 C Loan Payable 5600 The two translation adjustments will offset each other on the balance sheet Effect on OCI of translation of foreign subsidiary is 5780 Credit Effect on OCI of hedge loan payable 5 600 Debit Net effect on OCI Credit Consolidating the Foreign Subsidiary Example 4 Go back to Example 1 and assume that Pome Corporation paid 105000 FC for a 90 interest in Sori Corporation At the time of the acquisition January 1 2001 Sori equity consisted of 80000 FC of common stock and 20000 FC of retained earnings Upon acquisition of Sori Pome recorded its investment as follows D Investment in Sori 105000 C Cash 105000 FC x 100 105000 Assuming that any excess is traceable to patents with a 10year useful life the excess of cost over book value is determined as follows Price Paid FC 105000 Equity Purchased Common Stock FC 80000 Retained Earnings 20 000 Total Equity 100000 90 Interest Purchased 90 000 Excess Cost Traceable to Patents FC 15 000 Notice that the determination of excess is calculated in the foreign currency Assume that Pome used the simple equity method to account for its investment in Sori The following translation would be required to determine the subsidiary income recorded by Pome We are using the current rate method Thus the weightedaverage exchange rate for the year is used to translated income items Balance in Relevant Balance Functional Exchange in Account Currency Rate Dollars Sales Pome FC 80000 103 82400 Sales Other 200000 103 206000 Gain on Sale of Depreciable Assets 2000 103 2060 Cost of Goods Sold 180000 103 185400 Depreciation Expense 10000 103 10300 Income Tax Expense 30000 103 30900 Other Expenses 23 000 103 23 690 Net Income 39 900 40 170 Pome s Share 90 36 153 The entry on the parent s books to reflect its interest in the foreign subsidiary s undistributed income would be as follows D Investment in Sori 36153 C Subsidiary Income 36153 The consolidation process begins with the Current Year CY adjustment to eliminate the prior recognition of the foreign subsidiary s income on the parent s books This is done in the CY entry D Subsidiary Income 36153 C Investment in Sori 36153 We then eliminate the Pome s share 90 of the Sori s equity accounts and Pome s Investment in Sori account This is done in the EL entry D Common Stock Sori 72000 Retained Earnings Sori 18000 C Investment in Sori 90000 Remember that a Cumulative Translation Adjustment of 5780 is sitting in the equity of Sori as OCI This has to be allocated to Pome 5780 x 90 5202 and to the NCI 578 Pome s share of the Cumulative Translation Adjustment will be eliminated and the remaining 578 will be carried over to the NCI column This is done in the CT entry D Cumulative Translation Adjustment Sori 5202 C Cum Trans Adj Pome 5202 Next we have to distribute the excess purchase price allocable to the patent D We already figured out that the amount allocable to the patent was FC 15000 Now we have a problem Remember that we are supposed to use the current rate for assets under the current rate method Remember also that we are eliminating the Investment in Subsidiary account and that amount is based upon the exchange rate existing at the time of the investment Thus we have two rates and a potential uneven elimination entry The difference between the two will be allocated to the Cumulative Translation Adjustment account Pome Distribution of Asset Exch Rate US Depreciable Assets and Patents 15000 105 15750 Debit Investment in Sori 15000 100 15000 Credit Cumulative Translation Adjustment Pome 750 Credit This is done in the D entry D Depreciable Assets and Patents 3 15750 C Investment in Sori 15000 Cum Trans Adj Pome 750 You have a similar problem with the amortization A of the asset created by the excess purchase price Assets including the Accumulated Depreciation account are translated at the current rate while the Depreciation expense along with all income items is translated using the weightedaverage rate Distribution of Asset E Exch Rate US Acc Depreciation amp Amortization 1500 105 1575 Credit Depreciation amp Amortization Exp 1500 103 1545 Debit Cum Trans Adj Pome 30 Debit This is done in the A entry A D Depreciation amp Amortization Exp 1 545 Cum Trans Adj Pome 30 C Acc Depreciable amp Amortization 1575 Intercompany accounts IA must be eliminated Both are translated at the same rate the current spot exchange rate This is done in the IA entry IA D Accounts Payable 14700 C Accounts Receivable 14700 Intercompany sales IS must also be eliminated Again both are translated at the same rate the weightedaverage exchange rate This is done in the IS entry IS D Sales Pome 82400 C Cost of Goods Sales 36 82400 There is a potential problem if you have unsold markedup inventory from an intercompany sale The inventory will be translated at the current exchange rate while the actual profit booked by the seller will be based on the exchange rate at the time of the sale The elimination of the profit should be done using the exchange rate at the time of the sale to avoid this inconsistency Unconsolidated Investments Translation for the Cost of Equity Method If you have an investment in a foreign subsidiary that is reported using the Cost method then translation is not necessary The investment is recorded at the exchange rate on the date of the investment and the subsidiary income will be recorded using the date on which the dividends were declared If you have an investment in a foreign subsidiary that is reported using the Sophisticated Equity method then you have to make translation adjustments Example 5 Assume Pome paid 35000 FC 35000 for a 30 interest in Sori on January 1 2001 Assume that any excess is traceable to patents with a 10year useful life the excess of cost over book value is determined as follows Price Paid FC 35000 Equity Purchased Common Stock FC 80000 Retained Earnings 20 000 Total Equity 100000 30 Interest Purchased 30 000 Excess Cost Traceable to Patents FC 5 000 The following journal entry records the investment using the rate at the time of the investment on Pome s books D Investment in Sori 35000 C Cash 36 35000 Pome s interest in the adjusted net income of Sori is calculated as follows Sori s net income translated into dollars 40170 Pome s share Pome s interest in Sori net income 12051 Amortization of excess related to the patents 5000 FC 10 years 500 X 103 weightedaverage rate i Pome s equity share of Sori net income adjusted for amortization of excess 11 536 Pome must also recognize its share in the cumulative translation adjustment for 2001 calculated as follows Cumulative translation adjustment from Example 1 5780 Pome s share 30 Pome s interest in the cumulative translation adjustment 1 734 You take these two figures Pome s share of Sori s adjusted net income 11536 and Pome s interest in the cumulative translation adjustment 1734 and adjust the Investment in Sori by the same amount on Pome s books D Investment in Sori 13270 C Subsidiary Income 11536 Cum Trans Adj Pome 1734 Remeasured Financial Statements Foreign Currency to Functional Currency Now we are discussing the situation where the functional currency is not the domestic currency of the foreign subsidiary Thus the books of the subsidiary are not being kept using the functional currency The books of the subsidiary are referred to as the books of recordquot BR First we must remeasure the subsidiary s accounts from the BR currency to the functional currency using the historical rate method If the functional currency is not the parent s domestic currency then we must translate the accounts from the functional currency to the parent s domestic currency
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'