CHAPTER 10

OTHER ITEMS THAT AFFECT

NET INCOME AND OWNERS EQUITY
Changes from Eleventh Edition
Updated from Eleventh Edition.
Approach
This chapter contains several topics that instructors may wish to emphasize in varying degrees. In
particular, the rather detailed rules on extraordinary items, discontinued operations, change in accounting
principles, and correction of errors may be more than students can readily assimilate; they can always
refer back to the rules if this becomes necessary.
Similarly, some instructors prefer not to get into foreign currency matters at all in an introductory course;
some cover transactions but not translation; and others cover both, perhaps because of the increased
emphasis on covering international issues in the overall core curriculum.
With respect to personnel costs, the important point is the difference between transactions that are costs to
the company and those that result from the company serving as a collection agency for the government. In
my own view, any details of pension accounting can be withheld for an intermediate course, but I want
students to have an overview of the issues and complications of pension accounting.
I spend the most time on deferred taxes, both because virtually every set of financial statements students
are likely to see will contain this item and because it always seems to be a difficult topic for students to
master. The ease of teaching this subject diminished even further when MACRS allowances replaced the
usual tax deprecation illustrations using sum-of-the-years-digits depreciation. FAS109, in my view,
further complicates matters.
Cases
Norman Corporation (B) raises some new, and reviews some old, issues in expense recognition.
Silver Appliance Company enables students to explore deferred tax accounting in the context of the
installment method of reporting installment sales revenues.
Kansas City Zephyrs Baseball Club, Inc., requires students to apply accrual accounting to cash flows in
order to properly match costs and revenues.
Freedom Technology Company deals with the translation of financial statements. If desired, both the
currently required method and alternative approaches can be compared.
Proxim, Inc. raises issues related to proforma earnings disclosures. This case is new with the Twelfth
Edition.

Accounting: Text and Cases 12e Instructors Manual

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Problems
Problem 10-1
Wages Payable
Cash
FICA Taxes Payable
Withholding Taxes Payable
And, to finish, payment to government:
FICA Taxes Payable
Unemployment Taxes Payable
Withholding Taxes Payable
Cash

1,025.00
776.35
74.65
174.00
149.30
40.05
174.00
363.35

Problem 10-2

dr. Pension Cost...............................................................................................................................................................................

85,000
cr. Cash........................................................................................................................................................................................
40,100
Pension Liability.....................................................................................................................................................................
44,900
Problem 10-3

Financial Statements (Accrual Basis)

1999
2000
2001
2002
Revenues.........................................................................................................................................................................................
$456,000
$696,000
$840,000
$780,000
Expenses.........................................................................................................................................................................................
270,000
672,000
798,000
618,000
Profit before taxes...........................................................................................................................................................................
186,000
24,000
42,000
162,000
Tax provision (30%)........................................................................................................................................................................
55,800
7,200
12,600
48,600

Tax Return (Cash Basis)

1999
2000
2001
2002
Receipts...........................................................................................................................................................................................
$336,000
$636,000
$894,000
$690,000
Disbursements.................................................................................................................................................................................
288,000
528,000
750,000
606,000
Taxable income...............................................................................................................................................................................
48,000
108,000
144,000
84,000
Tax payment (30%).........................................................................................................................................................................
14,400
32,400
43,200
25,200

1999
2000
2001
2002
Tax provision..................................................................................................................................................................................
$55,800
$ 7,200
$ 12,600
$48,600
Tax payment....................................................................................................................................................................................
14,400
32,400
43,200
25,200
Difference.......................................................................................................................................................................................
41,400
(25,200)
(30,600)
23,400
Cumulative difference.....................................................................................................................................................................
$41,400
$16,200
$(14,400)
$ 9,000
Cash basis accounting for tax payment purposes was preferable for the 1999 - 02 period. It resulted in
lower cumulative tax payments.
The difference between the annual tax provision and tax payments would be handled through deferred tax
accounting.

2007 McGraw-Hill/Irwin

Chapter 10

Problem 10-4
Net book value of machinery for financial reporting purposes

Year
1997
1998
1999
2000
2001
2002

Cost
$2,750,000
2,750,000
2,750,000
2,750,000
2,750,000
2,750,000

Depreciation
Expense
$275,000
550,000
550,000
550,000
550,000
275,000

Cumulative
Depreciation
Allowance
$ 275,000
825,000
1,375,000
1,925,000
2,475,000
2,750,000

Net Book Value

$2,475,000
1,925,000
1,375,000
825,000
275,000
-0-

Depreciation
Deduction
$550,000
880,000
528,000
316,250
316,250
159,500

Cumulative
Depreciation
Deduction
$ 550,000
1,430,000
1,958,000
2,274,250
2,590,500
2,750,000

Net Tax Basis

$2,200,000
1,320,000
792,000
475,750
159,500
-0-

Net tax basis of machinery for tax purpose.

Year
1997
1998
1999
2000
2001
2002

Tax Basis
$2,750,000
2,750,000
2,750,000
2,750,000
2,750,000
2,750,000

Deferred Tax Liability Calculation

Year
1997
1998
1999
2000
2001
2002

Net Book Value

$2,475,000
1,925,000
1,375,000
825,000
275,000
-0-

Net Tax Basis

$2,200,000
1,320,000
792,000
475,750
159,500
-0-

Difference
$275,000
605,000
583,000
349,250
115,500
-0-

Deferred Tax
Liability
$110,000
242,000
233,200
139,700
46,200
-0-

Taxable Income
$ 950,000
620,000
972,000
1,183,750
1,183,750
1,340,500

Tax Payment
$380,000
248,000
388,800
473,500
473,500
536,200

Income Tax Payments

Year
1997
1998
1999
2000
2001
2002

Profit Before
Depreciation
$1,500,000
1,500,000
1,500,000
1,500,000
1,500,000
1,500,000

Depreciation
$550,000
880,000
528,000
316,250
316,250
159,500

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Anthony/Hawkins/Merchant

Income Tax Provisions

Year
1997
1998
1999
2000
2001
2002

1997
1998
1999
2000
2001
2002

Profit before
Depreciation
$1,500,000
1,500,000
1,500,000
1,500,000
1,500,000
1,500,000

Depreciation
$275,000
550,000
550,000
550,000
550,000
275,000

Pretax Income
$1,225,000
950,000
950,000
950,000
950,000
1,225,000

Tax Provision Presentation

Current
Deferred
Tax Expense
Tax Expense
$380,000
$110,000
248,000
132,000
388,800
(8,800)
473,500
(93,500)
473,500
(93,500)
536,200
(46,200)

Tax Provision
$490,000
380,000
380,000
380,000
380,000
490,000

Total Tax
Provision
$490,000
380,000
380,000
380,000
380,000
490,000

In 1999 the deferred tax liability account reverses.

A T-account tracking of the 1997 - 2002 tax payments, tax provision and deferred tax liability balances
can be constructed from the above schedules. Tax payments reduce cash. The deferred tax portion of the
total tax provision is initially a credit to the deferred tax liability account (1997 - 98) and thereafter a debit
entry.
Problem 10-5
1. APB Opinion No. 30 requires that in order to qualify as an extraordinary item, an event must satisfy
two criteria:
1. The event must be unusual; it should be highly abnormal and unrelated to, or only incidentally
related to, the ordinary activities of the entity.
2. The event must occur infrequently; it should be of a type that would not reasonably be expected
to recur in the foreseeable future.
Item 5 (loss of $300,000 due to explosion caused by disgruntled ex-husband of an employee) meets
the two extraordinary-item criteria.
Item 1 is explicitly excluded by APB No. 30 as an extraordinary item.
Item 2 is not an extraordinary item. Hurricanes are not an infrequent event in Louisiana.
Item 3 may be considered an extraordinary item if floods in northern New Mexico occur
infrequently.
Item 4 is not an extraordinary item. Selling segments of a business is a frequent business activity.

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Chapter 10

2.

Income before
extraordinary item........................................................................................................
$XXX,XXX
Extraordinary item, net
of applicable income
taxes ($90,000).............................................................................................................
210,000
Net income
$XXX,XXX

Problem 10-6
a. and b.

c.

1.

dr. Inventory...........................................................................................................................................
57,600
cr. Note Payable...................................................................................................................................
57,600

2.

dr. Note Receivable................................................................................................................................

2,700
cr. Sales................................................................................................................................................
2,700

3.

dr. Accounts Receivable.........................................................................................................................

720,000
cr. Sales................................................................................................................................................
720,000

4.

dr. Inventory...........................................................................................................................................
119,600
cr. Account Payable.............................................................................................................................
119,600

1.

Note Payable (year end).........................................................................................................................

$ 60,000
Note Payable (transaction date)..............................................................................................................
57,600
Exchange loss....................................................................................................................................
$ 2,400

2.

Note receivable (year end).....................................................................................................................

$ 3,000
Note receivable (transaction date)..........................................................................................................
2,700
Exchange gain....................................................................................................................................
$ 300

3.

Account receivable (year end)................................................................................................................

$692,308
Account receivable (transaction date)....................................................................................................
720,000
Exchange loss....................................................................................................................................
$ 27,692

4.

No exchange gain or loss. Exchange rate unchanged.

Cases
Case 10-1: Norman Corporation (B)

Note: This case has been updated from the Tenth Edition.
Approach
This case provides a basis for discussing several tough problems in expense recognition. Except for the
summary given in Exhibit A of this note, each of the topics is self-contained. They may provide more
material than the instructor wishes to cover in one session; any of them can be omitted without hurting the
overall results.
*

This teaching note was prepared by Robert N. Anthony. Copyright Robert N. Anthony.

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Answers to Questions
1. Although many firms charge the cost of such brochures as an expense when incurred, there is no
requirement that this be done. The $25,000 of brochures on hand are economic resources that will
benefit a future period. Unless the conservatism concept is given heavy weight, Normans treatment is
appropriate.
2. The almost universal and required practice is to charge advertising expenditures as expense in the
year incurred. There is one important exception to this requirement. Direct response advertising costs
can be capitalized if a reasonable estimate of the response rate can be made based on past advertising
programs. The argument made for capitalization seems sound. Because a prospective lender might
well question this departure from custom, however, Allen Burrows can argue that it is prudent to
charge the $75,000 as an expense.
3. However strong the rationale for capitalization, research/development costs must be expensed in
accordance with FASB Statement No. 2. Thus, expense must be increased by $19,000, which is the
difference between the amount charged and the expenditure for 2006. (This issue resurfaced in the
context of computer software development costs; see FASB-86. It permits capitalization if certain
conditions are met.)
This is a change in accounting principles and the cumulative effect of the change must be shown on
the income statement. Referring back to Exhibit 1 of the (A) case, the balance in the Development
Costs account at the beginning of 2006 must have been $105,648 ($124,648 - $55,000 + $36,000),
and this amount must be charged against income. (It is to be hoped that the lender will accept these
unusual charges for what they are in appraising the resulting net income.)
4. Despite the literature on the subject, human resource accounting is not a generally accepted
accounting principle. Those few companies that have reported such training costs as assets have done
so in supplementary notes or supplementary financial statements, not in the official statements. The
$35,000 should therefore be charged as an expense.
5. This is typical of situations in which there is no right answer. The net amount of accounts receivable
should be an amount that has a high probability of being received. In this case, if the firm pays off at
less than 77 cents on the dollar, the bad debt allowance ($5,250) is not large enough, even if there are
no other bad debts. The prudent solution is to increase the allowance. There is no point in debating the
amount of the increase at length because there are no facts to go on (which is typical in these
situations). The important point is that some increase is needed. A case can be made for increasing the
allowance by $14,000 or so, and this arbitrary amount is used here.
6. Imputing an expense for self-insurance is not permitted under generally accepted accounting
principles. Income should be increased by $1,250, which is the difference between the $5,000 charged
and the $3,750 that should have been charged. This is also a change in accounting principles, so the
opening balance of $19,650 ($20,900 - $5,000 + $3,750) in the reserve account should be credited to
income.
7. This problem illustrates the treatment of discontinued operations, even though the amount involved is
a little small to be material. APB Opinion No. 30 applies to discontinuance of a component of an
entity whose activities represent a separate major line of business or class of customer, . . . provided
that its assets, results of operations, and activities can be clearly distinguished, physically and
operationally and for financial reporting purposes, from the other assets, results of operations, and
activities of the entity. (par. 13)

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Chapter 10

The transaction must be reported in the year in which the decision to sell is made, in this case, 2006.
It is reported in two parts:
a. Operating income of the parking lot for 2006 is set out separately. In this case, it would be
$19,000, less applicable income taxes, assumed here to be $7,600 (40%), an increase in net
income of $11,400.
b. AP-30, par. 15, requires recognizing a loss on discontinued operations at the measurement date
(here, December 31, 2006); but a gain should not be reported until it is realized. This is consistent
with the conservatism concept. Thus, Normans treatment of this item was correct, even though
its rationale was not the relevant one.
8. The fact that the president sold the stock for $25,000 is irrelevant. This was a transaction between two
outside parties, and had no effect on the Norman Corporation itself. The $3,000 gain on the sale of the
treasury stock does not affect income. A corporation cannot make a gain by issuing its own stock. The
$3,000 should have been credited directly to Capital Surplus (which is the term used by Norman, but
which more properly is called Additional Paid-in Capital).
9. The charge to Retained Earnings should have been made when the $50,000 dividend was declared,
not when it was paid. Thus, the 2006 dividend should have been charged to Retained Earnings in
2006 rather than in 2007, so the amount reported as dividends for 2006 was correct. The result of
Normans practice is to omit a current liability, Dividends Payable. The balance sheet should
therefore be adjusted by increasing current liabilities by $50,000 and decreasing Retained Earnings by
$50,000. (There is, of course, no impact on income from dividend transactions.)
The effect of these transactions is summarized in Exhibit A.
Question 2
Norman could clean up its net nonoperating income and expense account (which should be called
nonoperating revenue and expense, but usually isnt in practice). These items actually are either operating
items (e.g., interest expense, which should be shown as a separate line), or extraordinary items,
accounting changes, correction of errors, or discontinued operations (all below the line items).
EXHIBIT A
NORMAN CORPORATION (B)
Item
1
2
3
3
4
5
6
6
7
7
8
9

(a)
(b)
(a)
(b)
(a)
(b)

Effect on Income of
Required Changes
None
None (?)
$ -19,000
-105,648
-35,000
-14 000 (?)
+1,250
+19,650
None
None
-3,000
None
Net effect.............................................................................................................................................
$-155,748
Of which, change in accounting principles..........................................................................................
$ - 85,998
Discontinued operations.......................................................................................................................
None
Other....................................................................................................................................................
-69,750
$-155,748
7

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Anthony/Hawkins/Merchant

Case 10-2: Silver Appliance Company*

Note: This case is the same version that was in the Eleventh Edition.
Approach
This case enables students to get some hands-on experience in dealing with the complex matter of
deferred taxes, and also in applying the installment method that was described in Chapter 5. It also
requires them to think through how these complexities can be explained to a nonaccountant, and to
recognize that a change in accounting method for tax purposes may involve transitional problems relating
to potential double taxation of income.
Many students will have difficulties figuring out the calculations required for Question 1. These
difficulties can be mitigated by including on the assignment sheet a worksheet format like that used in
Exhibit A of this note. Alternatively, we can hand out in class a copy of Exhibit A, or have them copy it
from a transparency. In any event, in class I go through an example for one year using T accounts, as
follows:

Book
Tax
Sales....................................................................................................................................................................................
$1,000
$900
Cost of sales @ 70%...........................................................................................................................................................
700
630
Gross margin.......................................................................................................................................................................
300
270
Other expenses....................................................................................................................................................................
200
200
Pretax income......................................................................................................................................................................
100
70
Income tax expense @ 34%................................................................................................................................................
34
23.8
Actual taxes as percent of pretax Book income...............................................................................................................
34%
23.8%
Cash (or Taxes
Payable)
23.8

Income Tax
Expense
34

Deferred
Taxes
10.2

This illustrates both the basic concept of deferred taxes, and also the rationale taxes as a percent of
pretax income would be understated (23.8% instead of the true 34%) if the book income tax expense
amount were the amount of actual taxes rather than the actual tax rate applied to book pretax income.
This example uses the deferral method--rather than the liability method--to compute deferred taxes.
Students find this deferral method easier to understand.

Comments on Questions
Question 1
The required calculations are displayed in Exhibit A. Line 8 shows how much less Silvers taxes would
have been in 1989-93 and that taxes would have been higher in 1993 using the installment method. Line 9
shows each years year-end balance of Deferred Taxes; again, note that the reversal in 1993 causes the
balance to decrease.

This teaching note was prepared by James S. Reece. Copyright James S. Reece.

2007 McGraw-Hill/Irwin

Chapter 10

Exhibit A
SILVER APPLIANCE COMPANY
(In Thousands)

Accounting: Text and Cases 12e Instructors Manual

(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)

Anthony/Hawkins/Merchant

1989
1990
1991
1992
1993
Year-end installment receivables.................................................................................................................................................
$190.1
$351.9
$526.2
$559.4
$489.1
Gross margin %...........................................................................................................................................................................
34.6%
35.1%
34.2%
33.4%
32.2%
Deferred gross margin (= 1 * 2)..................................................................................................................................................
65.77
123.52
179.96
186.84
157.49
Pretax profit, delivery basis.........................................................................................................................................................
332.6
415.3
478.2
492.5
461.3
Income taxes, delivery basis (34% of 4)......................................................................................................................................
113.08
141.20
162.59
167.45
156.84
Pretax profit, installment basis (= 4 - 3 +
previous years 3) 47.31..............................................................................................................................................................
266.83
357.55
421.76
485.62
490.65
Income taxes, installment basis (34% of 6).................................................................................................................................
90.72
121.57
143.40
165.11
166.82
1
2
Tax deferred (5 - 7)......................................................................................................................................................................
22.36
19.63
19.19
2.34
(9.98)
Cumulative tax deferred..............................................................................................................................................................
22.36
41.99
61.18
63.52
53.54

Liability method calculations is Line 3 ($65.77) times 34 percent.

Liability method calculations is $41.99 minus $22.36 (see line 9).

Question 2
The balance in the deferred tax account is best described as the cumulative amount of taxes that the
company has postponed by using the installment method rather than the delivery method for tax purposes.
Some people refer to this as an interest-free loan from the government. This is true in the sense that
these funds would have been paid in taxes if the tax laws did not permit use of the installment method. In
another sense, it is not true: if the company used the installment method for both book and tax
purposes, the company would have the same cash-flow benefit, but would not show any deferred tax
accounting (ignoring other possible book-tax accounting differences); that is, it would have the same
loan, even though the loan would not be reflected in the balance sheet.
I also feel it should be explained to Mr. Silver that deferred taxes are a liability, but not in the same sense
that taxes payable are. Personally, I find the APBs analogy in Opinion No. 11 very compelling: like
accounts payable, deferred taxes do come due and get paid, even though the balance in the account may
grow because each years credits (new payables or deferrals) exceed that years debits (accounts paid or
deferral reversals). Indeed 1993s simultaneous drop in installment sales and gross margin percentage
relative to 1992 clearly illustrates the phenomenon of turnover within the Deferred Taxes account. Like
Mr. Silvers architect friend, Silvers taxes could remain essentially constant even though delivery-basis
sales and profit have declined (see lines 4 and 6 of Exhibit A).
The instructor may wish to indicate in advance that he or she does not expect students to check the tax
code regarding the double taxation issue. The point of the question is to make students realize that there
can be transitional problems surrounding a change in accounting method for tax purposes. Students
should at least be able to answer, There will be double taxation on installment sales recognized in 1993
under the delivery method, but not collected until 1994 when the installment method is adopted, unless
the tax laws recognize this problem and provide relief for it. In fact, the tax law (Sec. 453) says that
Silver would have to report in 1994 all installment collections made in 1994, but could adjust 1994 taxes
downward for those 1994 collections that were taxed under the delivery method in 1993. In effect, then,
Silver would get a refund of that portion of 1993 taxes that related to installment sales that were reported
in both 1993 and 1994, and would be taxed on these collections only in 1994.
Although the question is not explicitly asked, the discussion should end with resolution of the issue as to
whether Silver should change to the installment method. If students have previously raised a similar
question on a switch from FIFO to LIFO, having seen here that 1993 taxes would have been higher on the
installment basis than the delivery basis, they are tempted to answer, It depends on the expected future
relationship between income on the installment basis and the delivery basis. However, in this instance

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that answer is not correct. Unless tax rates are expected to be increased, the installment method will
always provide some advantage: there is no way (given no double taxation in the year of change) that a
change from the delivery basis to the installment basis could result at any time in a negative (debit)
balance in Deferred Taxes. Thus, the change should be made.
Case 10-4: Freedom Technology Company*
Note: This case is unchanged from the Eleventh Edition.
Approach
Because FASB 8 proscribed the earlier freedom of choice of a translation method, and then FASB 52
changed FASB 8s method, I prefer teaching this case with a legislative history flavor, rather than just
dealing with the mechanics of the net investment or current rate method. While the students still learn the
basics behind the net investment method, they gain a better understanding of the translation concept in
general and also are exposed to the lengthy controversy surrounding some otherwise apparently
innocuous accounting rules. Of course, some instructors will choose to assign only Question 1.
This topic is not included in many core financial accounting courses. However, with the increase in
multinational operations of businesses, and the resultant concern about international content in the
business core curriculum, the topic seems more germane to the core course than it did in previous years.
Comments on Questions
I begin class with a student presenting the statements called for in questions 1 and 2 (see Ex. A and B).
Using the text example (Illustration 10-7) as a basis, students have little trouble with the net investment
method, except for the equity items. Some will forget to translate capital stock at the rate in effect when it
was issued. While most will have gotten the translation adjustment as a plug figure, many will have
trouble directly calculating it. As indicated at the bottom of Exhibit A, the importance of the calculation is
not the mechanics so much as the insight one gains into what the adjustment represents.
The remeasurement of monetary/nonmonetary method is more difficult, both because it is not illustrated
in the text and because of the nonmonetary asset adjustments being different from those in the net
investment method. These difficulties should not be permitted to obscure the different investment
exposure concepts behind the two methods. The net investment method views the owners equity as being
exposed to exchange rate fluctuations; i.e., fluctuations in assets translated amounts are offset to the
extent possible by liability fluctuations, leaving exposed only the portion of assets financed by equity. By
contrast, the monetary/nonmonetary method treats nonmonetary assets as a hedge against unfavorable
exchange rate fluctuations. (Compare especially the translated amounts for fixed assets under the two
methods.)
One word of caution is in order. To keep this problem as simple as possible, the foreign entity was formed
at the start of the current year (i.e., October 1, 20xl). It is for this reason (plus the assumption of no
dividends) that in Exhibits A and B the year-end retained earnings are the same as the years net income.
In succeeding years, the concept for getting the translation gain or loss as a plug figure remains the
same, but the mechanics become slightly more complex. (In fact, in practice this item is derived as a plug
figure, rather than calculated directly.)
This case example clearly illustrates the reason the translation method controversy at least among
statement preparers seems to have died down since the issuance of FASB 52. In circumstances such as
those faced by Freedom A (i.e., foreign currency value dropping relative to the dollar), the
*

This teaching note was prepared by Robert N. Anthony. Copyright Robert N. Anthony.

11

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Anthony/Hawkins/Merchant

monetary/nonmonetary method reports a smaller translation loss; hence, in pre-FASB 8 days, this method
would have been the better of the two from managements standpoint. The preparers real objection to
FASB 8, in my view, was not the method so much as it was treating the translation gain or loss as an
element of net income. Despite a companys best efforts to keep operating earnings consistently on the
rise, the translation gain or loss caused fluctuations, resulting in great consternation among top managers.
This phenomenon can lead the class, if the instructor wishes, into a discussion of the efficient markets
hypothesis as it relates to accounting methods. According to EMH, the translation method used should
have no impact on stock price, since cash flow is independent of method used. Of course, if management,
given a method they must use (e.g., monetary/nonmonetary), changes its decisions solely to influence the
result reported by the accounting method, then stock price could be affected because cash flows could be
different. A study done by Professor Shank, et al. (see Financial Executive, Feb. 1980 for a summary)
revealed that companies were in fact engaging in transactions that were induced more by FASB 8 than by
purely economic considerations, especially currency hedging transactions. The study also indicated that
FASB 8 did not change the markets perception of the riskiness of firms affected by FASB 8, and the
managements FASB 8 induced action was therefore unwarranted. To quote the study, Managers are so
committed to the importance of the accounting numbers that they will undertake actions in the foreign
currency area which they know will increase expected costs and risk levels just to preserve desired
relationships in the accounting numbers.

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Exhibit A
Net Investment Translation Method
(won in millions, dollars in thousands)
Freedom-Korea
Balance Sheet as of September 30, 20x2

Assets
Won
Exchange Rate
Dollars
Cash...................................................................................................................................................................................
W591
$0.00124
$ 732.8
Receivables........................................................................................................................................................................
1,182
0.00124
1,465.7
Inventories..........................................................................................................................................................................
552
0.00124
684.5
Fixed assets .......................................................................................................................................................................
575
0.00124
713.0
W2,900
$3,596.0
Liabilities and Owners Equity
Current liabilities................................................................................................................................................................
W624
0.00124
$ 773.8
Capital stock.......................................................................................................................................................................
1,000
0.00140
1,400.0
Retained earnings...............................................................................................................................................................
1,276
(see below)
1684.3
Accum. translation adjustments..........................................................................................................................................
---*
(262.1)
W2,900
$3,596.0

Income Statement for the year ended September 30, 20x2

Revenues............................................................................................................................................................................
W7,090
$0.00132
$9,358.8
Cost of sales ......................................................................................................................................................................
4,415
0.00132
5,827.8
Other expenses...................................................................................................................................................................
1,399
0.00132
1,846.7
Net Income.........................................................................................................................................................................
W1,276
$1,684.3

* Calculation of translation loss:

Oct. 1, 20xl net assets = W1,000
Translated at Sept 30, 20x2 rate = 1,000 * $0.00124..............................................................................................
$ 1,240.0
Translated at Oct. 1, 20xl rate = 1,000 * 0.00140...................................................................................................
1,400.0
Loss on beginning-of-year net assets......................................................................................................................
$ (160x.0)

Increment in net assets during FT 20x2 = W 1,276

Translated at Sept 30,20x2 rate = 1,276 * $0.00124...............................................................................................
$1,582.2
Translated at average FY 20x2 rate = 1,276 * 0.00132...........................................................................................
1,684.3
Loss on increment in net assets...............................................................................................................................
$ (102.1)

Total loss in dollar value of net assets........................................................................................................................

$ (262.1)
(The loss figure can be determined without the above calculation, since the loss is the amount needed to
make the balance sheet balance; but the calculation shows the rationale behind the loss, i.e., the loss
occurred because the parent held South Korean won net assets while the value of the won fell relative to
the dollar.)

13

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Exhibit B
Monetary/Nonmonetary Translation Method
(won in millions, dollars in thousands)
Freedom-Korea
Balance Sheet as of September 30, 20x2

Assets
Won
Exchange Rate
Dollars
Cash................................................................................................................................................................................................
W591
$0.00124
$ 732.8
Receivables.....................................................................................................................................................................................
1,182
0.00124
1,465.7
Inventories......................................................................................................................................................................................
552
0.00126
695.5
Fixed assets.....................................................................................................................................................................................
575
0.00140
805.0
W2,900
$3,699.0
Liabilities and Owners Equity
Current liabilities.............................................................................................................................................................................
W624
0.00124
$ 773.8
Capital stock....................................................................................................................................................................................
1,000
0.00140
1,400.0
Retained earnings............................................................................................................................................................................
1,276
(plug)
1,525.2
W2,900
$3,699.0

Income Statement for the year ended September 30, 20x2

Revenue..........................................................................................................................................................................................
W7,090
$0.00132
$9,358.8
Cost of sales....................................................................................................................................................................................
4,415
0.00132*
5,827.8*
Other expenses (excl. deprec.)........................................................................................................................................................
1,374
0.00132
1,813.7
Depreciation....................................................................................................................................................................................
25
0.00140
35.0
Operating income............................................................................................................................................................................
1,276
1,682.3
Translation gain (loss).....................................................................................................................................................................
---(plug)
(157.1)
Net Income .....................................................................................................................................................................................
W1,276
$1,525.2
*This is an approximation. A precise calculation incorporates beginning and ending inventories, as well as
purchases, thus:

Beginning inventory........................................................................................................................................................................
W0
0.00140
$
0.0
Plus purchases.................................................................................................................................................................................
4,967
0.00132
6,556.4
Less ending inventory.....................................................................................................................................................................
(552)
0.00126
(695.5)
Cost of sales....................................................................................................................................................................................
W4,415
$5,860.9

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