AC580 Test 2

Bankruptcy Reform Act of 1978

Based on an original provision of the US Constitution, Congress is responsible for creating bankruptcy laws Replaced all other bankruptcy laws passed by Congress Strives to achieve two goals in insolvency cases -fair distribution of assets to creditors -discharge of an honest debtor from debt

Going Concern Assumption

Basic assumption that a business will remain in business unless evidence to the contrary is discovered

Partnership Contribution of Intangible Assets

Bonus Method -splits the capital evenly between the two partners -recognizes only assets physically transferred to the business such as cash, patents, inventory, etc. Goodwill Method -based not he assumption that an implied value can be calculated mathematically and recorded for any intangible contribution made by a partner (Goodwill)

Current Rate Method - Calculation of Cost of Goods Sold

COGS in FC is translated using the average-for-the-period exchange rate COGS in FC x Average ER = COGS in $

Translation adjustments and remeasurement gains or losses are functions of two factors:

Changes in the exchange rate Balance Sheet exposure

Voluntary Bankruptcy

Company files a petition with courts requesting bankruptcy Exhibits listing all assets and debts must also be presented Company officials must respond to questions concerning various aspects of the business's affairs

Treatment of Additional Capital Contributions by Partners

Contribution is recorded as an increment in the partner's capital account based on fair value If a partner invests additional cash in the partnership, the partner's capital account balance is increased by the amount to reflect a transfer to the partnership

Hedges of a Recognized Foreign Currency-Denominated Asset

Date on which the company receives/sends goods from/to a foreign supplier to be paid in a foreign currency Export - asset - accounts receivable - forward contract, call option Import - liability - accounts payable - put option Company enters into a forward contract or purchases a put option on the date the sale is made Designated as either a cash flow or fair value hedge

Derivative Financial Instruments

A financial instrument that derives its value from the value of some other instrument (the underlying)

Foreign Currency Firm Commitment

A non cancelable order that specifies the foreign currency price and date of delivery; executory contract not normally recognized in financial statements; the company has not delivered the goods nor has the customer paid for them Change in FV results in a gain or loss that offsets the loss or gain on the hedging instrument (forward contract or option) Designated as either a cash flow or fair value hedge

Temporal Method - Calculation of Cost of Goods Sold

No single exchange rate can be used to directly translate COGS in FC to COGS in $ COGS must be decomposed into beginning inventory, purchases, and ending inventory, and each component must then be translated at its appropriate historical rate When purchases can be assumed to have been made evenly throughout the year, the average exchange rate is used to translate purchases

Partnership Allocation of Income

Partnership revenues and expenses must be closed out at the end of each fiscal period and the net income allocated to each partner's capital account Articles of Partnership should stipulate an established procedure If no arrangement is specified, state partnership laws dictate that all partners receive an equal allocation of income or loss

Temporal Method - Remeasurement of Balance Sheet

Remeasures cash, receivables, and liabilities into US dollars using the current exchange rate Inventory, PPE, patents, and contributed capital accounts are remeasured at historical rates resulting in differences in total assets and liabilities plus equity, which just be reconciled, resulting in a remeasurement gain or loss

Partner's Loan Balances

The loan is merged with the partner's capital account balance at the beginning of liquidation

Temporal Method - Remeasurement of Statement of Cash Flows

The US dollar value for net income is taken from the remeasured income statement Depreciation and amortization are remeasured at the rate used in the income statement (historical), and the remeasurement loss, a non cash item, is added back to net income Increases in A/R and A/P, related to sales and purchases, are remeasured at the average rate The increase in inventory is determined by the remeasurement of COGS

Accounting for Unrealized Gains and Losses on Foreign Currency Transactions

The accrual approach is used unrealized foreign exchange gains and losses are reported in net income in the period in which the exchange rate changes

Alternative Legal Forms of Partnerships

General Partnership Limited Partnership Limited Liability Partnership Limited Liability Company Subchapter S Corporation

Current Rate Method

The basic assumption is that a company's net investment in a foreign operation is exposed to foreign exchange risk A foreign operation represents a foreign currency net asset and if the foreign currency decreases in value against the US dollar, a decrease in the US dollar value of the foreign currency net asset occurs To measure the net investment's exposure to foreign exchange risk, all assets and liabilities of the foreign operation are translated at the current exchange rate Stockholders' Equity items are translated at historical rates Balance Sheet exposure is equal to the foreign operation's net asset position

Temporal Method

The basic objective is to produce a set of US dollar-translated financial statements as if the foreign subsidiary had actually used US dollars in conducting its operations Assets and Liabilities carried on the foreign operation's balance sheet at historical cost are translated at historical exchange rates to yield an equivalent historical cost in US dollars

Positive (credit) Translation Adjustment

When the ending translated value of the net assets is greater than the translated value of the net assets prior to any rate changes

Negative (debit) Translation Adjustment

When the translated value of the net assets prior to any rate changes is greater than the ending translated value

Distribution of Safe Payments

While awaiting final resolution, no compelling reason exists for the partnership to continue holding cash Initial distribution is based on the assumption that the capital deficit will be a total loss to the partnership Calculate the lowest possible amounts (or safe balances) that the partners must retain in their capital accounts to be able to absorb all future losses Determine the amount of safe payments that can be made to the partners without running the risk that future losses will cause either of these partners to have a deficit capital balance

3 Steps in Liquidation of a Partnership

1) Noncash partnership assets are sold for cash, and gains and losses on the sales are allocated to the capital accounts of individual partners on the basis of profit and loss ratios 2) Partnership liabilities and expenses incurred during the liquidation are paid out of the partnership's available cash 3) Any partnership cash remaining after paying liabilities and liquidation expenses is distributed to the individual partners on their basis of their respective capital balances

Four Types of Foreign Exchange Risk

1) Recognized foreign currency-denominated assets and liabilities 2) Unrecognized foreign currency firm commitments 3) Forecasted foreign currency-denominated transactions 4) Net investments in foreign operations

Fair Value Hedges

An instrument designated as a hedge of the exposure to changes in fair value of a recognized asset or liability, or of an unrecognized firm commitment, that are attributable to a particular risk Gains and losses are recognized immediately in net income FV exposure exists if changes in exchange rates can affect the fair value of an asset or liability reported on the balance sheet To qualify for hedge accounting, the FV risk must have the potential to a effect net income if not hedged FV exposure exists for foreign currency firm commitments

Foreign Currency Call Options

allow for the purchase of foreign currency by the option holder

Reporting Currency

currency in which an entity prepares its financial statements

Foreign Currency Option Intrinsic Value

equal to the gain that could be realized by exercising the option immediately an option with a positive ____ value is said to be "in the money"

Historical Exchange Rate

exchange rate that existed when a transaction occurred

Disclosures Related to Translation

Current standards require firms to present an analysis of the change in the cumulative translation adjustment account in the financial statements or notes thereto Although not specifically required to do so, many companies describe their translation procedures in their "summary of significant accounting policies" in the notes to the financial statements

Partnership Liquidation - Deficit Capital Balance

Deficits are most likely to occur when -the partnership is already insolent at the start of the liquidation, or -the disposal of non cash assets results in material losses The partner "shall contribute to the partnership an amount equal to excess charges over the credits in the partners' accounts"

Goodwill Monitoring During Bankruptcy

Entities are required to test goodwill annually for impairment Testing is more frequent if circumstances or events indicate that the fair value of a reporting unit is more likely than not to have fallen below its carrying amount

Export Sale

Exposure exists when a seller allows a buyer to pay in foreign currency after the sale has been made the seller is exposed to the risk that the foreign currency might depreciate between the sale and payment dates no foreign exchange exposure exists if the seller requires payment on the date of sale Type of Exposure - Asset (Receivable) FC Appreciates - Gain FC Depreciates - Loss

Foreign Currency Forward Contract

Fair value is determined by reference to changes in the forward rate over the life of the contract discounted to present value 3 pieces of information determine the FV 1 - the forward rate when the contract was entered into 2 - the current rate for a contract that matures on the same date as the contract entered into 3 - a discount rate

Advantages of Partnerships

For formation, only an oral agreement is necessary to create a legally binding partnership Depending on specific state laws, incorporation requires filing a formal application and completing various other forms and documents Operators of small businesses may find convenience and reduced cost involved in creating a partnership to be an especially appealing characteristic

Hedging Documentation

Formal documentation of the hedging relationship at the inception date of the hedge Prepare a document that identifies - the hedging item - the hedging instrument - the nature of the risk being hedged - how the hedging instrument's effectiveness will be assessed - the risk management objective and strategy for undertaking the hedge

Three Classifications of Creditors

Fully Secured Partially Secured Unsecured

Translation Adjustment

If a foreign currency is the foreign operation's functional currency, the currency balances are translated using the current rate method and a translation adjustment is reported on the balance sheet

Remeasurement

If a foreign operation's functional currency is the US dollar, the currency balances are remeasured into US dollars using the temporal method resulting in remeasurement gains and losses

Going Concern Financial Statement Footnotes

If substantial doubt is alleviated by management's plans, conditions or events that caused the concern are disclosed along with management's evaluation of their significance and the plans that are expected to solve the concern If substantial doubt is not alleviated by management's plans, the same information is disclosed, and a statement included in the footnote should state that substantial doubt exists about the entity's ability to continue as a going concern

Foreign Currency Indirect Quotes

Indicate the number of foreign currency units that could be purchased with one unit of domestic currency (inverse)

Cash Flow Hedge

Instrument designated as hedging the exposure to variability in expected future cash flows attributed to a particular risk Gains and losses are included in OCI CF exposure exists if changes in exchange rates can affect the amount of cash flow to be realized from a foreign currency transaction with changes in cash flow reflected in net income CF exposure exists for - Recognized foreign currency assets and liabilities - Foreign currency firm commitments - Forecasted foreign currency transactions

Fully Secured Creditor

Net realizable value of the collateral exceeds the amount of the obligation These creditors are completely protected by the pledged property

Treatment of Partnership Income

Partnership revenue and expense items must be assigned directly each year to the individual partners who pay the income taxes Passing income balances through to partners avoids double taxation of profits earned and distributed to owners Income is taxed only at the time the business initially earns it

Preliminary Distribution of Partnership Assets

Partnerships often have sufficient cash balances at the date of termination that some cash can be paid out to individual partners before non cash assets are sold A preliminary distribution ensures that a partnership maintains enough capital to absorb all future losses Any capital in excess of the maximum requirement is a safe balance, an amount that can be immediately conveyed to the partner

Conditions or Events that could Signal an Entity's Inability to Meet Debts

Recurring operating losses working capital deficiencies Negative cash flows from operating activities Loan default Work stoppages or other labor difficulties Legal proceedings Loss of a key asset such as a patent or franchise

Balance Sheet Date before Foreign Currency Transaction Date of Payment

Requires foreign currency balance to be revalued at the Balance Sheet date to account for change in exchange rates Foreign exchange gain or loss arises at the balance sheet date

Temporal Method - Inventory Translation

Requires the inventory's foreign currency cost to be translated into US dollars at the historical exchange rate and foreign currency net realizable value to be translated into US dollars at the current exchange rate

Current Rate Method - Translation of Statement of Cash Flows

Requires translating all operating items in the statement of cash flows at the average-for-the-period rate Any effect of exchange rate change on cash represents that part of the translation adjustment attributable to a change in Cash and is derived as a balancing amount

An individual partner's ownership rights include

Rights that can be sold: The right of co-ownership in the business property The right to share in profits and losses as specified in the partnership agreement Right that can't be sold without partners' approval: The right to participate in the management of the business

US Dollar Perspective to Translation

Some subsidiaries are so closely tied to their US parents, most of their transactions are recorded in US dollars Use the temporal method as if the foreign subsidiary had actually used the dollar in carrying out its activities Translation gains and losses are reported in net income

Importance of Capital Balances

Totals in individual capital accounts influence the assignment of profits and losses to partners Capital account balance is usually one factor in determining final distribution to be received by a partner at withdrawal or retirement Ending capital balances indicate allocation to be made of assets that remain following liquidation of a partnership

Current Rate Method - Gain/Loss on the Sale of an Asset

Translates the gain on the sale at the exchange rate in effect at the date of the sale

Admission of a New Partner

Two methods to account for the transfer of ownership -Book Value Approach -Goodwill (revaluation) Approach An outsider may be admitted to the ownership by contributing cash or other assets directly to the business

Perspective of Foreign Currency Transactions

Two-Transaction Perspective Treat the sale and collection of cash as two separate transactions Account for the original sale in US dollars at the date of sale Changes in the US dollar value of the foreign currency are accounted for as gains/losses from exchange rate fluctuations and are reported separately from sales in the income stmt

Disadvantages of Partnerships

Unlimited liability that each partner automatically incurs A partner can be held personally liable for all debts Potential risk is significant when coupled with mutual agency, the right each partner has to incur liabilities in the name of the partnership Partners acting within the normal scope of the business have the power to obligate the company for any amount (creditors can seek satisfactory remuneration from any partner they choose)

Articles of Partnership

Written agreement that supersedes UPA standards Clearly describes: Name and address of each partner Business location Description of the nature of the business Rights and responsibilities of each partner Initial contribution made by each partner and method to be used for valuation Specific method by which profits and losses are to be allocated Periodic withdrawal of assets by each partner Procedure for admitting new partners Method for arbitrating partnership disputes Life insurance provisions enabling remaining partners to acquire the interest of the deceased partner Method for settling a partner's share in the business upon withdrawal, retirement, or death

Foreign Currency Put Options

allow for the sale fo foreign currency by the option holder

Import Purchase

exposure exists when the buyer is required to pay in foreign currency sometime after the purchase the buyer is exposed to the risk that the foreign currency might appreciate between the purchase and payment dates, increasing the domestic currency paid no foreign exchange exposure exists if the buyer makes a payment on the date of the purchase Type of Exposure - Liability (Payable) FC Appreciates - Loss FC Depreciates - Gain

Foreign Currency is selling at a premium when

forward rate exceeds the spot rate, this produces positive forward points

Foreign Currency Options

give the holder of an option the right but not the obligation to trade foreign currency in the future fair value is its current market price quoted on the exchange

Foreign Currency Option Premium is a function of

intrinsic value and time value

Temporal Method - Translation of Retained Earnings

stockholders' equity items are translated at historical exchange rates under both the current rate and temporal methods retained earnings is an accumulation of all the net income less dividends declared by a company since its inception

Independent Float

the currency is allowed to fluctuate according to market forces

Pegged to Another Currency

the currency's value is fixed in terms of a particular foreign currency, and the central bank will intervene to maintain the fixed value

Foreign Currency Forward Points

the difference between forward rate and spot rate for currency at a given date

"The Spread"

the difference between the rates at which a bank is willing to buy and sell currency

Foreign Currency Option Strike Price

the exchange rate at which options will be executed if option holders decide to exercise options

Current Exchange Rate

the exchange rate that exists at the balance sheet date

Current Rate Method - Translation of Income Statement

All revenues and expenses are translated at the exchange rate in effect at the date of accounting recognition Use the weighted average exchange rate if each revenue and expense is recognized evenly throughout the year When an income account, such as a gain or loss, occurs at a specific point in time, the exchange rate as of that date is applied Depreciation and amortization expenses are translated at the average rate for the year Dividends are translated at the exchange rate on the date of declaration

Statement of Partners' Capital

In prepared in lieu of a Statement of Retained Earnings Changes made during the year in partners' capital accounts are outlined with totals representing the partnership

Treatment of Partnership Operating Losses

Income is taxable to partners as the business earns it; operating losses reduce their personal taxable income directly if they materially participated in the business

Foreign Currency Direct Quotes

Indicate the number of domestic currency needed to purchase one unit of foreign currency

Going Concern Information for Outside Decision-Makers

Management must have evidence to show that it can probably implement plans, and if so, that they will probably mitigate the conditions or events that have created the high level of doubt Whether implementation of plans is probable and whether mitigation is probable, disclosure is required Once substantial doubt has been raised, certain information must be included in the financial reporting so outside decision-makers are aware of the situation

Hedge Accounting

Minimizes the adverse effect that changes in exchange rates have on cash flows and net income Companies recognize the gain or loss from the hedge of net income in the same period as the loss or gain on the risk being hedged ONLY if the derivative is - used to hedge either a cash flow exposure or a fair value exposure to foreign exchange risk - highly effective in offsetting changes in the cash flows or fair value related to the hedged item - properly documented as a hedge

Foreign Currency Options that are "at the money"

Options purchased in the Over-the-Counter market that have a strike price equal to the spot rate on that date

Current Rate Method - Inventory Translation

Requires ending inventory on the foreign currency balance sheet to be translated at the current exchange rate whether carried at cost or a lower net realizable value

Hedge of a Forecasted Foreign Currency-Denominated Transaction

Some companies have foreign currency transactions that occur on a regular basis and can be reliably forecasted Company uses a foreign currency option Designated as a cash flow hedge only

Local Currency Perspective to Translation

Subsidiaries operate relatively independent of their parents Use the current rate method Translation adjustments should be reported as a separate component in AOCI on the balance sheet

Temporal Method - Gain/Loss on the Sale of an Asset

The cash received and the cost of the land sold must be translated into US dollars separately, the difference is the US dollar value of the gain Translates the cash account at the exchange rate on the date of the sale and the land account is translated at the historical rate

Reporting the Hedging Instrument

The company reports the hedging instrument (forward contract or option) at fair value Gains and losses are recorded in OCI until the date of the forecasted transaction, then transferred to net income on the projected transaction date

Hedging Foreign Exchange Risk

To avoid uncertainty of unfavorable changes in the value of foreign currencies in foreign transactions, companies often use derivative financial instruments to hedge against the effect of unfavorable changes in value of foreign currencies

Uniform Partnership Act (UPA)

To provide consistent application across state lines in regard to many legal aspects of a partnership Adopted by all states in some form Establishes uniform standers in areas such as the nature of the partnership, the relationship of the partners to outside parties, and the dissolution of the partnership Def of Partnership "an association of two or more persons to carry on a business as co-owners for profit"

Highly Inflationary Economies

When a country's cumulative 3-year inflation exceeds 100% The temporal method is required with remeasurement gains or losses reported in net income

Functional Currency

primary currency of the foreign entity's operating environment

Foreign Currency Option Time Value

relates to the spot rate which can change over time and cause the option's intrinsic value to increase decreases over time because less time remains for the option to increase in intrinsic value

Foreign Currency is selling at a discount when

spot rate exceeds the forward rate, this produces negative forward points

Speculative Derivatives

the change in the fair value must be recognized immediately as a gain or loss in net income

Exchange Rate

the cost of one currency in terms of another

Spot Rate

the price at which a foreign currency can be purchased or sold today

Forward Rate

the price available today at which foreign currency can be purchased or sold in the future they can fluctuate

Involuntary Bankruptcy

Creditors file a petition with the court If 12 or more unsecured creditors, 3 must sign Creditors must meet minimum unsecured debt limits

Two Methods of Financial Statement Translation

Current Rate Method Temporal Method

Statement of Liquidation

Accountants should produce frequent reports summarizing transactions as they occur Statement is prepared at periodic intervals to disclose: -transactions to date -assets still being held by the partnership -liabilities remaining to be paid -current cash and capital balances

Capital Withdrawals by Partners

Articles of Partnership allow withdrawals as a reward for ownership or as compensation for work performed Distributions are recorded initially in a separate drawing account that is closed into the individual partner's capital account at year-end

Accounting for a Fair Value Hedge

At each balance sheet date - adjust the hedged asset or liability to fair value based on changes in the spot exchange rate and recognize a foreign exchange gain or loss in net income - adjust the derivative hedging instrument to fair value (resulting in an asset or liability on the balance sheet) and recognize the counterpart as a gain or loss in net income

Accounting for a Cash Flow Hedge

At the balance sheet date - adjust the hedged asset or liability to fair value based on changes in the spot exchange rate and recognize a foreign exchange gain or loss in net income - adjust the derivative hedging instrument to fair value (resulting in an asset or liability reported on the balance sheet) with the counterpart recognized as a change in AOCI - the amount equal to the foreign exchange gain or loss on the hedged asset or liability is transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability - an additional amount is removed from AOCI and recognized in net income to reflect the current period's amortization of the original discount or premium on the forward contract, or the change in time value of the option

Partnership Liquidation Predistribution Plan

At the start of a liquidation, accountants produce a single predistribution plan to serve as a guide for all future payment Whenever cash becomes available, the plan indicates the appropriate recipients without drawing up ever-chains proposed schedules of liquidation As a prerequisite to developing a predistribution plan, the sensitivity to losses exhibited by each capital account should be measured

Withdrawal of a Partner

Bonus Method (no revaluation) -amount paid in excess of that partner's capital account is allocated against remaining partners' capital accounts Goodwill Method (revalution) -books are first adjusted to FMV, with a proportionate increase allocated to each partner's account -withdrawing partner is paid based on the balance in individual capital account Hybrid Method -restates assets and liabilities to fair value but does not record goodwill

Order for Relief

Creates an automatic stay that halts all actions against the debtor Granted when the court accepts the petition Provides time for various parties to consider steps that should be taken to limit losses The company comes under the authority of the bankruptcy court so that any asset distribution must be made in a fair manner