CFA Level 2

Question 76

SIMULATION - Ota L'Abbe, a supervisor at an investment research firm, has asked one of the junior analysts, Andreas Hally, to draft a research report dealing with various accounting issues. Excerpts from the request are as follows: "¢ "There's an exciting company that we're starting to follow these days. It's called Snowboards and Skateboards, Inc. They are a multinational company with operations and a head office based in the resort town of Whistler in western Canada. However, they also have a significant subsidiary located in the United States." "¢ "Look at the subsidiary and deal with some foreign currency issues including the specific differences between the temporal and all-current methods of translation, as well as the effect on financial ratios." "¢ "The attached file contains the September 30, 2008, financial statements of the U.S. subsidiary. Translate the financial statements into Canadian dollars in a manner consistent with U.S. GAAP." The following are statements from the research report subsequently written by Hally: Statement 1: Subsidiaries whose operations are well integrated with the parent will use the all-current method of translation. Statement 2: Self-contained, independent subsidiaries whose operating, investing, and financing activities are primarily located in the local market will use the temporal method of translation. Other information to be considered "¢ Exchange rates (CAD/USD) "¢ Beginning inventory for fiscal 2008 had been purchased evenly throughout fiscal 2007. The company uses the FIFO inventory value method. "¢ Dividends of USD 25,000 were paid to the shareholders on June 30, 2008. "¢ All of the remaining inventory at the end of fiscal 2008 was purchased evenly throughout fiscal 2008. "¢ All of the PP&E was purchased, and all of the common equity was issued at the inception of the company on October 1, 2004. No new PP&E has been acquired, and no additional common stock has been issued since then. However, they plan to purchase new PP&E starting in fiscal 2009. "¢ The beginning retained earnings balance for fiscal 2008 was CAD 1,550,000. "¢ The accounts payable on the fiscal 2008 balance sheet were all incurred on June 30, 2008. "¢ The U.S. subsidiary's operations are highly integrated with the main operations in Canada. "¢ The remeasured inventory for 2008 using the temporal method is CAD 810,000. "¢ All monetary asset and liability balances are the same as they were at the end of the 2007 fiscal year, except that long-term debt was USD 467,700. "¢ Costs of goods sold under the temporal method in 2008 is CAD 1,667,250. Suppose the parent uses the all-current method to translate the subsidiary for fiscal 2008. Will return on assets and net profit margin in U.S. dollars before translation be the same as, or different than, the translated Canadian dollar ratios?

Question 77

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation at the request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings in various industries. Specifically, Stephenson is interested in the effects of Iberia's investments on its financial performance and has decided to focus on two investments: Midland Incorporated and Odessa Company. Midland Incorporated - On December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80 million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia's investment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For the year ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. For the year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million. During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold all of the goods to a third party in 2010. Odessa Company - On January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-term investment. The purchase price was €20 per share and on December 31, 2009, the market price of Odessa was €17 per share. The decline in value was considered temporary. For the year ended 2009, Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers its investment in Odessa as an investment in financial assets. In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him to draft a report on accounting methods and ratio analysis. The following are statements from Stephenson's research report. Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account for joint ventures. Statement 2: In general, if the parent's consolidated net income is positive, the equity method reports a higher net profit margin than the acquisition method. Which of the following is the most appropriate classification of Iberia's investment in Odessa Corporation?

1. Held-to-maturity.
2. Held-for-trading.
3. Available-for-sale.

Question 78

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation at the request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings in various industries. Specifically, Stephenson is interested in the effects of Iberia's investments on its financial performance and has decided to focus on two investments: Midland Incorporated and Odessa Company. Midland Incorporated - On December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80 million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia's investment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For the year ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. For the year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million. During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold all of the goods to a third party in 2010. Odessa Company - On January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-term investment. The purchase price was €20 per share and on December 31, 2009, the market price of Odessa was €17 per share. The decline in value was considered temporary. For the year ended 2009, Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers its investment in Odessa as an investment in financial assets. In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him to draft a report on accounting methods and ratio analysis. The following are statements from Stephenson's research report. Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account for joint ventures. Statement 2: In general, if the parent's consolidated net income is positive, the equity method reports a higher net profit margin than the acquisition method. What amount should Iberia recognize in its 2009 income statement as a result of its investments in Midland and Odessa?

1. €1 million profit.
2. €2 million profit.
3. €3 million loss.

Question 79

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation at the request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings in various industries. Specifically, Stephenson is interested in the effects of Iberia's investments on its financial performance and has decided to focus on two investments: Midland Incorporated and Odessa Company. Midland Incorporated - On December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80 million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia's investment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For the year ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. For the year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million. During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold all of the goods to a third party in 2010. Odessa Company - On January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-term investment. The purchase price was €20 per share and on December 31, 2009, the market price of Odessa was €17 per share. The decline in value was considered temporary. For the year ended 2009, Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers its investment in Odessa as an investment in financial assets. In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him to draft a report on accounting methods and ratio analysis. The following are statements from Stephenson's research report. Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account for joint ventures. Statement 2: In general, if the parent's consolidated net income is positive, the equity method reports a higher net profit margin than the acquisition method. What amount should Iberia report on its balance sheet at the end of 2009 as a result of its investments in Midland and Odessa?

1. €84.4 million.
2. €101.4 million.
3. €102.0 million.

Question 80

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation at the request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings in various industries. Specifically, Stephenson is interested in the effects of Iberia's investments on its financial performance and has decided to focus on two investments: Midland Incorporated and Odessa Company. Midland Incorporated - On December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80 million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia's investment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For the year ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. For the year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million. During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold all of the goods to a third party in 2010. Odessa Company - On January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-term investment. The purchase price was €20 per share and on December 31, 2009, the market price of Odessa was €17 per share. The decline in value was considered temporary. For the year ended 2009, Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers its investment in Odessa as an investment in financial assets. In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him to draft a report on accounting methods and ratio analysis. The following are statements from Stephenson's research report. Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account for joint ventures. Statement 2: In general, if the parent's consolidated net income is positive, the equity method reports a higher net profit margin than the acquisition method. What adjustment, if any, must Iberia make to its 2010 income statement as a result of the intercompany transaction with Midland?

1. Sales and cost of goods sold should be reduced by Iberia's pro-rata ownership interest in the intercompany sale.
2. Midland's net income should be reduced by 20% of the gross profit from the intercompany sale.
3. No adjustment is necessary.