ACCT3301 – International Accounting Exam #2 Name:_____________________________________ Exercise #1 (15 points, 50% of exam) Denker Corporation has a wholly owned subsidiary in Sri Lanka that manufactures wooden bowls at a cost of $3.00 per unit. Denker imports the wooden bowls and sells them to retailers at a price of $12.00 per unit. The following information applies: Income tax rate Import Duty Withholding tax rate on dividends United States 35% 10%
‐ Sri Lanka 30% ‐
10% Import duties are levied on the invoice price and are deductible for income tax purposes. The Sri Lankan subsidiary must repatriate 100% of after‐tax income to Denker each year. Denker has determined an arm’s‐length range of reliable transfer prices to be $5.00 ‐ $6.00. Required: Determine the transfer price within the arm’s‐length range that would maximize Denker’s after‐
tax cash flow from the sale of wooden bowls. Be sure to document your work/calculations. Exercise #2 (15 points, 50% of exam) Zorba Company, a U.S. based exporter of specialty olive oil, received an order with a foreign customer for 500 cases of olive oil at a price of ¥9,300 (Japanese yen) per case. The total purchase price for the order is ¥4,650,000. The transaction date is March 1 with payment due March 31. Relevant exchange rates are as follows: Date March 1, 2010 March 15, 2010 March 31, 2010 Spot Rate $0.0108
$0.0107 $0.0101 Forward Rate (to March 31, 2010) $0.0106
$0.0104 $0.0101 Call Option Premium for March 31, 2010 (strike price = $0.0108) $0.04
$0.12 Zorba Company has an incremental borrowing rate of 12% (1% per month) and closes the books and prepares financial statements on December 31. Required: a. Prepare the journal entries to account for the sale and subsequent collection of the accounts receivable assuming Zorba does not hedge the transaction. b. Prepare the journal entries to account for the sale and subsequent collection of the accounts receivable assuming Zorba uses a forward contract designated as a fair value hedge to mitigate the risks associated with the sale transaction. ACCT3301 – International Accounting Exam #2 Name:_____________________________________ Bonus Questions (0.5 points each) Circle the best choice for each question below. 1. A) B) C) D) What is the term used for intercompany transactions from a parent to a subsidiary? upstream transfer downstream transfer international transfer none of the above 2. A) B) C) D) What is the primary characteristic of a decentralized organization? size of divisions number of divisions delegation of decision making authority diversity of foreign operations 3. A) B) C) D) Withholding taxes on dividends paid by a foreign subsidiary to a parent can be reduced by: raising prices paid by the parent for goods it acquires from the subsidiary. raising prices paid by the subsidiary for goods it acquires from the parent. negotiated transfer pricing. reducing prices charged by the parent for good transferred to the subsidiary. 4. A) B) C) What is a “foreign exchange rate?” the price to buy a foreign currency the price to buy foreign goods the difference between the price of goods in a foreign currency and the price in a domestic currency. D) the cost to hold all monetary assets in a single currency 5. When a currency is allowed to increase or decrease in value relative to other currencies, the currency is said to: A) be pegged to another currency. B) be less valuable. C) float. D) devalue. ACCT3301 – International Accounting Exam #2 Name:_____________________________________ Exercise #1 Revenue Cost of production Import duty (10%) Pretax income Income tax (30%, 35%) Aftertax income Witholding tax (10%) Cash flow Worldwide cash flow @ $5.00 TP
Sri Lanka Sub US Parent
$5.00 $12.00
3.00 5.00
0.50
2.00 6.50
0.60 2.275
1.40 4.225
0.14 1.26 4.225
$5.485 @ $6.00 TP
Sri Lank Sub
US Parent
$6.00
$12.00
3.00
6.00
0.60
3.00
5.40
0.90
1.89
2.10
3.51
0.21
1.89
3.51
$5.40
The $5.00 transfer price yields a higher net cash flow for Denker Corporation. Exercise #2 a. 3/1 Accounts receivable 50,220 Sales 50,220 3/31 Cash 46,965 Loss on foreign currency exchange 3,255 Accounts receivable 50,220 Net loss on the transaction is $3,255 because the entire transaction was a risk for appreciation of $US vs. ¥. b. 3/1 Accounts receivable 50,220 Sales 50,220 3/31 Loss on foreign currency exchange 3,255 (.0108 ‐ .0101)*4,650,000 Cash 49,290 (.0106 * 4,650,000) Accounts receivable 50,220 Gain on forward contract 2,325 (.0106 ‐ .0101)*4,650,000 Net loss on the transaction is $930 (0.0108 – 0.0106)*4,650,000. The transaction loss is partially offset by a forward contract gain. Multiple Choice 11‐2 Answer: B Level: Easy LO: 1 11‐5 Answer: C Level: Medium LO: 1 11‐19 Answer: B Level: Hard LO: 3 6‐3 Answer: A Level: Easy LO: 1 6‐6 Answer: C Level: Easy LO: 2
Comment [jaw1]: Cash flow is not the same as net income. It was not required to deal with U.S. credit for income taxes on Sri Lankan withholding. Comment [jaw2]: Without any hedging, the entire change in the value of ¥ is recorded as a loss at the date the transaction is settled. There are no entries needed for 3/15 as there is no transaction occurring on that date and there is no financial statement presentation. Comment [jaw3]: The gain on the forward contract mostly, but not entirely, offsets the loss in value of ¥.