Case Analysis for Trans-Global Corporation

 

1 - Case Analysis for Trans-Global Corporation introduction. Introduction

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This paper seeks to do several actions for Trans-Global Corporation (TGC) including analysis of factors in the context of multinational accounting to determine whether there is basis to provide Sarbanes-Oxley certification by the company, analysis of countries of corporations with subsidiaries that are required to prepare the first consolidate IFRS accounts for 2005 including those countries which has just joined EU in 2004. This will also determine gains and losses arising from a transaction involving another foreign currency and the effect of entering or not entering into forward contract. In addition two separate foreign subsidiaries from Europe are involved which will require the determination of functional currency and foreign currency translation method and the required translation of into their US-dollar-denominated financial statements. At the latter part will be the required outline of subsidiary accounts which are likely to have significant change as a result of transitioning from  US GAAP to IFRS.

 

2. Analysis and Discussion

 

2.1. An analysis of the factors in the multinational accounting area to be reviewed with the CFO to determine whether the company could provide Sarbanes-Oxley certification.

 

The factors to be reviewed with the CFO to determine whether the company could provide Sarbanes-Oxley certification include those that would ensure compliance with the requirements of Sarbanes-Oxley Act (SOA)  of 2002 in relation to the said certification. Section 302 of SOA requires a corporations principal executive and financial officers to make separate certification that the financial and other information as contained in the company’s issued financial statements quarterly and annually are in accordance with the requirements of the standards contained in the SOA including an evaluation of effectiveness of disclosure controls and procedures which are designed to ensure that required information in the files reports in accordance with US Securities Exchange Act of 1934  has complied with recording, processing and summarizing of reports of a timely basis (Sheikh and Wallace, 2008).

Therefore the certainty of whether the disclosure control and procedures of the subsidiaries are effective in ensuring that the information required in reports files under the US SEC ACT of 194 is recorded, processed, summarized and reported on a timely basis would entail knowing the factors of what would constitute effective disclosure controls and procedures and what constitute timely recording, processing and summarizing of reports.

2.2. An analysis of countries in which subsidiaries will be required to prepare their first full consolidated IFRS accounts for 2005. Prepare a similar analysis of countries joining the EU in May 2004 and give an estimate of when the subsidiaries in those countries will be required to prepare consolidated IFRS accounts.

 

The countries in which subsidiaries that will be required to prepare the consolidated IFRS accounts on for 2005 are all those countries where the subsidiaries are publicly listed companies in EU. These include all countries since the EC can prescribe rules to be followed as far as adoption and use IFRS are concerned with those countries within its jurisdiction.

The countries of corporations which have subsidiaries operating in EU after  joining EU in May 2004 will be deemed to be required to adopt  the use of consolidated IFRS accounts beginning also in 2005 as provided in the case facts in the absence of a clear law that would give  them special treatment since the condition for 2005 adoption is the subsidiary is publicly listed.

However, the IASB has realized that companies in the various countries may need more specific guidance on the first time application of the IFRS which has been made part of its agenda as early as 2001.  There is therefore an exposure draft 1 (ED 1) issued by the IASB for the first time application of the IFRS in 2003 but will be effective in January 2004.  In said ED 1, the corporations of those countries adopting IFRS for the first time as their basis to prepared their general-purpose financial statements will be guided accordingly since the exposure draft is aimed to ease the transition of all concerned and to ensure that users of accounts are provided with quality of information being characterized to have good quality.  The ED draft has in effect replaced an old standard under SIC-8 issued in 1998 which had also supplementary books about the basis of IASB’s conclusions and the implementation guidance (The Gale Group, 2008). The existence of these materials as early as 1998 would justify an easy transition to those that will be required to use IFRS. Hence, this paper believes that EU has not provided separate regulation or rule for those countries to have joined only in May, 2004.

 

2.3. Calculation of the gains/losses on currency translation on the Osterhousen transaction at the third quarter (October 30, 2004) and at year-end (December 31, 2004). (Exchange rates are provided in Exhibit 5.)

 

The gains/losses on currency translation on the Osterhousen transaction at the third quarter of (Oct 30, 2004) and at the year-end (December 31, 2004) would be zero.  This is based on the case facts which provide that the receipt of items purchased in Osterhousen transaction was made on November 1.2004 and the payment was made on Dec 1,2004. This means that October 31, 2004 financial result could not have effect on the gain or loss on currency translation since there was even no need to record the transaction as that point. The same argument may be made in the case of December 31, 2004 since payment was made before that date, any gain or loss on currency translation would be affected in December 1, 2004.  If financial statements will be prepared as of December 31, 2004 , the differences in figures as a result of differences in exchanges rates would no longer be reflected as gain or loss but will be called foreign currency translation adjustments which will  not be part of the income statement as gains or losses but will be found in the stockholders’ equity section of the balance sheet of Trans-Global. Things would be clearer in the summary of journal entries below.

 

 

 

Notice that exchange gain in the amount of $60,000 was recognized in December 1, 2004 which is the date of payment not in any other date.

 

2.4. Determination of how the gains/losses calculated in item 2.3 would have been impacted if TGC had entered a forward contract at the time of the Osterhousen purchase.

 

As to how the gains/losses calculated in item 2.3 would have increased/decreased if TGC had entered a forward contract at the time of the Osterhousen purchase, this researcher believes that it was impossible to make forward contract on November 1, 2004 because of the absence of quoted forward rate at that time as shown (below) in the given exchange rates per point in time.   For the purpose of deciding whether there could have been increased foreign exchange gain or loss if a forward was entered this paper will have to assume that the forward contract must have been entered in August for the expected delivery in November 1, 2004 which was case fact assuming that the company carefully predicted in August 1, 2004 that the goods would be received in November 1, 2008.

 

If indeed forward contract was entered last August 1.2004,  there would have been a loss of foreign currency translation because the forward rate was US$1.26 to a euro which was higher than the spot rate of 1.25 in December 1,2004 when the payment was made for the purchase. There could have been loss of 30,000 dollars instead of the recorded gain of $60,000.

 

 

2.5. Determination of the functional currency and the foreign currency translation method for Bergstraff GmbH.

 

The functional currency of Bergstraff GmbH is euro since it is the currency that is locally used in Germany. Since Germany is part of the EU which has adopted euro as its official currency, then euro is considered as the functional currency (FC) for Bergstraff GmbH since the subsidiary is located in Germany.

The foreign currency method to be used for Bergstraff GmbH is the current rate method based on the following set of rules: The first rule is to use temporal rate method if the FC is hyper-inflationary,  then there is a need to ignore the same and instead remeasure the currency of books and record (CBR) into the reporting currency (RC) using the temporal method.  Rule number 2 requires that if CBR is different from the FC, then what is done in Rule I still applies, that is, use the temporal rate by remeasuring CBR into the FC. The third rule is to translate from the FC into the RC using the current rate method (Texas A&M University, 2008).  Based on the foregoing, rules numbers 1 and 2 are not applicable because there is no evidence of hyper inflation in the case facts and that CBR is not different from FC that is both in euro. Therefore, this paper is obliged to recommend rule 3, that is — translate FC into RC under the current method.

 

2.6. Based on the determinations made in item 2.5, preparation of a financial statement translation for Bergstraff for the year ended December 31, 2004. Be able to explain the reasons for any gains/losses on currency translation.

 

The financial statement translation for Bergstraff for the year ended December 31, 2004 would be as follows:

 

BERGSTRAFF GMBH

Translation of Financial Statements to US Dollars

For the Year ended December 31, 2004

INCOME STATEMENT

As

Translated

(in € millions)
(in $ millions)
Sales
26,539
1.19
31,581
Cost of sales
13,487
1.19
16,050
Gross profit
13,052
1.19
15,532
Research and development
3,796
1.19
4,517
Amortization of patent

Selling, general and administrative
4,464
1.19
5,312
Depreciation

Operating income
4,792
1.19
5,702
Interest income
102
1.19
121
Interest expense
472
1.19
562
Income before tax
4,422
1.19
5,262
Tax
2,104
1.19
2,504
Net income
2,318
1.19
2,758

Statement of Retained Earnings

Retained earnings, 2003
8,008.00
1.1
8,809
Net Income
2,318.00

2,758
subtotal
10,326.00

11,567
Less: Dividends
0


Retained earnings, 2004
10,326.00

11,567
BALANCE SHEET

31-Dec-04

Assets

Translated
Current assets

Cash and cash equivalents
7,404
1.28
9,477
Short-term investments
3,382
1.28
4,329
Trading assets
1,801
1.28
2,305
Accounts receivable (net of allowance for doubtful accounts)
2,574
1.28
3,295
Inventories
2,276
1.28
2,913
Deferred tax assets
1,136
1.28
1,454
Other current assets
352
1.28
451
Total current assets
18,925
1.28
24,224
Plant, property and equipment, net
4,325
1.28
5,536
Other non-current asset
1,200
1.28
1,536
Total assets
24,450
1.28
31,296
Liabilities and stockholders equity

Current liabilities

Short-term debt
436
1.28
558
Accounts payable
1,543
1.28
1,975
Accrued compensation and benefits
1,287
1.28
1,647
Accrued advertising
622
1.28
796
Deferred income on shipments to middlemen
475
1.28
608
Other accrued liabilities
1,075
1.28
1,376
Income taxes payable
1,157
1.28
1,481
Total current liabilities
6,595
1.28
8,442
Long-term debt
2,590
1.28
3,315
Stockholders equity

Common stock
150
1.1
165
Inter-company account
4,789
1.1
5,268
Retained earnings
10,326

11,567
Foreign Currency Translation Adjustments

2,539
Total liabilities and stockholders equity
24,450

31,296

Exchange rates used:

Average rate
1.19

historical rate
1.1

Balance Sheet date rate
1.28

Gains or losses are not recognized in the real sense since the accounts for the foreign exchange difference is now called foreign currency translation adjustment and is made part of the equity section of the balance sheet. For purposes of accounting for the reasons for the so called foreign currency translation adjustment, the same may come from the differences in rates at different periods and which much be adjusted according to the method used as shown above.

2.7. Determination of the functional currency and the foreign currency translation method for Instantel.

 

The functional currency of Instantel GmbH is koruna since it is the currency that is locally used Czech Republic which is koruna.   The foreign currency method to be used for Bergstraff GmbH is the current rate method, just like the case of Bergstraff, based on the following set of rules:  Rule 1 is to use temporal rate method if the FC is hyper-inflationary,  then there is a need to ignore the same and instead remeasure the currency of books and record (CBR) into the reporting currency (RC) using the temporal method.  Second rule requires that if CBR is different from the FC, there is a need to use the temporal rate by remeasuring CBR into the FC. Rule 3 is simply to translate from the FC into the RC using the current rate method (Texas A&M University, 2008).  In view of the foregoing, the first and second rules find no application for Instantel because there is no evidence of hyper inflation in the case facts and that CBR is the same at the FC, that is, both in koruna. Therefore, Rule 3 is most pressing which will required translating FC into RC under the current method.

 

2.8. Based on the determinations made in item 2.7, preparation of a financial statement translation for Instantel for the year ended December 31, 2004. Be able to explain the reasons for any gains/losses on currency translation.

 

The financial statement translation for Instantel for the year ended December 31, 2004 would be as follows:

INSTANTEL

Translation of Financial Statements to US Dollars

For the Year ended December 31, 2004

Income Statement

As
For the Year ended December 31, 2004
(in millions
Translated

of korunas)
(in $ millions)
Sales
520,650
0.037
19,264
Cost of sales
253,728
0.037
9,388
Gross profit
266,922
0.037
9,876
Marketing and advertising
42,720
0.037
1,581
General and administrative
35,622
0.037
1,318
Operating income
188,580
0.037
6,977
Interest income
6,221
0.037
230
Interest expense
102,520
0.037
3,793
Income before tax
92,281
0.037
3,414
Tax
27,684
0.037
1,024
Net income
64,597
0.037
2,390

Statement of Retained Earnings

Retained earnings, 2003
36,259
0.028
1,015
Net Income
64,597

2,390
subtotal
100,856

3,405
Less: Dividends
0

0
Retained earnings, 2004
100,856

3,405

(in millions
Translated
Balance Sheet
of korunas)
(in $ millions)
Assets

Current assets

Cash and cash equivalents
110,221
0.041
4,519
Short-term investments
55,301
0.041
2,267
Trading assets 1
1,522
0.041
62
Accounts receivable (net of allowance for doubtful accounts)
53,361
0.041
2,188
Inventories
49,633
0.041
2,035
Deferred tax assets
592
0.041
24
Other current assets
662
0.041
27
Total current assets
271,292
0.041
11,123
Plant, property and equipment, net
45,670
0.041
1,872
Other non-current asset
3,102
0.041
127
Total assets
320,064

13,123
Liabilities and stockholders equity

Current liabilities

Short-term debt
85,221
0.041
3,494
Accounts payable
25,633
0.041
1,051
Accrued compensation and benefits
1,051
0.041
43
Accrued advertising
312
0.041
13
Deferred income on shipments to middlemen
330
0.041
14
Other accrued liabilities
407
0.041
17
Income taxes payable
561
0.041
23
Total current liabilities
113,515

4,654
Long-term debt
85,621
0.041
3,510
Stockholders equity

Common stock
462
0.028
13
Inter-company account
20,010
0.028
560
Retained earnings 1
100,856
0.028
3,405
Foreign Currency Translation Adjustments

980
Total liabilities and stockholders equity
320,464

13,123
Income Statement : Supplementary information

Exchange rates used

Average rate
0.037

historical rate
0.028

Balance Sheet date rate
0.041

Technically, gains or losses cannot come from translation if what is meant is presenting the same in the income statement since this is now a case of translating the financial statements and not recording a transaction.  Realistically, the account for the foreign exchange difference is now called foreign currency translation adjustment which is part of the equity section of the balance sheet. For purposes of accounting for the reasons for gains or losses, this paper treats the question as referring to foreign currency translation adjustment which arose from the differences in rates at different periods and which much be adjusted according to the method used as shown above.  In this particular case, the current rate  method was used which necessitated application of average rates for revenue and expense accounts, historical rate for retained earnings and stockholders accounts , and balance sheet date spot rate for assets and liabilities accounts.

 

2.9. Bergstraff and Instantel have traditionally prepared financial statements using U.S. generally accepted accounting principles (GAAP). In 2005, it is likely that Bergstraff will be required to prepare full consolidated accounts under IFRS. Preparation of an outline of the Bergstraff accounts that are likely to have a significant change as a result of transitioning from U.S. GAAP to IFRS is required.

 

The outline of Bergstraff accounts that are likely to have a significant change as a result of transitioning from US GAAP to IFRS will not be as extensive because there good similarities of US GAAP and IFRS as far as the names of accounts are concerned. What would significantly change are the governing principles in the preparation of financial statements from US GAAP to IFRS.

The income statement accounts of Sales, Cost of sales, Gross profit, Research and development, Amortization of patent, Selling, general and administrative

Depreciation, Operating income, Interest income and Interest expense are also nomenclatures that are allowed under IFRS in the same way that they are used under US GAAP.

The asset accounts of Cash and cash equivalents, Short-term investments, Trading assets, Accounts receivable, Allowance for doubtful accounts, Inventories, Deferred Tax Assets, Plant, property and equipment, Accumulated  Depreciation as allowed under the US GAAP are also perfectly acceptable accounts under IFRS. The liability accounts of  Short-term debt,  Accounts payable, Accrued compensation and benefits, Accrued advertising, Deferred income on shipments to middlemen, Other accrued liabilities, Income taxes payable , and Long-term debt  are also allowed under IFRS in the same that they are now used under US GAAP. Even the Stockholders equity accounts of Common stock, Inter-company account, Retained earnings and Foreign Currency Translation Adjustments are also allowed both under US GAAP and IFRS. This paper therefore takes the position that as far as the accounts are concerned , there could be little changes in the accounts after application of IFRS principles in the preparation of the financial statements.   This position is fully supported by experiences of  some US publicly listed companies which has their financial statements restated from IFRS as a requirement of the EU of these companies have their subsidiaries in EU countries.

 

3. Conclusion

 

Analysis of factors in the context of multinational accounting to determine whether Sarbanes-Oxley certification could be issued revealed the need to familiarize with the requirements of the SOA and the readiness of the subsidiaries to comply. Countries of corporations with subsidiaries that are required to prepare the first consolidate IFRS accounts for 2005 and there is not clear exception even to those countries which just joined in 2004. Gains arising from transaction involving another foreign currency was determined which would have been loss if forward contract was entered. This paper has also translated of the financial statements under IFRS from US GAAP for two subsidiaries of Trans-Global Corporation (TGC). The functional currencies for each subsidiary were also determined and the foreign currency translation method for both is the current rate method due to non-application of the first and second rules. The required outline of subsidiary accounts which are likely to have significant change as a result of transitioning from  US GAAP to IFRS turn out not to be extensive as it was almost nil because both standards differ most in the principles and their application and not in the account titles.

 

 

References:

 

Case Study – Trans-global  Corporation, Richard Ivey School of Business

Sheikh and Wallace (2008), The Sarbanes-Oxley Certification Requirement: Analyzing the Comments, { www document} URL, http://www.nysscpa.org/cpajournal/2005/1105/special_issue/essentials/p36.htm, Accessed October 20,2008

Texas and A&M University (2008), Foreign Currency Translation, {www document} URL, http://acct.tamu.edu/smith/fctrans.htm, Accessed October 20,2008

The Gale Group (2008), IASB issues a standard on first-time adoption of international financial reporting standards { www document} URL, http://goliath.ecnext.com/coms2/gi_0198-20222/IASB-issues-a-standard-on.html, Accessed October 20,2008

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