Question

On December 18, 2020, Stephanie Corporation acquired 100 percent of a Swiss company for 4.021 million Swiss francs (CHF), which is indicative of book and fair value. At the acquisition date, the exchange rate was $1.00 = CHF 1. On December 18, 2020, the book and fair values of the subsidiary’s assets and liabilities were as follows:

Cash CHF 821,000
Inventory 1,321,000
Property, plant, and equipment 4,021,000
Notes payable (2,142,000 )

Stephanie prepares consolidated financial statements on December 31, 2020. By that date, the Swiss franc has appreciated to $1.10 = CHF 1. Because of the year-end holidays, no transactions took place prior to consolidation.

Determine the translation adjustment to be reported on Stephanie’s December 31, 2020, consolidated balance sheet, assuming that the Swiss franc is the Swiss subsidiary’s functional currency. What is the economic relevance of this translation adjustment?

Answer 1

To determine the translation adjustment on Stephanie's December 31, 2020 consolidated balance sheet, the book and fair values of the subsidiary's assets and liabilities are converted to US dollars at the exchange rate on that date. The net difference between the translated values and the book and fair values at the acquisition date is reported as a translation adjustment on the balance sheet. This adjustment helps stakeholders understand the impact of currency fluctuations on the consolidated entity's financial position.

Step-by-step explanation:

To determine the translation adjustment to be reported on Stephanie’s December 31, 2020, consolidated balance sheet, we need to compare the subsidiary’s book and fair values at the acquisition date with the exchange rate on December 31, 2020.

At the acquisition date, the exchange rate was $1.00 = CHF 1. On December 31, 2020, the exchange rate was $1.10 = CHF 1. This means that the Swiss franc has appreciated relative to the US dollar.

To calculate the translation adjustment, we first need to convert the subsidiary’s assets and liabilities from Swiss francs to US dollars at the current exchange rate. Then we compare the translated values to the book and fair values at the acquisition date.

For example, the property, plant, and equipment had a book and fair value of CHF 4,021,000 at the acquisition date. Converting this amount to US dollars at the current exchange rate of $1.10 = CHF 1, we get $3,655,454.55. This is lower than the original book and fair value in Swiss francs.

We repeat this calculation for each asset and liability and sum up the differences. The translation adjustment is the net difference between the translated values and the book and fair values at the acquisition date. This adjustment is reported on Stephanie’s December 31, 2020, consolidated balance sheet as an other comprehensive income (OCI) item under shareholder’s equity.

The economic relevance of this translation adjustment is that it reflects the impact of changes in exchange rates on the value of the subsidiary’s assets and liabilities when they are expressed in the reporting currency (US dollars in this case). It allows investors and stakeholders to understand the effect of currency fluctuations on the financial position and performance of the consolidated entity.