Question #30

Under the current rate method, revenues and expenses are translated at the exchange rate that existed when the underlying transaction occurred. (Though, for practical reasons, an average exchange rate is often used to translate income items.) Under the temporal method, monetary assets and monetary liabilities are translated at the current exchange rate. Under the current rate method, while shareholder's equity (as a whole, including CTA) is translated at the current rate, common stock is translated at historical exchange rate. (Module 10.5, LOS 10.e) Navratov Corp. is a designer and manufacturer of high end sporting goods. The majority of the firm's business comes from Olympic athletes from Russia and the United States. On January 1, 2003, Navratov was purchased by a U.S. competitor, Evert Industries. Because Evert's business focuses on professional athletes in North America and Asia, Evert's management feels the acquisition of Navratov is a natural extension of their business and that buying the Russian firm should generate economies of scale. Peter Capriati is an analyst for Evert and has been assigned the task of integrating Navratov's financial statements into Evert's. Capriati knows that Evert's management pays a great deal of attention to making sure the firm's financial ratios are above the industry average. Because Navratov's sales are split evenly between the U.S. and Russia, management has given him the flexibility to designate the either the Ruble (Navratov's local currency) or the U.S. dollar (Evert's reporting currency) as Navratov's functional currency. As a result of choosing the functional currency, Capriati will use either the temporal or current rate method to convert Navratov's financial statements, depending on which method will have the most favorable impact on Evert's financial ratios. Selected financial data for Navratov Corp is shown below: Navratov Corporation Income Statement (in Russian Rubles) 12 months ended December 31, 2003 Revenue 7,400,000 Cost of Goods Sold (COGS) (5,200,000) Depreciation (1,200,000) Taxes (250,000) Net Income 750,000 Navratov Corporation Balance Sheet (in Russian Rubles) December 31, 2002 Assets Liabilities and Equity Cash 500,000 Accounts Payable 3,450,000 Accounts Receivable 2,500,000 Long Term Debt 5,000,000 Inventory 3,700,000 Common Stock 3,500,000 Net Fixed Assets 6,000,000 Retained Earnings 750,000 Total Assets 12,700,000 Total Liabilities and Equity 12,700,000 Navratov Corporation Balance Sheet (in Russian Rubles) December 31, 2003 Assets Liabilities and Equity Cash 1,000,000 Accounts Payable 2,000,000 Accounts Receivable 2,500,000 Long Term Debt 5,000,000 Inventory 3,700,000 Common Stock 3,500,000 Net Fixed Assets 4,800,000 Retained Earnings 1,500,000 Total Assets 12,000,000 Total Liabilities and Equity 12,000,000 Navratov Corp. did not pay dividends in 2003. The common stock was acquired on January 1, 2002. January 1, 2003 retained earnings in USD is $300,000. Depreciation is being taken on a straight-line basis over ten years for equipment which was acquired on January 1, 2002, at a cost of 12,000,000 rubles. Navratov uses FIFO inventory accounting and goods were sold evenly throughout the year. The average rate applicable to inventory and COGS is $0.37 / ruble. Exchange rates: January 1, 2002, $0.40 / ruble January 1, 2003, $0.40 / ruble June 30, 2003, $0.37 / ruble (avg. rate) December 31, 2003, $0.33 / ruble