Palmerstown Company established a subsidiary in a

foreign country on #3444

Palmerstown Company established a subsidiary in a foreign country on January 1, Year 1, by
investing 8,000,000 pounds when the exchange rate was $1.00/pound. Palmerstown negotiated
a bank loan of 4,000,000 pounds on January 5, Year 1, and purchased plant and equipment in
the amount of 10,000,000 pounds on January 8, Year 1. Plant and equipment is depreciated on
a straight-line basis over a 10-year useful life. The first purchase of inventory in the amount of
1,000,000 pounds was made on January 10, Year 1. Additional inventory of 12,000,000 pounds
was acquired at three points in time during the year at an average exchange rate of
$0.86/pound. Inventory on hand at year-end was acquired when the exchange rate was
$0.83/pound. The first-in, first-out (FIFO) method is used to determine cost of goods sold.
Additional exchange rates for the pound during Year 1 are as follows: January 1-31, Year 1
…………….. $1.00Average Year 1 ………………….. 0.90December 31, Year 1 …………….. 0.80The for
subsidiary's income statement for Year 1 and balance sheet at December 31, Year 1, are as
follows:Income Statement For the Year Ended December 31, Year 1Pounds (in
thousands)Sales 15,000Cost of goods sold 9,000Gross profit 6,000Selling and administrative
expenses 3,000Depreciation expense 1,000Income before tax 2,000Income taxes 600Net
income 1,400Retained earnings, 1/1/Y1 0Retained earnings, 12/31/Y1 1,400Balance Sheet At
December 31, Year 1Pounds (in thousands)Cash 2,400Inventory 4,000Fixed assets
10,000Less: Accumulated depreciation (1,000)Total assets 15,400Current liabilities 2,000Long-
term debt 4,000Contributed capital 8,000Retained earnings 1,400 Total liabilities and
stockholders' equity 15,400As the controller for Palmerstown Company, you have evaluated the
characteristics of the foreign subsidiary to determine that the pound is the subsidiary's functional
currency.Required1. Use an electronic spreadsheet to translate the foreign subsidiary's financial
statements into U.S. dollars at December 31, Year 1, in accordance with U.S. GAAP. Insert a
row in the spreadsheet after retained earnings and before total liabilities and stockholders'
equity for the cumulative translation adjustment. Calculate the translation adjustment separately
to verify the amount obtained as a balancing figure in the translation worksheet.2. Use an
electronic spreadsheet to remeasure the foreign subsidiary's financial statements into U.S.
dollars at December 31, Year 1, assuming that the U.S. dollar is the subsidiary's functional
currency, insert a row in the spreadsheet after depreciation expense and before income before
taxes for the remeasurement gain (loss).3. Prepare a report for the chief executive officer of
Palmerstown Company summarizing the differences that will be reported in the Year 1
consolidated financial statements because the pound, rather than the U.S. dollar, is the foreign
subsidiary's functional currency. In your report, discuss the relationship between the current
ratio, the debt-to-equity ratio, and the profit margin calculated from the foreign currency financial
statements and from the translated U.S.-dollar financial statements. Also, include a discussion
of the meaning of the translated U.S.-dollar amounts for inventory and for fixed assets.View
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Palmerstown Company established a subsidiary in a foreign country on

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