Discussion 2: How Do We Report This?
Southwestern Corporation operates
throughout Texas buying and selling widgets. To expand into more profitable
markets, the company recently decided to open a small subsidiary in the nearby
country of Gualos. The currency in Gualos is the vilsek. For some time, the
government of that country held the exchange rate constant: 1 vilsek equaled
$0.20 (or 5 vilseks equaled $1.00). Initially, Southwestern invested cash in
this new operation; its $90,000 was converted into 450,000 vilseks
($90,000 3 5). Southwestern used one-third of this money (150,000 vilseks,
or $30,000) to purchase land to hold for the possible construction of a plant,
invested one-third in short-term marketable securities, and spent one-third in
acquiring inventory for future resale.
Shortly thereafter, the Gualos
government officially revalued the currency so that 1 vilsek was worth $0.23.
Because of the strength of the local economy, the vilsek gained buying power in
relation to the U.S. dollar. The vilsek then was considered more valuable than
in the past. Southwestern’s accountants realized that a change had occurred;
each of the assets was now worth more in U.S. dollars than the original $30,000
investment: 150,000 vilseks 3 $0.23 5 $34,500. Two of the
company’s top officers met to determine the appropriate method for reporting
this change in currency values.
Controller: Nothing has
changed. Our cost is still $30,000 for each item. That’s what we spent.
Accounting uses historical cost wherever possible. Thus, we should do nothing.
Finance director: Yes, but the
old rates are meaningless now. We would be foolish to report figures based on a
rate that no longer exists. The cost is still 150,000 vilseks for each item.
You are right, the cost has not changed. However, the vilsek is now worth
$0.23, so our reported value must change.
Controller: The new rate
affects us only if we take money out of the country. We don’t plan to do that
for many years. The rate will probably change 20 more times before we remove
money from Gualos. We’ve got to stick to our $30,000 historical cost. That’s our
cost and that’s good, basic accounting.
Finance director: You mean
that for the next 20 years we will be translating balances for external
reporting purposes using an exchange rate that has not existed for years?
That doesn’t make sense. I have a real problem using an antiquated rate for the
investments and inventory. They will be sold for cash when the new rate is in
effect. These balances have no remaining relation to the original exchange
Controller: You misunderstand
the impact of an exchange rate fluctuation. Within Gualos, no impact occurs.
One vilsek is still one vilsek. The effect is realized only when an actual
conversion takes place into U.S. dollars at a new rate. At that point, we will
properly measure and report the gain or loss. That is when realization takes
place. Until then our cost has not changed.
Finance director: I simply see
no value at all in producing financial information based entirely on an
exchange rate that does not exist. I don’t care when realization takes place.
Controller: You’ve got to
stick with historical cost, believe me. The exchange rate today isn’t important
unless we actually convert vilseks to dollars.
How should Southwestern report each
of these three assets on its current balance sheet? Does the company have a
gain because the value of the vilsek has increased relative to the U.S. dollar?
Joe Hoyle, Thomas Schaefer, Timothy
Doupnil. Advanced Accounting, 12e, McGraw-Hill Education, New York,