Stanley Bostwick, CFA, is a business services industry analyst with Mortonworld Financial. Currently, his attention is focused on the 2008 financial statements of Global Oilfield Supply, particularly the footnote disclosures related to the company's employee benefit plans. Bostwick would like to adjust the financial statements to reflect the actual economic status of the pension plans and analyze the effect on the reported results of changes in assumptions the company used to estimate the projected benefit obligation (PBO) and net pension cost. But first, Bostwick must familiarize himself with the differences in the accounting for defined contribution and defined benefit pension plans.Global Oilfield's financial statements are prepared in accordance with International Financial Reporting Standards (IFRS). Excerpts from the company's annual report are shown in the following exhibits.Assume for this question only that economic pension expense for the year ended 2008 was €4,250. Ignoring income taxes, which of the following statements best describes the adjustment necessary for analyzing Global Oilfield's cash flow statement?
Answer(s): A
Economic pension expense represents the true cost of the pension. If the firm's contributions exceed its economic pension expense, the difference can be viewed as a reduction in the overall pension obligation similar to an excess principal payment on a loan. Pension contributions arc reported as operating activities in the cash flow statement while principal payments are reported as financing activities. Thus, the adjustment involves increasing operating cash flow by €750 (€5.000 employer contributions - €4,250 economic pension expense) and decreasing financing cash flow by the same amount. (Study Session 6, LOS 22.e)
Jason Bennett is an analyst for Valley Airlines (Valley), a U.S. firm. Valley owns a stake in Southwest Air Cargo (Southwest), also a U.S. firm. The two firms have had a long-standing relationship. The relationship has become even closer because several of Valley's top executives hold seats on Southwest's Board of Directors.Valley acquired a 45% ownership stake in Southwest on December 31, 2007. Acquisition of the ownership stake cost $9 million and was paid in cash. Valley's stake in Southwest is such that management can account for the investment using either the equity method or the acquisition method. While Valley's management desires to fairly represent the firm's operating results, they have assigned Bennett to assess the impact of each method on reported financial statements.Immediately prior to the acquisition. Valley's current asset balance and total equity were $96 million and $80 million, respectively. Southwest's current assets and total equity were $32 million and $16 million, respectively.While analyzing the use of the equity method versus the acquisition method, Bennett calculates the return on assets (ROA) ratio. He arrives at two conclusions:Statement 1: Compared to the acquisition method, the equity method results in a higher ROA because of the higher net income under the equity method.Statement 2: Compared to the acquisition method, the equity method results in a higher ROA because of the smaller level of total assets under the equity method.In order to get a better picture of Valley's operating condition, Bennett is also considering the use of proportionate consolidation to account for Southwest. He makes the following statements regarding the acquisition method and a proportionate consolidation:Statement 3: Both methods are widely accepted under the provisions of U.S. GAAP and International Financial Reporting Standards (IFRS).Statement 4: Both methods report the same level of assets on the parent's balance sheet. Statement 5: Both methods report all of Southwest's liabilities on the parent's balance sheet.In addition. Valley has always wanted to pursue its goal of vertical integration by expanding its scope of operations to include the manufacturing of airline parts for its own airplanes. Therefore, it established a subsidiary, Mountain Air Parts (Mountain), in Switzerland on January 1,2008.Switzerland was chosen as the location for economic and geographical diversification reasons. Mountain will operate as a self-contained, independent subsidiary. Local management in Switzerland will make the majority of operating, financing, and investing decisions.The Swiss franc (CHF) is the official currency in Switzerland. On January 1, 2008, the USD/CHF exchange rate was 0.77. At December 31, 2008, the exchange rate had changed to 0.85 USD/CHF. The average exchange rate in 2008 was 0.80 USD/CHF. In its first year of operations. Mountain paid no dividends and no taxes. Mountain uses the FIFO assumption for its flow of inventory.The balance of Valley's current assets as of December 31, 2007, using the acquisition method, is closest to:
Answer(s): B
Consolidated current assets are equal to $119 million ($96 Valley current assets - $9 cash for investment in Southwest + $32 Southwest current assets). (Study Session 5. LOS 21.a)
Jason Bennett is an analyst for Valley Airlines (Valley), a U.S. firm. Valley owns a stake in Southwest Air Cargo (Southwest), also a U.S. firm. The two firms have had a long-standing relationship. The relationship has become even closer because several of Valley's top executives hold seats on Southwest's Board of Directors.Valley acquired a 45% ownership stake in Southwest on December 31, 2007. Acquisition of the ownership stake cost $9 million and was paid in cash. Valley's stake in Southwest is such that management can account for the investment using either the equity method or the acquisition method. While Valley's management desires to fairly represent the firm's operating results, they have assigned Bennett to assess the impact of each method on reported financial statements.Immediately prior to the acquisition. Valley's current asset balance and total equity were $96 million and $80 million, respectively. Southwest's current assets and total equity were $32 million and $16 million, respectively.While analyzing the use of the equity method versus the acquisition method, Bennett calculates the return on assets (ROA) ratio. He arrives at two conclusions:Statement 1: Compared to the acquisition method, the equity method results in a higher ROA because of the higher net income under the equity method.Statement 2: Compared to the acquisition method, the equity method results in a higher ROA because of the smaller level of total assets under the equity method.In order to get a better picture of Valley's operating condition, Bennett is also considering the use of proportionate consolidation to account for Southwest. He makes the following statements regarding the acquisition method and a proportionate consolidation:Statement 3: Both methods are widely accepted under the provisions of U.S. GAAP and International Financial Reporting Standards (IFRS).Statement 4: Both methods report the same level of assets on the parent's balance sheet. Statement 5: Both methods report all of Southwest's liabilities on the parent's balance sheet.In addition. Valley has always wanted to pursue its goal of vertical integration by expanding its scope of operations to include the manufacturing of airline parts for its own airplanes. Therefore, it established a subsidiary, Mountain Air Parts (Mountain), in Switzerland on January 1,2008.Switzerland was chosen as the location for economic and geographical diversification reasons. Mountain will operate as a self-contained, independent subsidiary. Local management in Switzerland will make the majority of operating, financing, and investing decisions.The Swiss franc (CHF) is the official currency in Switzerland. On January 1, 2008, the USD/CHF exchange rate was 0.77. At December 31, 2008, the exchange rate had changed to 0.85 USD/CHF. The average exchange rate in 2008 was 0.80 USD/CHF. In its first year of operations. Mountain paid no dividends and no taxes. Mountain uses the FIFO assumption for its flow of inventory.Are Bennett's Statements 1 and 2 regarding ROA correct?Statement 1 Statement 2
Answer(s): C
ROA is calculated as net income / total assets. Both methods result in the same net income, so Statement 1 is incorrect. However, the acquisition method leads to higher reported total assets. Hence, the ROA is greater under the equity method and lower under the acquisition method (Statement 2 is correct). (Study Session 5, LOS 21.b)
Jason Bennett is an analyst for Valley Airlines (Valley), a U.S. firm. Valley owns a stake in Southwest Air Cargo (Southwest), also a U.S. firm. The two firms have had a long-standing relationship. The relationship has become even closer because several of Valley's top executives hold seats on Southwest's Board of Directors.Valley acquired a 45% ownership stake in Southwest on December 31, 2007. Acquisition of the ownership stake cost $9 million and was paid in cash. Valley's stake in Southwest is such that management can account for the investment using either the equity method or the acquisition method. While Valley's management desires to fairly represent the firm's operating results, they have assigned Bennett to assess the impact of each method on reported financial statements.Immediately prior to the acquisition. Valley's current asset balance and total equity were $96 million and $80 million, respectively. Southwest's current assets and total equity were $32 million and $16 million, respectively.While analyzing the use of the equity method versus the acquisition method, Bennett calculates the return on assets (ROA) ratio. He arrives at two conclusions:Statement 1: Compared to the acquisition method, the equity method results in a higher ROA because of the higher net income under the equity method.Statement 2: Compared to the acquisition method, the equity method results in a higher ROA because of the smaller level of total assets under the equity method.In order to get a better picture of Valley's operating condition, Bennett is also considering the use of proportionate consolidation to account for Southwest. He makes the following statements regarding the acquisition method and a proportionate consolidation:Statement 3: Both methods are widely accepted under the provisions of U.S. GAAP and International Financial Reporting Standards (IFRS).Statement 4: Both methods report the same level of assets on the parent's balance sheet. Statement 5: Both methods report all of Southwest's liabilities on the parent's balance sheet.In addition. Valley has always wanted to pursue its goal of vertical integration by expanding its scope of operations to include the manufacturing of airline parts for its own airplanes. Therefore, it established a subsidiary, Mountain Air Parts (Mountain), in Switzerland on January 1,2008.Switzerland was chosen as the location for economic and geographical diversification reasons. Mountain will operate as a self-contained, independent subsidiary. Local management in Switzerland will make the majority of operating, financing, and investing decisions.The Swiss franc (CHF) is the official currency in Switzerland. On January 1, 2008, the USD/CHF exchange rate was 0.77. At December 31, 2008, the exchange rate had changed to 0.85 USD/CHF. The average exchange rate in 2008 was 0.80 USD/CHF. In its first year of operations. Mountain paid no dividends and no taxes. Mountain uses the FIFO assumption for its flow of inventory.How many of Bennett's statements on proportionate consolidation are correct?
Proportionate consolidation only considers the proportion of the assets and liabilities owned by the parent firm (Statements 4 and 5 are incorrect). Also, proportionate consolidation is generally not allowed under U.S. GAAP (Statement 3 is incorrect). Proportionate consolidation is the preferred method under IFRS. Therefore, none of three statements is correct. (Study Session 5. LOS 21.b)
Jason Bennett is an analyst for Valley Airlines (Valley), a U.S. firm. Valley owns a stake in Southwest Air Cargo (Southwest), also a U.S. firm. The two firms have had a long-standing relationship. The relationship has become even closer because several of Valley's top executives hold seats on Southwest's Board of Directors.Valley acquired a 45% ownership stake in Southwest on December 31, 2007. Acquisition of the ownership stake cost $9 million and was paid in cash. Valley's stake in Southwest is such that management can account for the investment using either the equity method or the acquisition method. While Valley's management desires to fairly represent the firm's operating results, they have assigned Bennett to assess the impact of each method on reported financial statements.Immediately prior to the acquisition. Valley's current asset balance and total equity were $96 million and $80 million, respectively. Southwest's current assets and total equity were $32 million and $16 million, respectively.While analyzing the use of the equity method versus the acquisition method, Bennett calculates the return on assets (ROA) ratio. He arrives at two conclusions:Statement 1: Compared to the acquisition method, the equity method results in a higher ROA because of the higher net income under the equity method.Statement 2: Compared to the acquisition method, the equity method results in a higher ROA because of the smaller level of total assets under the equity method.In order to get a better picture of Valley's operating condition, Bennett is also considering the use of proportionate consolidation to account for Southwest. He makes the following statements regarding the acquisition method and a proportionate consolidation:Statement 3: Both methods are widely accepted under the provisions of U.S. GAAP and International Financial Reporting Standards (IFRS).Statement 4: Both methods report the same level of assets on the parent's balance sheet. Statement 5: Both methods report all of Southwest's liabilities on the parent's balance sheet.In addition. Valley has always wanted to pursue its goal of vertical integration by expanding its scope of operations to include the manufacturing of airline parts for its own airplanes. Therefore, it established a subsidiary, Mountain Air Parts (Mountain), in Switzerland on January 1,2008.Switzerland was chosen as the location for economic and geographical diversification reasons. Mountain will operate as a self-contained, independent subsidiary. Local management in Switzerland will make the majority of operating, financing, and investing decisions.The Swiss franc (CHF) is the official currency in Switzerland. On January 1, 2008, the USD/CHF exchange rate was 0.77. At December 31, 2008, the exchange rate had changed to 0.85 USD/CHF. The average exchange rate in 2008 was 0.80 USD/CHF. In its first year of operations. Mountain paid no dividends and no taxes. Mountain uses the FIFO assumption for its flow of inventory.Using the appropriate method of translation, the amount of total assets reported on Mountain's balance sheet at the end of 2008 is closest to:
See following table for 100 and 101. (Study Session 6, LOS 23.c,d)
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