Unit 6: Corporate Restructuring and International Finance Flashcards

Question

FX Transaction and GAAP

Answer 1

* **Two Transaction Perspective on exchange rate fluctuations** * **Under GAAP you must have two transactions (one for the purchase of transaction and one to purchase fx).** * **One transaction requires adjustment and is incomplete until is settled.**

Answer 2

* Accounting for transaction gains and losses * A transaction gain (loss) results from a change in exchange rates between the functional currency and the currency in which the transaction is denominated. It is the change of functional currency cash flows: * 1) Actually realized on settlement * 2) Expected on unsettled transactions * Transactions are recorded at the spot rate in effect at the transaction date. * Transaction gains and losses are recorded at each balance sheet date and at the date the receivable or payable is settled.

Answer 3

* If the accounting record is maintained in other than the functional currency, currency amounts must be remeasured into the functional using the **temporal method.** Then they should be translated into the reporting currency using the **current-rate method.** * **Nonmonetray** balance sheet items and related revenue, expense, gain and loss amounts are remeasured at the historical rate. * **Monetary** items are remeasured at the current rate. **_HELD TO MATURITY BONDS ARE INCLUDED HERE. Receivables, payables, inventories, marketable securities._** * Any net **gain or loss** on remeasurement of monetary assets and liabilities is recognized in current **income from continuing operations. _IMPACTS NET INCOME AND CASHFLOW._**

Answer 4

* **Translation is necessary when the functional currency differs from reporting currency.** * Assets and liabilities are restated using the **current exchange rate.** * Shareholder equity items are restated at **historical rates.** * A gain or loss on foreign currency translation is a component of **other comprehensive income, not earnings. _DOES NOT IMPACT NET INCOME NOR CASHFLOWS. LOOK AT QUESTION 23 from page 229/_**

Answer 5

* A company planning a foreign direct investment can either purchase the stock of a foreign corporation or make a **direct foreign investment (DFI).** A direct foreign investment involves buying equipment and buildings for a new company. * Advantages of DFI: * Lower taxes in the foreign nation * Annual D&A allowances (instead of full OPEX costing) for the amount invested * Access to foreign capital sources * Avoid trade restrictions imposed on foreign companies in the customer’s market. * Cost of capital for foreign projects is higher because of the increased * Exchange rate risk and PPP * Sovereignty (or political) risk from possible expropriation (or other restrictions). * Likelihood of laws requiring financing from certain sources, **such as requirement that foreign subsidiaries must be at least 51% owned by locals.** * Ownership rights in foreign corporations = **ADR**. The foreign stocks are deposited with a large US bank, which in turn issues ADRs representing ownership in the foreign shares. The ADR shares then trade on a US stock exchange, whereas the company’s original shares trade in foreign stock markets. ADRs allow Americas to invest abroad and foreigners to raise capital in the US. **_ADRs allow foreign companies to develop a US shareholder base without being subject to many SEC restrictions._**

Answer 6

* **Benefits to home country** include: * Improved earnings and exports of products to foreign subsidiaries. * Improved ability to obtain scarce resources. * The typical benefits of free trade, i.e. greater product availability, a better international monetary system, and improved international understanding. * **Adverse affects on the home country:** * Loss of jobs and tax revenues. * Instability due to less flexibility on foreign operations and risk of expropriation * Competitive advantage of multinationals over domestic rivals.

Answer 7

* **Benefits to the host country** * New investment in capital, tech and mgmt abilities. * Improvements in output and efficiency along with the resulting stronger balance of payments * Stimulation of competition, increased tax revenues and higher standard of living. * **Adverse affects on the host country:** * Remittance of royalties, dividends, and profits that can result in a net capital outflow. * Setting of transfer prices among subsidiaries so that profits will be earned where taxes are lowest or restrictions on the export of profits are least stringent. * Multinationals engaging in anticompetitive activities such as the formation of cartels.

Answer 8

* **Letters of credit** * Under a letter of credit, an issuer (usually a bank) undertakes with the account party (an import-buyer that obtains the letter of credit) to verify that the beneficiary (seller exporter) has performed under the contract. * Thus the issuer pays the beneficiary when it presents documents (such as bills of lading) that provide the evidence of performance. The issuer then is reimbursed by the account party. Is more like a backup contract where the bank requires from importer guarantees for performance. * **Banker’s Acceptances** * Are time drafts drawn on deposit in a bank. They are short term credit investments created by a nonfinancial firm with payment guaranteed (accepted) by a bank. These are essentially **commercial drafts.** A draft contains and order by the drawer to the drawee to pay a fixed sum of money to the payee. * Acceptances are traded at discounts in secondary markets. These instruments have been a popular investment for money market funds. * **Forfaiting (factoring)** * Forfaiting is a form of factoring that involves the sale by exporters of large, medium to long term receivables to buyers (**forfaiters)** who are willing and able to bear the costs and risk of credit and collections. * **Countertrade** * Countertrade at its simplest is a barter, the exchange of goods or services for other goods or services rather than merely for cash. * **Sight Draft or Bill of Exchange** * An exporter uses a sight draft to obtain payment from an importer. The exporter holds title to the shipped goods until the importer has received the shipment and paid for it. The sight draft and shipping documents are sent to the importer’s bank, which remits payment to the exporter. * **Open Account Sale** * A sale on open-account is risky because the exporter merely ships good to the importer who signs an invoice acknowledging receipt. Thus the exporter is not assured of payment if the importer defaults. Such an arrangement is mostly like if the parties have previously transacted business. * **Prepayment** * Under a prepayment arrangement, the exporter will not ship the goods until the buyer ( importer ) has wired payment to the exporter’s bank account.

Answer 9

* Most countries tax only the income sourced to that country. * US taxes worldwide income (**independently of the source) of a _DOMESTIC COMPANY_. Double taxation is avoided by allowing a credit for income tax paid to foreign countries or by treaty provisions.** * In case of foreign entity, US taxes only income sourced to the US.

Answer 10

* Transfer pricing (important aspect of tax calculation for multi corps that transfer inventories between countries) * The US tax laws have limits on the amount of profit that can be transferred from a US parent to a foreign subsidiary. * Thus transfer prices charged to foreign subsidiaries may differ substantially from those charged to domestic subsidiaries. * The existence of tariffs in a foreign country may necessitate a lower transfer price to reduce a tariff based on the inventory value.