1: Governmental Reporting
You have recently graduated from an accounting program and been hired for a position in the administrative office of the City of East Chester. The city has just elected a new mayor who was a local football hero and is fond of saying he is “not good with numbers.” However, he is interested in learning about the city’s financial situation because he made a lot of expensive campaign promises and needs to figure out whether he can keep them.
He has been given four statements – the government-wide statement of net assets, the government-wide statement of activities, the balance sheet for the General Fund, and the statement of revenues, expenditures and changes in the fund balances of the General Fund. He needs help with the following:
1. He has noticed that sometimes the expenses on one statement equal the expenditures on another. What is the difference between expenses and expenditures and why do they (only) sometimes equal each other?
2. He has also noticed that assets minus liabilities equals net assets on one statement but assets minus liabilities equals the fund balance on the other. How can this be? Shouldn’t they be the same? What is the difference between the two? Please explain.
3. The total fund balance seems to have increased in the past year, but total net assets decreased. How could this happen?
4. He decides he doesn’t want to look at all four statements and wants to know which one he should look at to figure out how much he can spend on his campaign promises. What is your response?
Note: The mayor has never taken an accounting class and does not understand journal entries, so please do not include any in your memo.
Question 2: Hedge Accounting
You have been recently hired as a staff accountant at Global Design, Inc., a small chain of retail home furnishing stores. You report directly to the Chief Financial Officer (CFO). The company specializes in home products with high-quality “European” design, but reasonable prices. Most of their products are manufactured in foreign countries but purchased from domestic wholesalers; these transactions are therefore denominated in U.S. dollars. However, the company’s president is interested in purchasing more products directly from foreign suppliers because he believes he could reduce product costs by doing so. The president is concerned, though, about the effects of foreign currency exchange rate risk on his company’s financial reports if he decides to purchase directly from foreign producers. He is particularly concerned about its effect on earnings volatility because the company is hoping to expand soon by raising capital through a private debt issue.
Over the weekend, the president went golfing with a college buddy who mentioned something about using forward contracts or foreign exchange options as “cash flow hedges” and how this would solve all his problems. The president has now asked the CFO to prepare a memo outlining the financial reporting effects of 1) purchasing inventory denominated in a foreign currency; 2) hedging the foreign exchange risk by using forward contracts versus FX call options; and 3) designating the hedge as a “cash flow” hedge versus a “fair value” hedge. The president has also asked the CFO to make a clear recommendation on whether he thinks they should use forward contracts or options to hedge their exposure and whether a “cash flow” or a “fair value” hedge designation would be best for Global Design. The CFO is too busy to write the memo, so he has asked you to do it.
Note: The company president has never taken an accounting class and does not understand journal entries, so please do not include any in your memo.
Question 3. Foreign Currency Translation and Remeasurement
You have been recently hired as a staff accountant at Global Design, Inc., a small chain of retail home furnishing stores. You report directly to the Chief Financial Officer (CFO). The company specializes in home products with high-quality “European” design, but reasonable prices. Most of their products are manufactured in foreign countries but purchased from domestic wholesalers; these transactions are therefore denominated in U.S. dollars. However, the company’s president is entertaining the idea of acquiring subsidiaries in several foreign countries to ensure a reliable supply chain. He also believes that the exchange rates of some foreign currencies will rise about 10% in the next year and he is keen on reporting a gain in Global Design’s income statement when it does.
The president has asked you to prepare a memo outlining the effects of his plan, including 1) the financial reporting effects of acquiring a foreign subsidiary; 2) how changes in the foreign currency exchange rate will affect Global Design’s financial statements; and 3) under what circumstances Global Design could record a gain from a foreign subsidiary. The president has also asked you to make a clear recommendation on whether he should proceed with his plan.
