Chapter 10, Problem 14EP

a.

To determine

Create worksheet for the restatement of income and retained earnings and the balance sheet for the year ended December 31, Year 1.

Explanation of Solution

Income:

Net income is the profit for the business. It is obtained by subtracting all the expenses and losses incurred from revenue.

Retained earnings:

Retained earnings are that part of profit which is taken out to meet unexpected expenses and losses. It can also be taken out for reinvestment.

Worksheet for restatement of income and retained earnings to U.S, GAAP for the year ended December 31, year 1:

Items	Local GAAP (in $m)	U.S. GAAP (in $m)
Sales	$7,952$	$7,922$
Less: Cost of goods sold	$\left(4,415\right)$	$\left(4,355\right)$
Gross profit	$3,537$	$3,567$
Less: Operating expenses	$\left(421\right)$	$\left(442\right)$
Operating income	$3,116$
Less: Interest expense	$\left(186\right)$	$\left(171\right)$
Less: other expense	$\left(12\right)$	$\left(26\right)$
Income before income taxes	$2,918$	$2,980$
Provision for income taxes	$\left(875\right)$	$\left(894\right)$
Net income	$2,043$	$2,086$
Retained earnings (Jan 1)	-	-
Dividends	-	-
Retained earnings (Dec 31	$2,043$	$2,086$

Table (1)

Worksheet for restatement of balance sheet to U.S. GAAP for the year ended December 31, Year 1:

Items	Local GAAP (in $m)	U.S. GAAP (in $m)
Assets
Current assets:
Cash	$1,272$	$1,272$
Accounts receivable	$2,064$	$2,064$
Inventories	$4,240$	$4,300$
Total current assets(A)	$7,576$	$7,636$
Fixed and long-term assets:
Property, plant and equipment	$9,524$	$9,312$
Long-term investments	$1,113$	$1,113$
Deferred charges	$345$	$321$
Total fixed and long-term assets (B)	$10,982$	$10,746$
Total assets (A+B)	$18,558$	$18,382$
Liabilities and stockholder’s equity
Current liabilities:
Accounts payable	$507$	$507$
Accrued expenses	$1,262$	$1,262$
Short-term debt	$1,000$	$1,000$
Other current liabilities	$115$	$115$
Total current liabilities (C)	$2,884$	$2,884$
Long term liabilities:
Long-term debt	$5,000$	$5,000$
Deferred income tax	$56$	$75$
Other long term liabilities	$612$	$612$
Total long-term liabilities (D)	$5,668$	$5,687$
Total liabilities (E) (C+D)	$8,552$	$8,571$
Stockholder’s equity:
Capital	$150$	$150$
Capital surplus	$7,575$	$7,575$
Retained earnings	$2,043$	$2,086$
Revaluation reserve	$200$	-
Unrealized gains (losses)	$38$	-
Total stockholder’s equity (F)	$10,006$	$9,811$
Total liabilities and stockholder’s equity (E+F)	$18,558$	$18,382$

Table (2)

b.

To determine

Prepare reconciling entries for each Year 1 reconciliation item included in the reconciliation from Local GAAP to U.S. GAAP in Exhibit 10.11.

Explanation of Solution

Journalizing:

Journalizing is the process of recording the transactions of an organization in the order of happening of events Based on these journal entries recorded, the accounts are posted to the relevant ledger accounts.

Accounting rules for journal entries:

• To increase balance of the account: Debit assets, expenses, losses and credit all liabilities, capital, revenue and gains.
• To decrease balance of the account: Credit assets, expenses, losses and debit all liabilities, capital, revenue and gains.

To record inventory indirect costs:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Inventories		$60$
	Cost of goods sold			$60$
	(to record inventory indirect costs)

Table (3)

• Since inventories is an asset and assets increased. Hence, inventories is debited.
• Since cost of goods sold is a revenue and revenues increased. Hence, COGS is credited.

To record revaluation of property, plant and equipment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Revaluation reserve		$200$
	Property, plant and equipment			$200$
	(to record revaluation )

Table (4)

• Since revaluation reserve is a liability and liabilities decreased. Hence, revaluation reserve is debited.
• Since property, plant and equipment is an asset and assets decreased. Hence, property, plant and equipment is credited.

To record capitalized interest:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Property, plant and equipment		$15$
	Interest expense			$15$
	(to record capitalized interest)

Table (5)

• Since property, plant and equipment is an asset and assets are increased. Hence, property, plant and equipment is debited.
• Since interest expense is a gain and gains are increased. Hence, interest expense is credited.

To record deferred charges:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Operating expense		$24$
	Deferred charges			$24$
	(to record deferred charges)

Table (6)

• Since operating expense is an expense and expenses are increased. Hence, operating expense is debited.
• Since deferred charges are an asset and assets are decreased. Hence, deferred charges is credited.

Recording government grants:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Revenue		$30$
	Property, plant and equipment			$27$
	Operating expense			$3$
	(to record government grants)

Table (7)

• Since revenue is a revenue and revenue is decreased. Hence, revenue is debited.
• Since property, plant and equipment is an asset and assets are decreased. Hence, property, plant and equipment is credited.
• Since operating expense is an expense and expenses are decreased. Hence, operating expense is credited.

To record unrealized loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Unrealized loss		$38$
	Other expenses			$38$
	(to record unrealized loss)

Table (8)

• Since unrealized loss is a loss and losses are increased. Hence, unrealized loss is debited.
• Since other expenses are an expense and expenses are decreased. Hence, other expenses is credited.

To record deferred tax effect of U.S. GAAP adjustments:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
Y1	Provision for income taxes		$19$
	Deferred income taxes			$19$
	(to record adjustment to deferred tax)

Table (9)

• Since provision for income taxes is a liability and liabilities decreased. Hence, provision for income taxes is debited.
• Since deferred income taxes is an asset and assets decreased. Hence, deferred income taxes is credited.

c.

To determine

Post the reconciling entries for Year 1 worksheets created in (a) and determine balances for Year 1 on a U.S. GAAP basis.

Explanation of Solution

Worksheet for restatement of income and retained earnings to U.S, GAAP for the year ended December 31, year 1:

Items	Local GAAP (in $m)	U.S. GAAP (in $m)
Sales	$7,952$	$7,922$
Less: Cost of goods sold	$\left(4,415\right)$	$\left(4,355\right)$
Gross profit	$3,537$	$3,567$
Less: Operating expenses	$\left(421\right)$	$\left(442\right)$
Operating income	$3,116$	$3,125$
Less: Interest expense	$\left(186\right)$	$\left(171\right)$
Less: other expense	$\left(12\right)$	$\left(26\right)$
Income before income taxes	$2,918$	$2,980$
Provision for income taxes	$\left(875\right)$	$\left(894\right)$
Net income	$2,043$	$2,086$
Retained earnings (Jan 1)	-	-
Dividends	-	-
Retained earnings (Dec 31	$2,043$	$2,086$

Table (10)

d.

To determine

Calculate current ratio, total asset turnover ratio, debt/equity ratio, times interest earned, net profit margin, operating income as percent of total stockholders’ equity on a Local GAAP and a U.S. GAAP basis.

Explanation of Solution

On Local GAAP basis:

Calculation of current ratio:

The formula to calculate current ratio is,

$\mathrm{Current}ratio=\left(\frac{\mathrm{Current}assets}{\mathrm{Current}liabilities}\times 100\right)$

Substitute $\$7,576$ for current assets and $\$2,884$ for current liabilities in the above formula.

$\begin{array}{c}\mathrm{Current}ratio=\left(\frac{\$7,576}{\$2,884}\right)\\ =2.63\end{array}$

Thus, current ratio is $2.63$.

Calculation of total asset turnover:

The formula to calculate total asset turnover is,

$\mathrm{Total}assetturnover=\frac{\mathrm{Sales}}{\mathrm{Total}assetsatyear-end}$

Substitute $\$7,952$ for sales and $\$18,558$ for total assets at year-end in the above formula.

$\begin{array}{c}\mathrm{Total}assetturnover=\frac{\$7,952}{\$18,558}\\ =0.43\end{array}$

Thus, total asset turnover is $0.43$.

Calculation of debt/equity ratio:

The formula to calculate debt/equity ratio is,

$\mathrm{Debt}/equityratio=\frac{\mathrm{Total}liabilities}{\mathrm{Total}stockholders\text{'}equity}$

Substitute $\$8,552$ for sales and $\$10,006$ for total assets at year-end in the above formula.

$\begin{array}{c}\mathrm{Debt}/equityratio=\frac{\$8,552}{\$10,006}\\ =0.83\end{array}$

Thus, debt/equity ratio is $0.83$.

Calculation of times interest earned:

$\mathrm{Times}interestearned=\frac{\mathrm{Income}before\mathrm{income}taxes+\mathrm{Interest}expense}{\mathrm{Interest}expense}$

Substitute $\$2,918$ for income before taxes and $\$186$ for interest expense in the above formula.

$\begin{array}{c}\mathrm{Times}interestearned=\frac{\$2,918+\$186}{\$186}\\ =16.69\end{array}$

Thus, times interest earned is $16.69$.

Calculation of net profit margin:

The formula to calculate net profit margin is,

$\mathrm{Net}profitmargin=\frac{Netincome}{Sales}$

Substitute $\$2,043$ for net income and $\$7,952$ for sales in the above formula.

$\begin{array}{c}\mathrm{Net}profitmargin=\frac{\$2,043}{\$7,952}\\ =0.26\end{array}$

Thus, net profit margin is $0.26$.

Calculation of return on equity:

The formula to calculate return on equity is,

$\mathrm{Return}onequity=\frac{Netincome}{Averagetotalstockholders\text{'}equity}$

Substitute $\$2,043$ for net income and $\$10,006$ for average total stockholders’ equity in the above formula.

$\begin{array}{c}\mathrm{Return}onequity=\frac{\$2,043}{\$10,006}\\ =0.20\end{array}$

Thus, return on equity is $0.20$.

Calculation of operating profit margin:

The formula to calculate operating profit margin is,

$\mathrm{Operating}profitmargin=\frac{\mathrm{Operating}income}{\mathrm{Sales}}$

Substitute $\$3,116$ for operating income and $\$7,952$ for sales in the above formula.

$\begin{array}{c}\mathrm{Operating}profitmargin=\frac{\$3,116}{\$7,952}\\ =0.39\end{array}$

Thus, operating profit margin is $0.39$.

Calculation of income as percent of total stockholders’ equity:

The formula to calculate IPTSE is,

$\mathrm{IPTSE}=\frac{\mathrm{Operating}income}{\mathrm{Average}totalstockholders\text{'}equity}$

Substitute $\$3,116$ for operating income and $\$10,006$ for average total stockholders’ equity in the above formula.

$\begin{array}{c}\mathrm{IPTSE}=\frac{\$3,116}{\$10,006}\\ =0.31\end{array}$

Thus, IPTSE is $0.31$.

On U.S. GAAP basis:

Calculation of current ratio:

The formula to calculate current ratio is,

$\mathrm{Current}ratio=\left(\frac{\mathrm{Current}assets}{\mathrm{Current}liabilities}\times 100\right)$

Substitute $\$7,636$ for current assets and $\$2,884$ for current liabilities in the above formula.

$\begin{array}{c}\mathrm{Current}ratio=\left(\frac{\$7,636}{\$2,884}\right)\\ =2.65\end{array}$

Thus, current ratio is $2.65$.

Calculation of total asset turnover:

The formula to calculate total asset turnover is,

$\mathrm{Total}assetturnover=\frac{\mathrm{Sales}}{\mathrm{Total}assetsatyear-end}$

Substitute $\$7,922$ for sales and $\$18,382$ for total assets at year-end in the above formula.

$\begin{array}{c}\mathrm{Total}assetturnover=\frac{\$7,922}{\$18,382}\\ =0.43\end{array}$

Thus, total asset turnover is $0.43$.

Calculation of debt/equity ratio:

The formula to calculate debt/equity ratio is,

$\mathrm{Debt}/equityratio=\frac{\mathrm{Total}liabilities}{\mathrm{Total}stockholders\text{'}equity}$

Substitute $\$8,571$ for sales and $\$9,811$ for total assets at year-end in the above formula.

$\begin{array}{c}\mathrm{Debt}/equityratio=\frac{\$8,571}{\$9,811}\\ =0.87\end{array}$

Thus, debt/equity ratio is $0.87$.

Calculation of times interest earned:

$\mathrm{Times}interestearned=\frac{\mathrm{Income}before\mathrm{income}taxes+\mathrm{Interest}expense}{\mathrm{Interest}expense}$

Substitute $\$2,980$ for income before taxes and $\$171$ for interest expense in the above formula.

$\begin{array}{c}\mathrm{Times}interestearned=\frac{\$2,980+\$171}{\$171}\\ =18.43\end{array}$

Thus, times interest earned is $18.43$.

Calculation of net profit margin:

The formula to calculate net profit margin is,

$\mathrm{Net}profitmargin=\frac{Netincome}{Sales}$

Substitute $\$2,086$ for net income and $\$7,922$ for sales in the above formula.

$\begin{array}{c}\mathrm{Net}profitmargin=\frac{\$2,086}{\$7,922}\\ =0.26\end{array}$

Thus, net profit margin is $0.26$.

Calculation of return on equity:

The formula to calculate return on equity is,

$\mathrm{Return}onequity=\frac{Netincome}{Averagetotalstockholders\text{'}equity}$

Substitute $\$2,086$ for net income and $\$9,811$ for average total stockholders’ equity in the above formula.

$\begin{array}{c}\mathrm{Return}onequity=\frac{\$2,086}{\$9,811}\\ =0.21\end{array}$

Thus, return on equity is $0.21$.

Calculation of operating profit margin:

The formula to calculate operating profit margin is,

$\mathrm{Operating}profitmargin=\frac{\mathrm{Operating}income}{\mathrm{Sales}}$

Substitute $\$3,125$ for operating income and $\$7,922$ for sales in the above formula.

$\begin{array}{c}\mathrm{Operating}profitmargin=\frac{\$3,125}{\$7,922}\\ =0.39\end{array}$

Thus, operating profit margin is $0.39$.

Calculation of income as percent of total stockholders’ equity:

The formula to calculate IPTSE is,

$\mathrm{IPTSE}=\frac{\mathrm{Operating}income}{\mathrm{Average}totalstockholders\text{'}equity}$

Substitute $\$3,125$ for operating income and $\$9,811$ for average total stockholders’ equity in the above formula.

$\begin{array}{c}\mathrm{IPTSE}=\frac{\$3,125}{\$9,811}\\ =0.32\end{array}$

Thus, IPTSE is $0.32$.