402 Planning and Forecasting
the effects of changes in the value of the dollar, that is, the price of the dollar.
As (1) involves no unique adjustments related to foreign subsidiary status, only
(2) will be considered further.
Consider the income statements in Exhibit 12.28 in foreign currency (FC)
and the U.S. dollar. Assume that in the following year, domestic results are as
given in Exhibit 12.28 and that the foreign currency has depreciated to an av-
erage rate of $0.50 for the year (recall that income statement amounts are
translated at the average rate under the all-current method). The new transla-
tion would now be as outlined in Exhibit 12.29.
Net income in year two, in the foreign currency, increased by 65% over
Year 1 (from FC180 to FC 297). However, the income improvement on a trans-
lated dollar basis was less than half this amount, only 32% ($112 to $148). The
impact of the change in exchange rates needs to be removed if the translated
income statement is to be used to evaluate performance of the subsidiary’s
management—on the assumption that management has no control over ex-
change rates. Net income can be adjusted as follows:
Year 2 net income in the foreign currency FC297
Translate at year 1 exchange rate ×0.62
Year 2 net income at constant exchange rate $184EXHIBIT 12.28 Year 1 income statement (in foreign
currency and dollars).
FC Exchange Rates U.S.
Sales 1,000 $0.62 $620
Less cost of sales 600 0.62 372
Gross margin 400 248
Less SG&A 100 0.62 62
Pretax profit 300 186
Less tax provision 120 0.62 74
Net income 180 $112EXHIBIT 12.29 Year 2 income statement (in foreign
currency and dollars).
FC Exchange Rates U.S.
Sales 1,200 $0.50 $600
Less cost of sales 660 0.50 330
Gross margin 540 270
Less SG&A 115 0.50 58
Pretax profit 425 212
Less tax provision 128 0.50 64
Net income 297 $148