Question: Foreign Infants Adoption Inc. (FIA) is a
Foreign Infants Adoption Inc. (FIA) is a consulting company wholly owned by Roger Tremblay, a wealthy, recently retired lawyer. FIA helps Canadian families adopt infants from other countries. Typically, these infants have been abandoned or have lost their parents to disease or war, and are being sheltered in government-sponsored orphanages. Further information on the activities of FIA can be found in Exhibit VI. FIA is a full-service coordinator, helping parents with all aspects of the international adoption process (Exhibit VII). The company charges a fee to cover the costs associated with the adoption process and its consulting service. FIA is required to be registered as an international adoption coordinator with the Canadian government, and as such must follow certain criteria set out by Citizenship and Immigration Canada (CIC). Effective July 1, Year 7, CIC now requires all registered coordinators to submit audited financial statements in accordance with IFRS, and to hold fees collected in trust on behalf of the parents. The fees requirement also applies to all adoptions already in process. Throughout the adoption process, FIA can only withdraw funds from the trust to pay for adoption-related expenses. Once an adoption has been finalized, FIA can withdraw the remaining funds. FIA's financial statements have never been audited or reviewed. The company relies on the services of a full-time bookkeeper to complete its internal financial statements. The financial statements for the most recently completed year are presented in Exhibit VIII, and additional information is presented in Exhibit IX. It is August 15, Year 8, and you are a CPA with the firm of Mitton Horne McKnight Chartered Professional Accountants (MHM). The partner on the engagement, Kate Horne, has asked you to address the accounting issues for the FIA engagement. Exhibit VI: 
Exhibit VII: 
Exhibit VIII: 
Exhibit IX: 
Exhibit X: 
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The international adoption process can be daunting. FIA managers assist potential adoptive parents with every step of the process, from the initial application through to the post-adoption report. Managers also travel with parents to the countries where the adoptions take place, usually in groups of 10 families or fewer. Adoptive par- ents must cover their own travel expenses. Upon signing a contract, FIA charges a flat fee of $25,000, regardless of which country the parents adopt from. This fee pays all costs related to the adoption (averaging $20,000), and must also cover FIA's administra- tive and overhead costs. The following are the countries FIA supports through its international adoption assistance programs, and the number of adoptive families currently awaiting child proposals from each country: Country Pending Child Proposals China 68 India 58 Pakistan 47 Ethiopia 40 Sudan 38 Haiti 10 Philippines 269 Due to local hostilities and the deteriorating relationship between the Sudanese and Canadian governments, Sudan recently announced that they will not permit adoptions by Canadian residents after October 1, Year 8. To replace the number of adoptions FIA will lose as a result of the decision made by the Sudanese govern- ment, the company is considering expanding its list to include countries like Vietnam, Cambodia, and Afghani- stan. However, FIA does not have experience with these countries, or any formal criteria for determining whether a country should be added, so the managers are not sure how they should proceed. Several steps must be completed in order to adopt a child from a foreign country. While the steps vary slightly between countries, the adoption process is similar. 1. Adoption application. The adoptive parents complete an application in the format prescribed by the foreign authorities. A social worker performs a home assessment to ensure the applicants would be suitable par- ents for international adoption. The social worker prepares a report and forwards it to the foreign authori- ties. There is a long waiting period (anywhere from 6 to 24 months) before the adoptive parents receive a proposal from the foreign country. (continued) 2. Child proposal/acceptance. The foreign authorities propose a child for adoption. The adoptive parents must indicate within 48 hours whether they accept the proposed child. 3. Adoption finalization. About four weeks after the Child Proposal is accepted, the parents travel to the country to finalize the adoption. This includes paying legal fees, a mandatory orphanage donation, a medical examination fee, and other government fees. Typically this step takes between 10 and 12 days. 4. Post-adoption reports. Foreign countries require a progress report six months after adoption in order to ensure the child's well-being. The one-page report must be prepared by a social worker. Direct Adoption-Related Costs Although the costs can vary significantly between countries, the estimated average adoption-related costs are as follows: Adoption application (includes home assessment report) $ 4,100 Accommodation, airfare, and other travel costs for FIA staff only 3,500 Legal and court costs in foreign country 3,200 Mandatory donation to orphanage 4,000 Medical examination in foreign country 900 Other foreign government fees 4,300 $20,000 FOREIGN INFANTS ADOPTION INc. BALANCE SHEET As at June 30 (unaudited) Year 8 Year 7 Assets Current assets: Cash $2,097,474 $2,002,308 Accounts receivable 125,657 76,904 Prepaid insurance 35,500 26,575 2,258,631 2,105,787 127,768 $2,386,399 123,459 $2,229,246 Capital assets Liabilities Current liabilities: Accounts payable and accrued liabilities $ 391,062 $358,131 Wages payable 43,567 35,678 164,298 558,107 400,000 Other current liabilities 170,968 605,597 400,000 Shareholder's Equity Shareholder loan Common shares 100 100 Retained earnings 1,380,702 1,380,802 $2,386,399 1,271,039 1,271,139 $2,229,246 (continued) FOREIGN INFANTSS ADOPTION INC. INCOME STATEMENT For the years ended June 30 (unaudited) Year 8 Year 7 Revenue: Adoption fees $5,912,500 $5,467,500 20,542 5,933,042 18,674 5,486,174 Interest and other Expenses: Adoption application fee 1,027,915 965,830 Travel costs 765,745 726,706 Legal and court costs 675,420 660,398 Mandatory orphanage donations 827,600 796,500 Medical examinations 189,675 175,678 Miscellaneous foreign government fees 965,405 1,005,345 Administrative wages and benefits 485,672 421,876 Foreign country assistants' wages 250,224 345,698 China subsidiary operations (Exhibit X) 267,985 - Rent 145,985 154,325 Other expenses 182,320 5,783,946 170,986 5,423,342 Income before tax 149,096 62,832 39,433 $ 109,663 Income tax 16,789 Net income $ 46,043 At June 30, Year 7, 242 adoptive families were awaiting a Child Proposal. FIA completed 203 adoptions during the fiscal year. At June 30, Year 8, 269 adoptive families were in the adoption process, and all of them were awaiting a Child Proposal. FIA records revenue when payments are due from adoptive parents. Half of the total payment is due up front (with the adoption application) and the remaining half is due one month prior to travel. Accounts receivable at June 30, Year 8, represent fees not yet received for a trip to China in late July Year 8. All amounts were eventually collected. FIA records an expense when it receives the invoice. In the absence of an invoice, the expense is recorded when paid. Certain countries require cash payments, for miscellaneous costs such as orphanage donations, so FIA maintains bank accounts or similar facilities in all the countries to which it travels so staff can quickly obtain cash in local currencies. Most cash payments are provided on the same day that the adoptive parents take charge of the infant. Payments are usually due in local currencies or US dollars. None of the parents awaiting an adoption from Sudan have asked for a refund yet, and FIA hopes they will try to adopt from another country. These parents will need to go through the adoption process again, potentially all the way back to the initial application. The $25,000 fee has been sufficient to cover FIA's minimal costs and allow the operations to continue. Roger has not focused on the detailed financial information, and really only monitors the financial affairs to ensure there is enough money available to pay the bills. He does not know the detailed costs for each country. During fiscal Year 8, FIA incorporated a wholly owned subsidiary in Beijing, China, to deal with administration issues in China. The company maintains an office in Beijing that employs one full-time person. It holds a bank account, and receives funds from FIA for expenditures made in China. A summary of the expenditures made in fiscal Year 8 is as follows (amounts are in Chinese yuan): ¥ 763,125 Accommodation, airfare, and other travel costs for FIA staff only Legal and court costs 331,210 Required donations to orphanages 436,534 101,567 142,908 Medical examinations Miscellaneous government fees Wages and benefits 135,596 Rent 35,768 156,784 ¥2,103,492 Furniture, fixtures, and computers Total expenditures in Chinese yuan Exchange rate at June 30, Year 8 Total expenditures in Canadian dollars 0.1274 $ 267,985
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> What difference does it make whether the foreign operation's functional currency is the same or different than the parent's presentation currency? What method of translation should be used for each?
> What should happen if a foreign subsidiary's financial statements have been prepared using accounting principles different from those used in Canada?
> Define a foreign operation as per IAS 21.
> How are gains and losses on financial instruments used to hedge the net investment in a foreign operation reported in the consolidated financial statements when the PCT method is used to translate the foreign operation?
