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Question: Inc. In 1993 Icelandic Enterprises was incorporated

Inc. In 1993 Icelandic Enterprises was incorporated in Reykjavik to manufacture and distribute women’s cosmetics in Iceland. All of its outstanding stock was acquired at the beginning of 2001 by International Cosmetics, Ltd. (IC), a U.S.-based MNE headquartered in Shelton, Connecticut. Competition with major cosmetics manufacturers both within and outside Iceland was very keen. As a result, Icelandic Enterprises (now a whollyowned subsidiary of International Cosmetics) was under constant pressure to expand its product offerings. This required frequent investment in new equipment. Competition also affected the company’s pricing flexibility. As the demand for cosmetics was price elastic, Icelandic lost market share every time it raised its prices. Accordingly, when Icelandic increased selling prices, it did so in small increments while increasing its advertising and promotional efforts to minimize the adverse effects of the price increase on sales volume. International Cosmetics’ financial policies with respect to Icelandic were dictated by two major considerations: the continued inflation and devaluation of the Icelandic krona (ISK). To counter these, headquarters management was eager to recoup its dollar investment in Icelandic Enterprises through dollar dividends. If dividends were not possible, subsidiary managers were instructed to preserve IC’s original equity investment in Icelandic krona. Due to the unstable krona, all financial management analyses were made in dollars. International Cosmetics designated the dollar as Icelandic Enterprise’s functional currency. Accordingly, it adopted the temporal method when translating Icelandic’s krona accounts to their dollar equivalents. All monetary assets and liabilities were translated to dollars using the current exchange rate. All nonmonetary items, except those assets that were carried at current values, were translated using historical rates. Income and expense accounts were translated at the average exchange rates prevailing during the year, except depreciation and amortization charges related to assets translated at historical exchange rates. Translation gains and losses were taken directly to consolidated earnings. Adjusting Icelandic’s accounts for inflation was not attempted. Management believed that such restatements were too costly and subjective. IC’s management also claimed that translating Icelandic’s accounts to dollars automatically approximated the impact of inflation. The following is a comparative balance sheet and income statement for Icelandic Enterprises, along with relevant foreign exchange and general price-level indexes. Required: 1. Comment on International Cosmetics’ policies on the basis of “as reported” earnings. 2. Is management correct in stating that by translating their financial reports into dollars they “automatically approximate the impact of inflation”? 3. What revised actions/policies would you recommend based on inflation adjusted figures?
Inc. In 1993 Icelandic Enterprises was incorporated in Reykjavik to manufacture and distribute women’s cosmetics in Iceland. All of its outstanding stock was acquired at the beginning of 2001 by International Cosmetics, Ltd. (IC), a U.S.-based MNE headquartered in Shelton, Connecticut.
Competition with major cosmetics manufacturers both within and outside Iceland was very keen. As a result, Icelandic Enterprises (now a whollyowned subsidiary of International Cosmetics) was under constant pressure to expand its product offerings. This required frequent investment in new equipment. Competition also affected the company’s pricing flexibility. As the demand for cosmetics was price elastic, Icelandic lost market share every time it raised its prices. Accordingly, when Icelandic increased selling prices, it did so in small increments while increasing its advertising and promotional efforts to minimize the adverse effects of the price increase on sales volume. 
International Cosmetics’ financial policies with respect to Icelandic were dictated by two major considerations: the continued inflation and devaluation of the Icelandic krona (ISK). To counter these, headquarters management was eager to recoup its dollar investment in Icelandic Enterprises through dollar dividends. If dividends were not possible, subsidiary managers were instructed to preserve IC’s original equity investment in Icelandic krona. Due to the unstable krona, all financial management analyses were made in dollars. International Cosmetics designated the dollar as Icelandic Enterprise’s functional currency. Accordingly, it adopted the temporal method when translating Icelandic’s krona accounts to their dollar equivalents. All monetary assets and liabilities were translated to dollars using the current exchange rate. All nonmonetary items, except those assets that were carried at current values, were translated using historical rates. Income and expense accounts were translated at the average exchange rates prevailing during the year, except depreciation and amortization charges related to assets translated at historical exchange rates. Translation gains and losses were taken directly to consolidated earnings.
Adjusting Icelandic’s accounts for inflation was not attempted. Management believed that such restatements were too costly and subjective. IC’s management also claimed that translating Icelandic’s accounts to dollars automatically approximated the impact of inflation. The following is a comparative balance sheet and income statement for Icelandic Enterprises, along with relevant foreign exchange and general price-level indexes.

Required:
1. Comment on International Cosmetics’ policies on the basis of “as reported” earnings.
2. Is management correct in stating that by translating their financial reports into dollars they “automatically approximate the impact of inflation”?
3. What revised actions/policies would you recommend based on inflation adjusted figures?

Inc. In 1993 Icelandic Enterprises was incorporated in Reykjavik to manufacture and distribute women’s cosmetics in Iceland. All of its outstanding stock was acquired at the beginning of 2001 by International Cosmetics, Ltd. (IC), a U.S.-based MNE headquartered in Shelton, Connecticut.
Competition with major cosmetics manufacturers both within and outside Iceland was very keen. As a result, Icelandic Enterprises (now a whollyowned subsidiary of International Cosmetics) was under constant pressure to expand its product offerings. This required frequent investment in new equipment. Competition also affected the company’s pricing flexibility. As the demand for cosmetics was price elastic, Icelandic lost market share every time it raised its prices. Accordingly, when Icelandic increased selling prices, it did so in small increments while increasing its advertising and promotional efforts to minimize the adverse effects of the price increase on sales volume. 
International Cosmetics’ financial policies with respect to Icelandic were dictated by two major considerations: the continued inflation and devaluation of the Icelandic krona (ISK). To counter these, headquarters management was eager to recoup its dollar investment in Icelandic Enterprises through dollar dividends. If dividends were not possible, subsidiary managers were instructed to preserve IC’s original equity investment in Icelandic krona. Due to the unstable krona, all financial management analyses were made in dollars. International Cosmetics designated the dollar as Icelandic Enterprise’s functional currency. Accordingly, it adopted the temporal method when translating Icelandic’s krona accounts to their dollar equivalents. All monetary assets and liabilities were translated to dollars using the current exchange rate. All nonmonetary items, except those assets that were carried at current values, were translated using historical rates. Income and expense accounts were translated at the average exchange rates prevailing during the year, except depreciation and amortization charges related to assets translated at historical exchange rates. Translation gains and losses were taken directly to consolidated earnings.
Adjusting Icelandic’s accounts for inflation was not attempted. Management believed that such restatements were too costly and subjective. IC’s management also claimed that translating Icelandic’s accounts to dollars automatically approximated the impact of inflation. The following is a comparative balance sheet and income statement for Icelandic Enterprises, along with relevant foreign exchange and general price-level indexes.

Required:
1. Comment on International Cosmetics’ policies on the basis of “as reported” earnings.
2. Is management correct in stating that by translating their financial reports into dollars they “automatically approximate the impact of inflation”?
3. What revised actions/policies would you recommend based on inflation adjusted figures?

Inc. In 1993 Icelandic Enterprises was incorporated in Reykjavik to manufacture and distribute women’s cosmetics in Iceland. All of its outstanding stock was acquired at the beginning of 2001 by International Cosmetics, Ltd. (IC), a U.S.-based MNE headquartered in Shelton, Connecticut.
Competition with major cosmetics manufacturers both within and outside Iceland was very keen. As a result, Icelandic Enterprises (now a whollyowned subsidiary of International Cosmetics) was under constant pressure to expand its product offerings. This required frequent investment in new equipment. Competition also affected the company’s pricing flexibility. As the demand for cosmetics was price elastic, Icelandic lost market share every time it raised its prices. Accordingly, when Icelandic increased selling prices, it did so in small increments while increasing its advertising and promotional efforts to minimize the adverse effects of the price increase on sales volume. 
International Cosmetics’ financial policies with respect to Icelandic were dictated by two major considerations: the continued inflation and devaluation of the Icelandic krona (ISK). To counter these, headquarters management was eager to recoup its dollar investment in Icelandic Enterprises through dollar dividends. If dividends were not possible, subsidiary managers were instructed to preserve IC’s original equity investment in Icelandic krona. Due to the unstable krona, all financial management analyses were made in dollars. International Cosmetics designated the dollar as Icelandic Enterprise’s functional currency. Accordingly, it adopted the temporal method when translating Icelandic’s krona accounts to their dollar equivalents. All monetary assets and liabilities were translated to dollars using the current exchange rate. All nonmonetary items, except those assets that were carried at current values, were translated using historical rates. Income and expense accounts were translated at the average exchange rates prevailing during the year, except depreciation and amortization charges related to assets translated at historical exchange rates. Translation gains and losses were taken directly to consolidated earnings.
Adjusting Icelandic’s accounts for inflation was not attempted. Management believed that such restatements were too costly and subjective. IC’s management also claimed that translating Icelandic’s accounts to dollars automatically approximated the impact of inflation. The following is a comparative balance sheet and income statement for Icelandic Enterprises, along with relevant foreign exchange and general price-level indexes.

Required:
1. Comment on International Cosmetics’ policies on the basis of “as reported” earnings.
2. Is management correct in stating that by translating their financial reports into dollars they “automatically approximate the impact of inflation”?
3. What revised actions/policies would you recommend based on inflation adjusted figures?





Transcribed Image Text:

Balance Sheet 2001 2002 (000's) Dollars Krona Dollars Krona Cash 7,715 221,176 9,086 368,414 Accounts receivable 18,000 516,078 21,202 859,633 Inventory PP&E, neta Other assets 118,706 283,252 2,949,017 1,221,237 154,988 265,706 4,912,187 3,057,000 22,022 272,013 28,838 1.024.950 Total 449,695 5,179,521 479,820 8,172,284 Current liabilities 94,748 2,716,438 82,673 3,351,980 Due to parent 50,000 1,433,500 50,000 2,027,250 Capital stockb Retained earnings 98,758 713,430 98,758 713,430 206,189 449,695 316,153 5,179,521 248,389 479,820 2,079,624 8,172,284 Total Income Statement 2001 2002 Dollars Krona Dollars Krona Net sales 328,805 8,168,500 462,248 14,650,500 Cost of sales Gross margin Selling expenses General and administrative expenses 150,012 3,726,750 199,874 6,334,800 178,793 4,441,750 262,354 8,315,700 78,493 1,950,000 110,841 3,513,000 28,680 712,500 49,647 1,573,500 Depreciation Operating income Interest expense Income before taxes 44,056 27,564 122,124 1,657,126 47,002 54,864 305,700 2,923,500 363,000 2,560,500 7,064 175,500 1,481,626 11,453 43,411 20,500 1997 1998 1999 2000 2001 2002 National Inflation and Exchange Ratesd Consumer price index: Iceland 63.1 100.0 150.6 224.7 418.2 547.0 United States 88.1 100.0 110.4 117,1 120.9 126.1 Krona per dollar: Year-end 3.949 6.239 8.173 16.625 28.670 40.545 Average 3.526 4.798 7.224 12.352 24.843 31.694 "Plant and equipment were acquired at the beginning of each period as follows: 1998, ISK 1,250,000; 1999, ISK 427,500; 2000, ISK 375,000; 2001, ISK 160,000; 2002, ISK 844,500. Depreciation is calculated at 10 percent per annum. A full year's depreciation is charged in the year of acquisition. Assume there were no disposals during any of the years. Common stock was acquired when the Exchange Rate was ISK 7.224 = $1. "Inclusive of translation gains and losses. "The inflation and exchange rate relationships used here are based on actual data for an earlier period.


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4.99

See Answer