How do we Report This?
Southwestern Corporation operates throughout Texas buying and selling widgets. To expand into more profitable markets the company recently decided to open a
small subsidiary in the nearby country of Gualos. The currency in Gualos is the vilsek. For some time the government of that country held the exchange rate
constant: 1 vilsek equaled $0.20 (or 5 vilseks equaled $100). Initially Southwestern invested cash in this new operation; its $90000 was converted into
450000 vilseks ($90000 x 5). Southwestern used one-third of this money (150000 vilseks or $30000) to purchase land to hold for the possible construction
of a plant invested one-third in short-term marketable securities and spent one-third in acquiring inventory for future resale.
Shortly thereafter the Gualos government officially revalued the currency so that 1 vilsek was worth $0.23. Because of the strength of the local economy the
viklsek gained buying power in relation to the U.S. dollar. The vilsek then was considered more valuable than in the past. Southwestern%u2019s accountants
realized that a change had occurred; each of the assets was now worth more in U.S. dollars than the original $30000 investment: 150000 vilseks x $0.23 =
$34000. Two of the company%u2019s top officers met to determine the appropriate method for reporting this change in currency values.
Controller: Nothing has changed. Our cost is still $30000 for each item. That%u2019s what we spent. Accounting uses historical cost wherever possible. Thus
we should do nothing.
Finance director: Yes but the old rates are meaningless now. We would be foolish to report figures based on a rate that no longer exists. The cost is still
150000 vilseks for each item. You are right the cost has not changed. However the vilsek is now worth $0.23 so our reported value must change.
Controller: The new rate affects us only if we take money out of the country. We don%u2019t plan to do that for many years. The rate will probably change 20
more times before we remove money from Gualos. We%u2019ve got to stick to our $30000 historical cost. That%u2019s our cost and that%u2019s good basic
accounting.
Finance director: You mean that for the next 20 years we will be translating balances for external reporting purposes using an exchange rate that has not
existed for years? That doesn%u2019t make sense. I have a real problem using an antiquated rate for the investments and inventory. They will be sold for cash
when the new rate is in effect. These balances have no remaining relation to the original exchange rate.
Controller: You misunderstand the impact of an exchange rate fluctuation. Within Gualos no impact occurs. One vilsek is still one vilsek. The effect is
realized only when an actual conversion takes place into U.S. dollars at a new rate. At that point we will properly measure and report the gain or loss. That
is when realization takes place. Until then our cost has not changed.
Finance director: I simply see no value at all in producing financial information based entirely on an exchange rate that does not exist. I don%u2019t care
when realization takes place.
Controller: You%u2019ve got to stick with historical cost believe me. The exchange rate today isn%u2019t important unless we actually convert vilseks to
dollars.
How should Southwestern report each of these three assets on its current balance sheet? Chose a position and defend it. Perhaps you are a banker or a
stockholder or a member of management. In the role you choose what figure would you consider the fairest representation of each of the three assets? What
figure is the best conveyor of information to an outside party? There is no single best answer to these questions. Do not assume the current pronouncement is
correct. Consider the objectives of financial reporting in formulating your answer.