International Accounting 7th Edition Choi, F & Meek, G.2011.
The book is available for references at:http://phallywtech.weebly.com/uploads/1/2/8/0/12806463/ebooksclub.org__international_accounting__seventh_edition.pdf
Case 11-2
Value at Risk:What Are Our Options?
The scene is a conference room on the 10th floor of an office building on Wall Street, occupied by Anthes Enterprises, a small, rapidly growing manufacturer of electronic trading systems for equities, commodities, and currencies.
The agenda for the 8:00 A.M. meeting concerns reporting issues associated with a potential sales contract for the stock exchange in the Slovak Republic, which wants to upgrade its technology to
effectively participate in the globalization of financial markets. In attendance are Anthes Enterprises COO Shevon Estwick, Controller Sy Jones, Treasurer, Bebi Karimbaksh, and Vice President of Marketing Autherine Allison.
SHEVON: Thank you for agreeing to meet on such short notice. Autherine, are you ready to
give us an update on Slovakia?
AUTHERINE: You mean the Slovak Republic.
SHEVON: Yes.
AUTHERINE: I think there is a 90 percent chance well land the contract. Things move a little
slowly over there and theyre still concerned about some of the legal details of our sales contract. I think they find the legalese a bit intimidating and I cant say I blame them. Ive scheduled another trip next month to go over contract details. This time Im taking our legal counsel and have asked him to prepare another draft expressed in terms that are easier to understand. Theyre
also waiting for approvals from their Central Bank, which has to approve major transactions such as this one.
SHEVON: Good. Are we prepared to deliver on the contract?
AUTHERINE: Yes, weve lined up the financing, have done our credit checks, and the equipment and installation teams are ready to proceed on two weeks notice
SHEVON: Given the size of the contract, are we hedged against the possibility of a devaluation?
BEBI: Yes, weve written a put option on the koruna for 90 days.
SHEVON: Do we think well close on the deal before then?
BEBI: Autherine doesnt think so, but you never know. The problem is no one will write an option for a longer term. Well renew the option as we have other transactions of this extended duration.
SHEVON: Sy, are we all right on the reporting front?
SY: Not really.
SHEVON: Hows that?
SY: It looks like were up against a reporting standard that requires that gains or losses on cash flow hedges whose maturities do not match that of the underlying be recognized in current earnings.
SHEVON: Come again?
SY: The bottom line is that we wont be able to treat gains or losses on our put options as a part of comprehensive income, but well have to recognize them in current earnings.
SHEVON: Wont that mess up our bottom line?
SY: Im afraid so. There would be no offsetting gain or loss from our anticipated sale.
BEBI: Its taken me a whole year to get to know the right people and win their trust and friendship. I now have that. Theres no doubt in my mind that this sale is a done deal and I anticipate closing the transaction within the next six to nine months.
SY: That may be, but we just cant find anyone whos willing to write an option for more than
90 days at a time.
SHEVON: I dont want to think about what the accounting will do to our stock price! I mean, were about to float our first Euro-equity issue. A lower offering price would be disastrous at this stage of our development, not to mention the effect on our shareholders.
AUTHERINE:Given the nature of our business, I dont think the transactions side of our business will change much.
SHEVON: Do you think it would be worthwhile having a consultant advise us on this one?
SY, AUTHERINE, AND BEBI (IN UNISON)Why not?
SHEVON: When you do, would you show that individual the following pages that I ripped out from an annual report I just received as a shareholder and see if it has any information value? (see attachment)
Required
As a consultant for Anthes Enterprises, identify what you believe are promising hedge accounting options.
**Each question should be a few paragraphs long and enough detail to prove opinion.There also needs to be a complete bibliography along with the answers.
Attachment: Torn Pages from the Annual Report of a Major U.S. Manufacturer
First page: Note 10:
We are exposed to the risk of loss arising from adverse changes in:
commodity prices, affecting the cost of our raw materials and energy,
foreign exchange risks,
interest rates,
stock prices, and
discount rates affecting the measurement of our pension and retiree medical liabilities.
In the normal course of business, we manage these risks through a variety of strategies, including the use of derivatives. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market
through earnings. For cash flow hedges, changes in fair value are deferred in accumulated other comprehensive loss within shareholders equity until the underlying hedged item is recognized in net income. For fair value hedges, changes in fair value are recognized immediately in earnings, consistent with the underlying hedged item. Hedging transactions are limited to an underlying exposure. As a result, any change in the value of our derivative financial instruments would be substantially offset by an opposite change in the value of the underlying hedged items. Hedging
ineffectiveness and a net earnings impact occur when the change in the value of the hedge does not offset the change in the value of the underlying hedged item. If the derivative instrument is
terminated, we continue to defer the related gain or loss and include it as a component of the cost of the underlying hedged item. Upon determintation that the hedged item will not be part of an
actual transaction, we recognize the related gain or loss in net income in that period. We also use derivatives that do not qualify for hedge accounting treatment. We account for such derivatives
at market value with the resulting gains and losses reflected in our income statement. We do not use derivative instruments for trading or speculative purposes and we limit our exposure to individual counterparties to manage credit risk.
Commodity PricesWe are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price purchase orders, pricing agreements, geographic diversity and derivatives. We use derivatives, with terms of no more than two years, to economically hedge price fluctuations related to a portion of our anticipated
commodity purchases, primarily for natural gas and diesel fuel. For those derivatives that are designated as cash flow hedges, any ineffectiveness is recorded immediately. However our
commodity cash flow hedges have not had any significant ineffectiveness for all periods presented. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. During the next 12 months, we expect to reclassify gains of $24 million related to cash flow hedges from accumulated other comprehensive loss into net income.
Foreign ExchangeOur operations outside of the U.S. generate over a third of our net revenue of which Mexico, the United Kingdom and Canada comprise nearly 20%. As a result, we are exposed to foreign currency risks from unforeseen economic changes and political unrest. On occasion, we enter into hedges, primarily forward contracts with terms of no more than two years, to reduce the effect of foreign exchange rates. Ineffectiveness on these hedges has not been material. (rest of page torn off)
Partial second page:
Our DivisionsWe manufacture or use contract manufacturers, market and sell a variety of salty, sweet and grain-based snacks, carbonated and non-carbonated beverages, and foods through our North American and international business divisions. Our North American divisions include the United States and Canada. The accounting policies for the divisions are the same as those described in Note 2, except for certain allocation methodologies for stockbased compensation expense and pension and retiree medical expense, as described in the unaudited information in Our Critical Accounting Policies. Additionally, beginning in the fourth quarter of 2005, we began centrally managing commodity derivatives on behalf of our divisions. Certain of the commodity derivatives, primarily those related to the purchase of energy for use by our divisions, do not qualify for hedge accounting treatment. These derivative hedge underlying commodity price risk and were not entered into for speculative purposes. Such derivatives are marked to market with the resulting gains and losses recognized as a component of corporate unallocated expense. These gains and losses are reflected in division results when the divisions take delivery of the underlying commodity. Therefore, division results reflect the contract purchase price of the energy or other commodities. Division results are based on how our Chairman and Chief Executive Officer evaluates our divisions. Division results exclude certain Corporate-initiated restructuring and impairment charges, merger related costs and divested businesses. For addition unaudited information on our divisions, see Our Operations in
Managements Discussion and Analysis.
CASE 12-1
The Shirts Off Their Backs
Do accountants share the blame for Third World poverty? A report by the U.K.-based Christian Aid says so.31 It attacks accounting firms for helping to perpetuate poverty in the developing
world through their aggressive marketing of tax-avoidance schemes: The tax avoidancefirms] has a very negative impact on developing countries and their ability to raise taxationwhich is . . . critical for their escape from poverty.32 According to the report, the debate over how poor countries fund their escape from poverty has up to this point
focused mainly on calls for debt cancellation and increases in aid.33 While these factors are important, they are only pieces in a larger and more complicated puzzle. Solving this puzzle involves looking not only at the money that flows into poor countries, but also at money
they cant get their hands on and the money that leaks away. Taxation is facing a crisis in poorer countries. In the rich world, government revenue from taxation between 1990 and 2000 averaged 30 percent of gross domestic product (GDP). In sub-Saharan Africa, the average over the same period was 17.9 percent, in Latin America it was 15.1 percent, and in south Asia it was 10.5 percent. The low tax yield in poorer regions of the world limits the amount of
domestically generated resources that are available to governments for essential public services, such as healthcare and education. To quote the report: It is not by accident that poor countries have been unable to increase the amount of revenue they raise through taxation. There are three specific tax strategies that have hindered them:
1. Tax competitionbetween countries means poorer nations have been forced to lower corporate tax rates, often dramatically, in order to attract foreign investment.
2. Trade liberalizationhas deprived poorer countries of taxes on imports. In some cases, these had yielded up to one-third of their tax revenue.
3. Tolerance of tax havenshas helped wealthy individuals and multinational companies (as well corrupt leaders and terrorists) move their wealth and profits offshore to avoid paying taxes.34 Tax havens affect developing countries in a number of ways:
Secret bank accounts and offshore trusts encourage wealthy individuals and companies to escape paying taxes by providing a place for untaxed earnings and profits to be banked.
Many multinational corporations launder profits earned in developing countries by importing goods at hugely inflated prices and exporting commodities at a fraction of their true value.35 They do this through paper subsidiaries in tax havens, providing them with a significant tax advantage over their nationally based competitors and fleecing governments of tax revenue.
Banking secrecy and trust services provided by globalized financial institutions operating offshore provide a secure cover for laundering the proceeds of political corruption, fraud, embezzlement, illicit arms trading, and the global drugs trade.36 Who is to blame for this crisis? The study points the finger at international institutions like the International Monetary Fund and the World Bank, multinational corporations, banks, and accountants. Accountancy firms . . . are champions of tax planning whereby, along with their clients they organize networks of offshore subsidiaries to avoid paying tax. The collapse of Enron provided a rare insight into precisely how this works. The U.S. Senate report into the Enron case shows how accountants Andersen facilitated Enrons massive tax avoidance. The company paid no tax at all between 1995 and 1999.37 Tax planning by accountants made this possible and involved setting up a global network of 3,500 companies, more than 440 of which were in the Cayman Islands. The subsequent Sarbanes-Oxley legislation in the United States is intended to act as a deterrent, by making directors and shareholders more responsible for the consequences of such strategies. But it does little to lift the veil of secrecy surrounding tax havens.38
Required
1.Why should wealthy nations be concerned about seeing that poor ones collect their fair share of taxes?
2.Do you agree that accountants and accounting firms share the blame for perpetuating poverty in the developing world? Why or why not?
3.Is tax planning wrong?
4.Assume that you agree that new policies are needed to improve the ability of Third World countries to increase their tax yields. List policy recommendations that will achieve this result, and explain why you think these policies are needed.
**Each question should be a few paragraphs long and enough detail to prove opinion.There also needs to be a complete bibliography along with the answers.
