anthonyIM_10

CHAPTER 10 OTHER ITEMS THAT AFFECT NET INCOME AND OWNER’S EQUITY Changes from Eleventh Edition Updated from Eleventh Edition. Approach This chapter contains several topics that instructors may wish to emphasize in varying degrees. In particular, the rather detailed rules on extraordinary items, discontinued operations, change in accounting principles, and correction of errors may be more than students can readily assimilate; they can always refer back to the rules if this becomes necessary. Similarly, some instructors prefer not to get into foreign currency matters at all in an introductory course; some cover transactions but not translation; and others cover both, perhaps because of the increased emphasis on covering international issues in the overall core curriculum. With respect to personnel costs, the important point is the difference between transactions that are costs to the company and those that result from the company serving as a collection agency for the government. In my own view, any details of pension accounting can be withheld for an intermediate course, but I want students to have an overview of the issues and complications of pension accounting. I spend the most time on deferred taxes, both because virtually every set of financial statements students are likely to see will contain this item and because it always seems to be a difficult topic for students to master. The ease of teaching this subject diminished even further when MACRS allowances replaced the usual tax deprecation illustrations using sum-of-the-years’-digits depreciation. FAS109, in my view, further complicates matters. Cases Norman Corporation (B) raises some new, and reviews some old, issues in expense recognition. Silver Appliance Company enables students to explore deferred tax accounting in the context of the installment method of reporting installment sales revenues. Kansas City Zephyrs Baseball Club, Inc., requires students to apply accrual accounting to cash flows in order to properly match costs and revenues. Freedom Technology Company deals with the translation of financial statements. If desired, both the currently required method and alternative approaches can be compared. Proxim, Inc. raises issues related to proforma earnings disclosures. This case is new with the Twelfth Edition.

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Problems Problem 10-1 Wages Payable Cash FICA Taxes Payable Withholding Taxes Payable And, to finish, payment to government: FICA Taxes Payable Unemployment Taxes Payable Withholding Taxes Payable Cash

1,025.00 776.35 74.65 174.00 149.30 40.05 174.00 363.35

Problem 10-2

dr. Pension Cost............................................................................................................................................................................... 85,000 cr. Cash........................................................................................................................................................................................ 40,100 Pension Liability..................................................................................................................................................................... 44,900 Problem 10-3

Financial Statements (Accrual Basis) 1999 2000 2001 2002 Revenues......................................................................................................................................................................................... $456,000 $696,000 $840,000 $780,000 Expenses......................................................................................................................................................................................... 270,000 672,000 798,000 618,000 Profit before taxes........................................................................................................................................................................... 186,000 24,000 42,000 162,000 Tax provision (30%)........................................................................................................................................................................ 55,800 7,200 12,600 48,600

Tax Return (Cash Basis) 1999 2000 2001 2002 Receipts........................................................................................................................................................................................... $336,000 $636,000 $894,000 $690,000 Disbursements................................................................................................................................................................................. 288,000 528,000 750,000 606,000 Taxable income............................................................................................................................................................................... 48,000 108,000 144,000 84,000 Tax payment (30%)......................................................................................................................................................................... 14,400 32,400 43,200 25,200

1999 2000 2001 2002 Tax provision.................................................................................................................................................................................. $55,800 $ 7,200 $ 12,600 $48,600 Tax payment.................................................................................................................................................................................... 14,400 32,400 43,200 25,200 Difference....................................................................................................................................................................................... 41,400 (25,200) (30,600) 23,400 Cumulative difference..................................................................................................................................................................... $41,400 $16,200 $(14,400) $ 9,000 Cash basis accounting for tax payment purposes was preferable for the 1999 - 02 period. It resulted in lower cumulative tax payments. The difference between the annual tax provision and tax payments would be handled through deferred tax accounting.

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Problem 10-4 Net book value of machinery for financial reporting purposes

Year 1997 1998 1999 2000 2001 2002

Cost $2,750,000 2,750,000 2,750,000 2,750,000 2,750,000 2,750,000

Depreciation Expense $275,000 550,000 550,000 550,000 550,000 275,000

Cumulative Depreciation Allowance $ 275,000 825,000 1,375,000 1,925,000 2,475,000 2,750,000

Net Book Value $2,475,000 1,925,000 1,375,000 825,000 275,000 -0-

Depreciation Deduction $550,000 880,000 528,000 316,250 316,250 159,500

Cumulative Depreciation Deduction $ 550,000 1,430,000 1,958,000 2,274,250 2,590,500 2,750,000

Net Tax Basis $2,200,000 1,320,000 792,000 475,750 159,500 -0-

Net tax basis of machinery for tax purpose.

Year 1997 1998 1999 2000 2001 2002

Tax Basis $2,750,000 2,750,000 2,750,000 2,750,000 2,750,000 2,750,000

Deferred Tax Liability Calculation Year 1997 1998 1999 2000 2001 2002

Net Book Value $2,475,000 1,925,000 1,375,000 825,000 275,000 -0-

Net Tax Basis $2,200,000 1,320,000 792,000 475,750 159,500 -0-

Difference $275,000 605,000 583,000 349,250 115,500 -0-

Deferred Tax Liability $110,000 242,000 233,200 139,700 46,200 -0-

Taxable Income $ 950,000 620,000 972,000 1,183,750 1,183,750 1,340,500

Tax Payment $380,000 248,000 388,800 473,500 473,500 536,200

Income Tax Payments Year 1997 1998 1999 2000 2001 2002

Profit Before Depreciation $1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000

Depreciation $550,000 880,000 528,000 316,250 316,250 159,500

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Income Tax Provisions Year 1997 1998 1999 2000 2001 2002

1997 1998 1999 2000 2001 2002

Profit before Depreciation $1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000

Depreciation $275,000 550,000 550,000 550,000 550,000 275,000

Pretax Income $1,225,000 950,000 950,000 950,000 950,000 1,225,000

Tax Provision Presentation Current Deferred Tax Expense Tax Expense $380,000 $110,000 248,000 132,000 388,800 (8,800) 473,500 (93,500) 473,500 (93,500) 536,200 (46,200)

Tax Provision $490,000 380,000 380,000 380,000 380,000 490,000

Total Tax Provision $490,000 380,000 380,000 380,000 380,000 490,000

In 1999 the deferred tax liability account reverses. A T-account tracking of the 1997 - 2002 tax payments, tax provision and deferred tax liability balances can be constructed from the above schedules. Tax payments reduce cash. The deferred tax portion of the total tax provision is initially a credit to the deferred tax liability account (1997 - 98) and thereafter a debit entry. Problem 10-5 1. APB Opinion No. 30 requires that in order to qualify as an extraordinary item, an event must satisfy two criteria: 1. The event must be unusual; it should be highly abnormal and unrelated to, or only incidentally related to, the ordinary activities of the entity. 2. The event must occur infrequently; it should be of a type that would not reasonably be expected to recur in the foreseeable future. Item “5” (loss of $300,000 due to explosion caused by disgruntled ex-husband of an employee) meets the two extraordinary-item criteria. Item “1” is explicitly excluded by APB No. 30 as an extraordinary item. Item “2” is not an extraordinary item. Hurricanes are not an infrequent event in Louisiana. Item “3” may be considered an extraordinary item if floods in northern New Mexico occur infrequently. Item “4” is not an extraordinary item. Selling segments of a business is a frequent business activity.

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2.

Income before extraordinary item........................................................................................................ $XXX,XXX Extraordinary item, net of applicable income taxes ($90,000)............................................................................................................. 210,000 Net income $XXX,XXX

Problem 10-6 a. and b.

c.

1.

dr. Inventory........................................................................................................................................... 57,600 cr. Note Payable................................................................................................................................... 57,600

2.

dr. Note Receivable................................................................................................................................ 2,700 cr. Sales................................................................................................................................................ 2,700

3.

dr. Accounts Receivable......................................................................................................................... 720,000 cr. Sales................................................................................................................................................ 720,000

4.

dr. Inventory........................................................................................................................................... 119,600 cr. Account Payable............................................................................................................................. 119,600

1.

Note Payable (year end)......................................................................................................................... $ 60,000 Note Payable (transaction date).............................................................................................................. 57,600 Exchange loss.................................................................................................................................... $ 2,400

2.

Note receivable (year end)..................................................................................................................... $ 3,000 Note receivable (transaction date).......................................................................................................... 2,700 Exchange gain.................................................................................................................................... $ 300

3.

Account receivable (year end)................................................................................................................ $692,308 Account receivable (transaction date).................................................................................................... 720,000 Exchange loss.................................................................................................................................... $ 27,692

4.

No exchange gain or loss. Exchange rate unchanged.

Cases Case 10-1: Norman Corporation (B)

*

Note: This case has been updated from the Tenth Edition. Approach This case provides a basis for discussing several tough problems in expense recognition. Except for the summary given in Exhibit A of this note, each of the topics is self-contained. They may provide more material than the instructor wishes to cover in one session; any of them can be omitted without hurting the overall results. *

This teaching note was prepared by Robert N. Anthony. Copyright © Robert N. Anthony.

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Answers to Questions 1. Although many firms charge the cost of such brochures as an expense when incurred, there is no requirement that this be done. The $25,000 of brochures on hand are economic resources that will benefit a future period. Unless the conservatism concept is given heavy weight, Norman’s treatment is appropriate. 2. The almost universal and required practice is to charge advertising expenditures as expense in the year incurred. There is one important exception to this requirement. Direct response advertising costs can be capitalized if a reasonable estimate of the response rate can be made based on past advertising programs. The argument made for capitalization seems sound. Because a prospective lender might well question this departure from custom, however, Allen Burrows can argue that it is prudent to charge the $75,000 as an expense. 3. However strong the rationale for capitalization, research/development costs must be expensed in accordance with FASB Statement No. 2. Thus, expense must be increased by $19,000, which is the difference between the amount charged and the expenditure for 2006. (This issue resurfaced in the context of computer software development costs; see FASB-86. It permits capitalization if certain conditions are met.) This is a change in accounting principles and the cumulative effect of the change must be shown on the income statement. Referring back to Exhibit 1 of the (A) case, the balance in the Development Costs account at the beginning of 2006 must have been $105,648 ($124,648 - $55,000 + $36,000), and this amount must be charged against income. (It is to be hoped that the lender will accept these unusual charges for what they are in appraising the resulting net income.) 4. Despite the literature on the subject, human resource accounting is not a generally accepted accounting principle. Those few companies that have reported such training costs as assets have done so in supplementary notes or supplementary financial statements, not in the “official” statements. The $35,000 should therefore be charged as an expense. 5. This is typical of situations in which there is no right answer. The net amount of accounts receivable should be an amount that has a high probability of being received. In this case, if the firm pays off at less than 77 cents on the dollar, the bad debt allowance ($5,250) is not large enough, even if there are no other bad debts. The prudent solution is to increase the allowance. There is no point in debating the amount of the increase at length because there are no facts to go on (which is typical in these situations). The important point is that some increase is needed. A case can be made for increasing the allowance by $14,000 or so, and this arbitrary amount is used here. 6. Imputing an expense for self-insurance is not permitted under generally accepted accounting principles. Income should be increased by $1,250, which is the difference between the $5,000 charged and the $3,750 that should have been charged. This is also a change in accounting principles, so the opening balance of $19,650 ($20,900 - $5,000 + $3,750) in the reserve account should be credited to income. 7. This problem illustrates the treatment of discontinued operations, even though the amount involved is a little small to be material. APB Opinion No. 30 applies to discontinuance of “a component of an entity whose activities represent a separate major line of business or class of customer, . . . provided that its assets, results of operations, and activities can be clearly distinguished, physically and operationally and for financial reporting purposes, from the other assets, results of operations, and activities of the entity.” (par. 13)

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The transaction must be reported in the year in which the decision to sell is made, in this case, 2006. It is reported in two parts: a. Operating income of the parking lot for 2006 is set out separately. In this case, it would be $19,000, less applicable income taxes, assumed here to be $7,600 (40%), an increase in net income of $11,400. b. AP-30, par. 15, requires recognizing a loss on discontinued operations at the measurement date (here, December 31, 2006); but a gain should not be reported until it is realized. This is consistent with the conservatism concept. Thus, Norman’s treatment of this item was correct, even though its rationale was not the relevant one. 8. The fact that the president sold the stock for $25,000 is irrelevant. This was a transaction between two outside parties, and had no effect on the Norman Corporation itself. The $3,000 gain on the sale of the treasury stock does not affect income. A corporation cannot make a gain by issuing its own stock. The $3,000 should have been credited directly to Capital Surplus (which is the term used by Norman, but which more properly is called Additional Paid-in Capital). 9. The charge to Retained Earnings should have been made when the $50,000 dividend was declared, not when it was paid. Thus, the 2006 dividend should have been charged to Retained Earnings in 2006 rather than in 2007, so the amount reported as dividends for 2006 was correct. The result of Norman’s practice is to omit a current liability, Dividends Payable. The balance sheet should therefore be adjusted by increasing current liabilities by $50,000 and decreasing Retained Earnings by $50,000. (There is, of course, no impact on income from dividend transactions.) The effect of these transactions is summarized in Exhibit A. Question 2 Norman could “clean up” its net nonoperating income and expense account (which should be called nonoperating revenue and expense, but usually isn’t in practice). These items actually are either operating items (e.g., interest expense, which should be shown as a separate line), or extraordinary items, accounting changes, correction of errors, or discontinued operations (all “below the line” items). EXHIBIT A NORMAN CORPORATION (B) Item 1 2 3 3 4 5 6 6 7 7 8 9

(a) (b) (a) (b) (a) (b)

Effect on Income of Required Changes None None (?) $ -19,000 -105,648 -35,000 -14 000 (?) +1,250 +19,650 None None -3,000 None Net effect............................................................................................................................................. $-155,748 Of which, change in accounting principles.......................................................................................... $ - 85,998 Discontinued operations....................................................................................................................... None Other.................................................................................................................................................... -69,750 $-155,748 7

Accounting: Text and Cases 12e – Instructor’s Manual

Anthony/Hawkins/Merchant

Case 10-2: Silver Appliance Company* Note: This case is the same version that was in the Eleventh Edition. Approach This case enables students to get some “hands-on” experience in dealing with the complex matter of deferred taxes, and also in applying the installment method that was described in Chapter 5. It also requires them to think through how these complexities can be explained to a nonaccountant, and to recognize that a change in accounting method for tax purposes may involve transitional problems relating to potential double taxation of income. Many students will have difficulties figuring out the calculations required for Question 1. These difficulties can be mitigated by including on the assignment sheet a worksheet format like that used in Exhibit A of this note. Alternatively, we can hand out in class a copy of Exhibit A, or have them copy it from a transparency. In any event, in class I go through an example for one year using T accounts, as follows:

“Book” Tax Sales.................................................................................................................................................................................... $1,000 $900 Cost of sales @ 70%........................................................................................................................................................... 700 630 Gross margin....................................................................................................................................................................... 300 270 Other expenses.................................................................................................................................................................... 200 200 Pretax income...................................................................................................................................................................... 100 70 Income tax expense @ 34%................................................................................................................................................ 34 23.8 Actual taxes as percent of pretax “Book” income............................................................................................................... 34% 23.8% Cash (or Taxes Payable) 23.8

Income Tax Expense 34

Deferred Taxes 10.2

This illustrates both the basic concept of deferred taxes, and also the rationale taxes as a percent of pretax income would be understated (23.8% instead of the “true” 34%) if the “book” income tax expense amount were the amount of actual taxes rather than the actual tax rate applied to “book” pretax income. This example uses the deferral method--rather than the liability method--to compute deferred taxes. Students find this deferral method easier to understand.

Comments on Questions Question 1 The required calculations are displayed in Exhibit A. Line 8 shows how much less Silver’s taxes would have been in 1989-93 and that taxes would have been higher in 1993 using the installment method. Line 9 shows each year’s year-end balance of Deferred Taxes; again, note that the reversal in 1993 causes the balance to decrease.

*

This teaching note was prepared by James S. Reece. Copyright © James S. Reece.

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Exhibit A SILVER APPLIANCE COMPANY (In Thousands)

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(1) (2) (3) (4) (5) (6) (7) (8) (9)

Anthony/Hawkins/Merchant

1989 1990 1991 1992 1993 Year-end installment receivables................................................................................................................................................. $190.1 $351.9 $526.2 $559.4 $489.1 Gross margin %........................................................................................................................................................................... 34.6% 35.1% 34.2% 33.4% 32.2% Deferred gross margin (= 1 * 2).................................................................................................................................................. 65.77 123.52 179.96 186.84 157.49 Pretax profit, delivery basis......................................................................................................................................................... 332.6 415.3 478.2 492.5 461.3 Income taxes, delivery basis (34% of 4)...................................................................................................................................... 113.08 141.20 162.59 167.45 156.84 Pretax profit, installment basis (= 4 - 3 + previous year’s 3) 47.31.............................................................................................................................................................. 266.83 357.55 421.76 485.62 490.65 Income taxes, installment basis (34% of 6)................................................................................................................................. 90.72 121.57 143.40 165.11 166.82 1 2 Tax deferred (5 - 7)...................................................................................................................................................................... 22.36 19.63 19.19 2.34 (9.98) Cumulative tax deferred.............................................................................................................................................................. 22.36 41.99 61.18 63.52 53.54

1

Liability method calculations is Line 3 ($65.77) times 34 percent. Liability method calculations is $41.99 minus $22.36 (see line 9).

2

Question 2 The balance in the deferred tax account is best described as the cumulative amount of taxes that the company has postponed by using the installment method rather than the delivery method for tax purposes. Some people refer to this as “an interest-free loan from the government.” This is true in the sense that these funds would have been paid in taxes if the tax laws did not permit use of the installment method. In another sense, it is not true: if the company used the installment method for both “book” and tax purposes, the company would have the same cash-flow benefit, but would not show any deferred tax accounting (ignoring other possible book-tax accounting differences); that is, it would have the same “loan,” even though the “loan” would not be reflected in the balance sheet. I also feel it should be explained to Mr. Silver that deferred taxes are a liability, but not in the same sense that taxes payable are. Personally, I find the APB’s analogy in Opinion No. 11 very compelling: like accounts payable, deferred taxes do come due and get paid, even though the balance in the account may grow because each year’s credits (new payables or deferrals) exceed that year’s debits (accounts paid or deferral reversals). Indeed 1993’s simultaneous drop in installment sales and gross margin percentage relative to 1992 clearly illustrates the phenomenon of turnover within the Deferred Taxes account. Like Mr. Silver’s architect friend, Silver’s taxes could remain essentially constant even though delivery-basis sales and profit have declined (see lines 4 and 6 of Exhibit A). The instructor may wish to indicate in advance that he or she does not expect students to check the tax code regarding the double taxation issue. The point of the question is to make students realize that there can be transitional problems surrounding a change in accounting method for tax purposes. Students should at least be able to answer, “There will be double taxation on installment sales recognized in 1993 under the delivery method, but not collected until 1994 when the installment method is adopted, unless the tax laws recognize this problem and provide relief for it.” In fact, the tax law (Sec. 453) says that Silver would have to report in 1994 all installment collections made in 1994, but could adjust 1994 taxes downward for those 1994 collections that were taxed under the delivery method in 1993. In effect, then, Silver would get a refund of that portion of 1993 taxes that related to installment sales that were reported in both 1993 and 1994, and would be taxed on these collections only in 1994. Although the question is not explicitly asked, the discussion should end with resolution of the issue as to whether Silver should change to the installment method. If students have previously raised a similar question on a switch from FIFO to LIFO, having seen here that 1993 taxes would have been higher on the installment basis than the delivery basis, they are tempted to answer, “It depends on the expected future relationship between income on the installment basis and the delivery basis.” However, in this instance

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that answer is not correct. Unless tax rates are expected to be increased, the installment method will always provide some advantage: there is no way (given no double taxation in the year of change) that a change from the delivery basis to the installment basis could result at any time in a negative (debit) balance in Deferred Taxes. Thus, the change should be made. Case 10-4: Freedom Technology Company* Note: This case is unchanged from the Eleventh Edition. Approach Because FASB 8 proscribed the earlier freedom of choice of a translation method, and then FASB 52 changed FASB 8’s method, I prefer teaching this case with a “legislative history” flavor, rather than just dealing with the mechanics of the net investment or current rate method. While the students still learn the basics behind the net investment method, they gain a better understanding of the translation concept in general and also are exposed to the lengthy controversy surrounding some otherwise apparently innocuous accounting rules. Of course, some instructors will choose to assign only Question 1. This topic is not included in many “core” financial accounting courses. However, with the increase in multinational operations of businesses, and the resultant concern about international content in the business core curriculum, the topic seems more germane to the core course than it did in previous years. Comments on Questions I begin class with a student presenting the statements called for in questions 1 and 2 (see Ex. A and B). Using the text example (Illustration 10-7) as a basis, students have little trouble with the net investment method, except for the equity items. Some will forget to translate capital stock at the rate in effect when it was issued. While most will have gotten the translation adjustment as a “plug” figure, many will have trouble directly calculating it. As indicated at the bottom of Exhibit A, the importance of the calculation is not the mechanics so much as the insight one gains into what the adjustment represents. The remeasurement of monetary/nonmonetary method is more difficult, both because it is not illustrated in the text and because of the nonmonetary asset adjustments’ being different from those in the net investment method. These difficulties should not be permitted to obscure the different investment exposure concepts behind the two methods. The net investment method views the owners’ equity as being exposed to exchange rate fluctuations; i.e., fluctuations in assets’ translated amounts are offset to the extent possible by liability fluctuations, leaving exposed only the portion of assets financed by equity. By contrast, the monetary/nonmonetary method treats nonmonetary assets as a hedge against unfavorable exchange rate fluctuations. (Compare especially the translated amounts for fixed assets under the two methods.) One word of caution is in order. To keep this problem as simple as possible, the foreign entity was formed at the start of the current year (i.e., October 1, 20xl). It is for this reason (plus the assumption of no dividends) that in Exhibits A and B the year-end retained earnings are the same as the year’s net income. In succeeding years, the concept for getting the translation gain or loss as a “plug” figure remains the same, but the mechanics become slightly more complex. (In fact, in practice this item is derived as a plug figure, rather than calculated directly.) This case example clearly illustrates the reason the translation method controversy at least among statement preparers seems to have died down since the issuance of FASB 52. In circumstances such as those faced by Freedom A (i.e., foreign currency value dropping relative to the dollar), the *

This teaching note was prepared by Robert N. Anthony. Copyright © Robert N. Anthony.

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monetary/nonmonetary method reports a smaller translation loss; hence, in pre-FASB 8 days, this method would have been the better of the two from management’s standpoint. The preparers’ real objection to FASB 8, in my view, was not the method so much as it was treating the translation gain or loss as an element of net income. Despite a company’s best efforts to keep operating earnings consistently on the rise, the translation gain or loss caused fluctuations, resulting in great consternation among top managers. This phenomenon can lead the class, if the instructor wishes, into a discussion of the efficient markets hypothesis as it relates to accounting methods. According to EMH, the translation method used should have no impact on stock price, since cash flow is independent of method used. Of course, if management, given a method they must use (e.g., monetary/nonmonetary), changes its decisions solely to influence the result reported by the accounting method, then stock price could be affected because cash flows could be different. A study done by Professor Shank, et al. (see Financial Executive, Feb. 1980 for a summary) revealed that companies were in fact engaging in transactions that were induced more by FASB 8 than by purely economic considerations, especially currency hedging transactions. The study also indicated that FASB 8 did not change the market’s perception of the riskiness of firms affected by FASB 8, and the managements’ FASB 8 induced action was therefore unwarranted. To quote the study, “Managers are so committed to the importance of the accounting numbers that they will undertake actions in the foreign currency area which they know will increase expected costs and risk levels just to preserve desired relationships in the accounting numbers.”

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Exhibit A Net Investment Translation Method (won in millions, dollars in thousands) Freedom-Korea Balance Sheet as of September 30, 20x2

Assets Won Exchange Rate Dollars Cash................................................................................................................................................................................... W591 $0.00124 $ 732.8 Receivables........................................................................................................................................................................ 1,182 0.00124 1,465.7 Inventories.......................................................................................................................................................................... 552 0.00124 684.5 Fixed assets ....................................................................................................................................................................... 575 0.00124 713.0 W2,900 $3,596.0 Liabilities and Owners’ Equity Current liabilities................................................................................................................................................................ W624 0.00124 $ 773.8 Capital stock....................................................................................................................................................................... 1,000 0.00140 1,400.0 Retained earnings............................................................................................................................................................... 1,276 (see below) 1684.3 Accum. translation adjustments.......................................................................................................................................... ---* (262.1) W2,900 $3,596.0

Income Statement for the year ended September 30, 20x2 Revenues............................................................................................................................................................................ W7,090 $0.00132 $9,358.8 Cost of sales ...................................................................................................................................................................... 4,415 0.00132 5,827.8 Other expenses................................................................................................................................................................... 1,399 0.00132 1,846.7 Net Income......................................................................................................................................................................... W1,276 $1,684.3

* Calculation of translation loss: Oct. 1, 20xl net assets = W1,000 Translated at Sept 30, 20x2 rate = 1,000 * $0.00124.............................................................................................. $ 1,240.0 Translated at Oct. 1, 20xl rate = 1,000 * 0.00140................................................................................................... 1,400.0 Loss on beginning-of-year net assets...................................................................................................................... $ (160x.0)

Increment in net assets during FT 20x2 = W 1,276 Translated at Sept 30,20x2 rate = 1,276 * $0.00124............................................................................................... $1,582.2 Translated at average FY 20x2 rate = 1,276 * 0.00132........................................................................................... 1,684.3 Loss on increment in net assets............................................................................................................................... $ (102.1)

Total loss in dollar value of net assets........................................................................................................................ $ (262.1) (The loss figure can be determined without the above calculation, since the loss is the amount needed to make the balance sheet balance; but the calculation shows the rationale behind the loss, i.e., the loss occurred because the parent held South Korean won net assets while the value of the won fell relative to the dollar.)

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Exhibit B Monetary/Nonmonetary Translation Method (won in millions, dollars in thousands) Freedom-Korea Balance Sheet as of September 30, 20x2

Assets Won Exchange Rate Dollars Cash................................................................................................................................................................................................ W591 $0.00124 $ 732.8 Receivables..................................................................................................................................................................................... 1,182 0.00124 1,465.7 Inventories...................................................................................................................................................................................... 552 0.00126 695.5 Fixed assets..................................................................................................................................................................................... 575 0.00140 805.0 W2,900 $3,699.0 Liabilities and Owners’ Equity Current liabilities............................................................................................................................................................................. W624 0.00124 $ 773.8 Capital stock.................................................................................................................................................................................... 1,000 0.00140 1,400.0 Retained earnings............................................................................................................................................................................ 1,276 (“plug”) 1,525.2 W2,900 $3,699.0

Income Statement for the year ended September 30, 20x2 Revenue.......................................................................................................................................................................................... W7,090 $0.00132 $9,358.8 Cost of sales.................................................................................................................................................................................... 4,415 0.00132* 5,827.8* Other expenses (excl. deprec.)........................................................................................................................................................ 1,374 0.00132 1,813.7 Depreciation.................................................................................................................................................................................... 25 0.00140 35.0 Operating income............................................................................................................................................................................ 1,276 1,682.3 Translation gain (loss)..................................................................................................................................................................... ---(“plug”) (157.1) Net Income ..................................................................................................................................................................................... W1,276 $1,525.2 *This is an approximation. A precise calculation incorporates beginning and ending inventories, as well as purchases, thus:

Beginning inventory........................................................................................................................................................................ W0 0.00140 $ 0.0 Plus purchases................................................................................................................................................................................. 4,967 0.00132 6,556.4 Less ending inventory..................................................................................................................................................................... (552) 0.00126 (695.5) Cost of sales.................................................................................................................................................................................... W4,415 $5,860.9

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