sample exam question wrong?

Why does the answer say that actual return is positive, when it clearly shows it being negative? Is this a mistake? -------------------------------------------------------------------------------- Brigitte Langlois, a fixed income securities analyst for Cunard Securities, is responsible for evaluating and monitoring the creditworthiness of companies whose bonds are held in Cunard’s High Yield International Corporate Bond Fund. Langlois bases her buy and sell decisions on a multivariate bankruptcy prediction model that estimates the probability that a company will face insolvency within the next 18 months. As inputs into the model, Langlois uses adjusted, rather than reported, accounting data to calculate a company’s liquidity, solvency, and profitability ratios. Langlois and her research assistant, Barclay Kingston, are preparing a research report on Duban Inc., a U.S.-based company, and Kerwin Corporation, Duban’s publicly listed Swedish affiliate, to determine whether either company’s intermediate-term bonds would be suitable investments for Cunard’s bond fund. Langlois assigns Kingston several tasks: "I want you to analyze Duban’s long-term solvency because I am concerned about its obligation to provide pension benefits. Because Duban uses U.S. GAAP while Kerwin uses International Accounting Standards (IAS GAAP), I want you to prepare an analysis of their financial statements.” Langlois provides Kingston with information about Duban’s pension plan, which is shown below in Exhibit 1. Exhibit 1 Duban Inc. Selected Footnote Disclosure Pension Plan Information (in U.S. $ millions) 2007 2006 Reconciliation of Pension Benefit Obligation (PBO) Opening Balance $1,606 $1,296 Service cost 86 81 Interest Cost 147 131 Plan Amendments 237 Benefits Paid (148) (145) Participant Contributions 8 6 Closing Balance $1,699 $1,606 2007 2006 Reconciliation of Plan Assets Opening Balance $507 $592 Return on Plan Assets (41) (21) Employer Contributions 117 75 Participant Contributions 8 6 Benefits Paid (148) (145) Closing Balance $443 507 Other Information Unrecognized Prior Service Cost 227 250 Unrecognized Actuarial Loss 348 205 Expected Return on Plan Assets 46 45 Amortization of Unrecognized Prior Service Cost 23 12 Amortization of Unrecognized Loss 15 10 Langlois continues to outline Kingston’s tasks: "Additionally, I want you to compute the 2007 translation gain or loss on Kerwin’s assets from the change in exchange rates. Finally, I want you to separate the change in 2007 operating income into two components: the operational effect, and the exchange rate effect due to changes in the Swedish Krona/U.S. dollar (SEK/USD) exchange rate. Selected information from Duban’s financial statements relating to its investment in Kerwin is shown below in Exhibit 2.” Exhibit 2 Selected Information from Duban’s 2007 Financial Statements Concerning Duban’s Investment in Kerwin Sweden is an important foreign market for Duban Inc. In 2007, we increased our investment in Kerwin in expectation of strong consumer demand. As indicated below, Kerwin's 2007 net sales increased by 25% compared with 2006 sales. In addition, Kerwin's 2007 operating profit increased by 40% compared with 2006 operating profit, as a result of management's tighter control of operating expenses. Kerwin: Selected Financial Data (in U.S. millions) 2007 2006 Net Sales $5,500 $4,400 Operating profit 3,850 2,750 Identifiable assets 3,055 2,350 SEK/USD Exchange Rate 2007 2006 Year-end rate, 31 December 6.4000 = $1 6.850 = $1 Average rate during year * 6.8000 = $1 7.375 = 1 \*Average of month-end rates -------------------------------------------------------------------------------- Question Based on Exhibit 1, the underlying economic pension expense ( millions) for Duban for 2007 would be closest to: A. 187. B. 192. C. 233. D. 274. Feedback: You have answered incorrectly. Correct answer = D “Understanding Retirement Benefit Accounting and Disclosures for Financial Analysis,” Thomas R. Robinson, Paul Munter, and Julia Grant 2008 Modular Level II, Vol. 2, pp. 124, 130 Study Session 6-24-f calculate the underlying economic pension and other post-employment expense (income) based upon disclosures after removing the effect of amortized items and smoothing mechanisms The economic pension expense is calculated as follows: Service Cost 86 Interest Cost 147 Actual Return on Plan Assets 41 Economic Pension Expense 274

actual return is negative

so 86+147 + 41 = pernsion expense of 274 or w.e

Because normally you would subtract the return, but since its a negative number, you are adding it in this equation.

Actual Return on plan assets is negative so you need to add it to the expense. So it is actually 86 + 147 - (-41) = 274.

affect of change in operational income is multiplied by previous year average rate? Why does the answer multiply by the current year average rate??? ---- “Analysis of Multinational Operations,” Gerald I. White, Ashwinpaul C. Sondhi, and Dov Fried 2008 Modular Level II, Vol. 2, pp. 188-191 Study Session 6-26-d, f analyze and evaluate the effects of the all-current and temporal methods on the parent company’s balance sheet and income statement; calculate the translation effects of the all-current and temporal methods of foreign currency translation “The operational effect is estimated by multiplying the change in the income statement component (in local currency) by the previous period’s average exchange rate” (p. 189). Multiplying Kerwin’s operating income in dollars by the average rate produces operating income in millions of krona. For example: 2007 Operating Income (krona) = $ Operating Income x 2007 Average Rate = $3,850 x 6.800 = $26,180. Instructions: Click the Continue

You use 2007 average rate for 2007 income. So 6.8 * 3850.

sv102307 Wrote: ------------------------------------------------------- > Actual Return on plan assets is negative so you > need to add it to the expense. So it is actually > 86 + 147 - (-41) = 274. Thanks. I need to review 3rd grade math!!!

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sv102307 Wrote: ------------------------------------------------------- > You use 2007 average rate for 2007 income. So 6.8 > * 3850. If that is the case the answer is inconsistent. “The operational effect is estimated by multiplying the change in the income statement component (in local currency) by the previous period’s average exchange rate” (p. 189). The answer was B. Use 2006 average rate!!!

I am a little confused now. Did they use 2006 or 2007 Average rate. My understanding is that you would use the average for the period you are doing the income stmt for. If they used 2007 rate, i assume when they say previous period they mean 2007 (because you are presumably in 2008 when you do the income stmt)

Just to add … I checked pg 189 and it says - Generally revenues and most expense categories are translated at the average rate for the period regardless of the choice of functionak currency. Dont see why they say previous period in the answer key

opeartional effect = ignoring fx, the change in revs in usd… so, hold fx consntant and see how they performed better as a business