Case 11-3

Nova MineEngineering/ Zimbabwe Platinum Management[1]

The first question that must be answered is,“Consolidate or not?”  IFRS is clear inthat all subsidiaries should be consolidated.

The next question is the selection of the translation method.  The choice between the temporal and thecurrent rate method depends, first of all, on the functional currency of ZPMand the primary relationship between Nova and ZPM.  Is ZPM integrated or self-sustaining?  The secondment of staff supports theassertion that it is integrated.  Statusas self-sustaining is supported by the fact that there are limited flowsbetween the firms, except for information. Discussion of suchfactors as product flows would lead to a conclusion as to a lack ofintegration; expatriate staff has been sent outfor relatively long terms, also suggesting a lack of integration.  This lack of integration suggests that ZPM isa self-sustaining subsidiary. Accordingly, the current rate method should be usedwhen translating ZPM’s financial statements and any foreign exchangeadjustments should be reported in other comprehensive income, rather than beingrecognized in net income.

A further stage of analysis is necessary.   Is Zimbabwe a highly inflationarycountry?  It is noted (显著的) in the case that inflation was “persistent （坚持的， 稳固的） ... recently about 35%.”  Aconclusion, based on the facts, that Zimbabwe was highly inflationary (note theIAS guideline of 100% over 3 years, about 25% per year compounded) would leadto the use of inflation-adjusted financial statements for ZPM followed bytranslation of all financial statements items using the closing rate.  The exchange adjustments would be reported inother comprehensive income. The high inflation, and the severe decline in therelative exchange rate, may potentially lead to losses (associated with theinvestment in “working capital”), which must be recognized by Nova.  As noted in the case, these potential lossescannot be hedged because of the “stressed” state of the Zimbabwe currency.

Regardless of the conclusion as to the translation method, thesevere decline in the exchange rates and the overall deterioration ofZimbabwe’s economy may lead to a permanent decline in value, such that theinvestment should be written down.  Footnotedisclosure of the potential for further difficulties would be appropriate inany case.

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[1]Peter Secord,Saint Mary’s University.