Explain the operational hedging strategies that may offset exposure.

Unit VII Case Study
Complete both parts of this assignment and submit as a single document.
Part One:
Based upon recording balance of payment (BOP) transactions, determine whether or not the following is a debit, credit, or no entry to the U.S. Balance of Payment statement. Also determine what chart of account is affected (i.e., CA, KA, or OSB): 1. U.S. resident purchases Mercedes Benz C230, 2. U.S. resident purchases Chevrolet Impala, 3. foreigner purchases GE dryer, 4. U.S. resident purchases UK stock, and 5. U.S. resident borrows funds from British broker to purchase stock.
Part Two:
Read the case study, pp. 759-762, “H&M: The Challenges of Global Expansion and the Move to Adopt International Financial Reporting Standards.” Answer questions 19-3 and 19-4 at the end of the case study and the questions listed below. Your response for all four questions should be at least three pages in length and follow APA style guidelines. • What type of exposure could the CFO of H&M in the U.S. be subjected to since H&M is based in Sweden and the financial statements are prepared according to IFRS? • Payments or liabilities may also be subjected to exposure. Explain the operational hedging strategies that may offset exposure.

H&M: The Challenges of Global Expansion and the Move to Adopt International Financial Reporting Standards – pp. 759-762
Hennes & Mauritz AB (also known as H&M) , the Swedish MNE that is a trendsetter in the latest fashion trends, has a stated goal “to give customers unbeatable value by offering fashion and quality at the best price.” It doesn’t own any factories, but rather outsources production to independent suppliers, primarily in Asia and Europe. H&M also rents space from international and local landlords rather than owning its own stores.
H&M is a major firm in the apparel retail market where fashion trends are critical and where goods move quickly. In this industry, the key buyers are consumers, and the key suppliers are clothing manufacturers and wholesalers, and designers are king and a fast, well-organized supply chain is essential. Depending on the individual firm strategy, the apparel retail market doesn’t have to be capital intensive, but the largest players in the industry are very international, both in retail footprint and suppliers. The biggest companies in the industry are U.S.-based The Gap, H&M, and Spain-based Industria de Diseno Textil, S.A. (Inditex), better known by its flagship brand, Zara. All three companies have different store brands: Gap, Banana Republic, Old Navy, and Athleta for The Gap; H&M, COS (collection of style), Monki, Weekday, and Cheap Monday for H&M; and Zara, Bershka, Pull and bear, Massimo Dutti, Stradivarius, Oysho, Zara Home and Uterque for Inditex.
Global Spread and Strategy
Both of H&M’s competitors are very international. H&M operates about 2,800 stores in 49 markets, whereas The Gap operates 3,100 company stores and over 300 franchise stores worldwide, and Inditex operates in a network of over 5,000 stores in 77 countries. Zara has the largest geographic spread within Inditex with stores in 74 countries.
Hennes & Mauritz AB started as a single women’s wear store in Sweden in 1947. Today, H&M’s business is much broader and currently includes the sales of clothing, accessories, footwear, cosmetics, and home textiles. Although H&M is known as one of Sweden’s premier MNEs, it generates 21.5% of its sales in Germany, 8.9% in the United States, and 7.4% in the United Kingdom, compared to only 5.8% of total sales in Sweden.
H&M and Zara have very different strategies. Zara delivers new products to its stores twice a week. Because of its highly organized supply chain, Zara only takes 10–15 days to go from design to the stores. Although it sources its apparel from around the world, it has adopted just-in-time manufacturing from the auto industry and established 14 highly automated Spanish factories where robots cut and dye fabrics creating the unfinished “gray goods” which are the foundation for their final products. It then takes the gray goods and outsources them to a network of small shops in Portugal and Spain to do the finish work. Store managers are constantly sending updated information on consumer demand so that they can move to the next hot fashion. The rule at Zara is that if you see it in the store and you
like it, you’d better buy it because as soon as it is gone, you’ll never see it again. Veteran Zara consumers keep track of when new shipments come in so they can buy the latest stuff. H&M is trendy, but it outsources production to a network of 800 suppliers, 60 percent of which are in Asia. It offers a main collection twice a year in the spring and the fall with several sub- collections that allow it to bring in new trendy items. Longer lead time items are produced in Asia, whereas short lead time items are manufactured in Europe.
Currently the second largest apparel retailer behind Inditex, H&M has met its target growth rate of 10–15% per year, with no plans of slowing its expansion. Despite its global presence, H&M is listed solely in the Stockholm stock exchange in Sweden and therefore uses the EU’s accepted IFRS to present its financial statements in both English and Swedish. The financial statements are reported in Swedish kronor, which also serve as its functional currency. Because the retail industry is less capital intensive, most companies have no need to list in any foreign stock exchanges. Zara lists only on the stock exchanges throughout its home country, Spain, including Madrid, Barcelona, Bilbao, Valencia, and the Automated Quotation System. Consistent with domestic listings, The Gap, which was founded in the U.S. in 1969, is listed solely on the NYSE.
The ability to list solely in the country in which a company is domiciled can simplify the financial reporting process by avoiding the need to present financial statements that adhere to the accounting rules of multiple countries. Ericsson, another popular Swedish MNE, required much more capital and was therefore listed on both the Stockholm exchange in Sweden as well as the NASDAQ in the United States. As a result, Ericsson has had to accommodate multiple accounting bodies and become more transparent in its reports because of its desire to raise capital on foreign exchanges.
The Gap, H&M, and Inditex come from different accounting and regulatory environments. In its 2012 annual report, H&M states that its consolidated accounts have been prepared in accordance with IFRS issued by the IASB and the interpretations provided by the IFRS Interpretations Committee. In addition, the IFRS that is used for its parent company reports are only those approved by the EU. Besides IFRS, H&M provides disclosures in accordance with the Swedish Financial Reporting Board’s recommendation RFR 1. Both the parent company and consolidated balance sheets use the following format: fixed assets + current assets = equity + long term liabilities + current liabilities.
Given that Sweden is a member of the European Union, H&M was required to adopt IFRS as of 2005, which was a change from its past practices. Prior to that, H&M was using recommendations issued by the Swedish Financial Standards council, which were largely based in International Accounting Standards, so the consolidated reports of H&M were already pretty much adjusted to IAS. In preparation for the switch from Swedish GAAP to IFRS, H&M began a transition process in 2003 and 2004 that was intensified in 2005. In its 2005 annual report, H&M reported that the greatest impact of the change was because of financial instruments and hedge accounting. H&M decided at that time to apply IAS 32 and IAS 39 on financial instruments. Prior to the adoption of these standards, H&M was holding derivatives for cash flow hedging, and gains and losses on derivatives were recognized when the hedged transaction took place, but under IAS 39, all derivatives had to be recognized at fair value, so H&M commented that reported profit was probably going to be more volatile than it was when gains and losses on hedges were deferred and recognized outside the balance sheet. That is exactly the volatility that the European, especially French, banks wanted to avoid, resulting in the EU carving out the treatment of derivatives.
Before the Changeover to IFRS
Prior to the move to IFRS in 2006, H&M reported its financial results in compliance with Swedish GAAP—a bit of a mixture between Anglo-American accounting, which is driven by the capital markets, and Germanic accounting, which is driven by bank financing and taxation. Swedish reporting tends to be a little more transparent than German accounting but less transparent than Anglo-American accounting.
Issues of Transparency
One reason why Swedish accounting has been less transparent is its orientation to creditors, government, and tax authorities. In addition, because the Swedish Stock Exchange has become a focal point for listings by Nordic companies, the influential Swedish accounting profession has pushed for consolidated accounts to represent the needs of shareholders, whereas the parent-company accounts have reflected Swedish legal requirements. Swedish accounting tends to be very conservative due to the importance of taxes to fund extensive social welfare programs and the tendency of the Swedish government to use tax policies to influence investment in areas deemed important to the government and its social objectives.
Sweden and the EU
Since Sweden entered the EU, its accounting has evolved to incorporate EU accounting directives and philosophies. The Swedish government established an Accounting Standards Board (BFN) in 1976 to recommend accounting principles that fit within the framework of the Company Law. The Swedish Financial Accounting Council (RR) was established in 1991 to take over the role of the accounting profession in making recommendations on accounting practices, especially with respect to how to prepare an annual report according to the Annual Accounts Act.
The Swedish Stock Exchange has supported the efforts of the Accounting Council and the BFN, even though the recommendations of both bodies are voluntary and subject to the Company Law. However, the decision by the EU to require firms to use IFRS for consolidated financial statements takes precedence over everything for consolidated financial statements.
Conversion Costs
H&M didn’t provide much information about the cost of converting to IFRS in 2005, but Ericsson, another Swedish company did. Ericsson provided more information because it was listing on NASDAQ as well the Swedish stock exchange, so it had to provide a Form 20F reconciliation between Swedish and U.S. GAAP. Because of its higher level of disclosure, Ericsson estimated that the conversion to IFRS in 2005 would result in a difference of about 1.5 billion Swedish kronor for 2004 net income and a difference of 5.7 billion kronor for equity as of January 1, 2005. Net income under Swedish GAAP would have been 17,539 million kronor under IFRS, compared with 19,024 million under Swedish GAAP. In addition, the recognition of cash on the balance sheet appears to be quite different under IFRS than it is under Swedish GAAP, with cash under IFRS being SEK46.1 billion less than cash under Swedish GAAP. From Ericsson’s Form 20-F report, one can also see that cash at the end of 2004 was the same under U.S. GAAP and IFRS.
Costs of implementing IFRS are difficult to gauge. Many countries implemented national regulations that attempted alignment with IFRS (e.g., Sweden). Thus costs of implementation may have been spread out over several years because companies knew that full IFRS implementation was drawing near. Ericsson’s management notes the following in the 2004 annual report:
Because Swedish GAAP, in recent years, has been adapted to IFRS to a high degree and as the rules for first time adopters allows certain exemptions from full retrospective restatements, the transition from Swedish GAAP to IFRS is expected to have a relatively limited effect on our financial statements. Furthermore, we believe the conversion to IFRS will align our reporting more closely with US GAAP.
19-3. If an investor wants to compare the financial results of The Gap, Inditex, and H&M, what dif- ference does it make that their financial statements are prepared according to different GAAP? Would you expect there to be a big difference between U.S. GAAP as used by The Gap and IFRS as used by H&M and Inditex?
19-4. What are the major sources of influence on H&M’s accounting standards and practices?

19-5. What type of IFRS did H&M decide to disclose in its financial statements in 2005? In 2012?
19-6. H&M says in its accounting policies that it uses IFRS as issued by the IASB for its consolidated accounts and, since its parent company is a company within the EU, only IFRS as approved by the EU are used in its financial statements. What difference does it make whether or not the financial statements are prepared according to full IFRS or IFRS as approved by the EU? Why does the EU insist on having a veto power over IFRS?

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