Case 8-3 BellSouth Corporation BellSouth Corporation invested in two wireless co
ID: 2424143 • Letter: C
Question
Case 8-3
BellSouth Corporation
BellSouth Corporation invested in two wireless communications operations in Brazil in the mid-1990s that are being accounted for under the equity method. The following note is taken from BellSouth Corporation’s interim report for the quar- ter ended March 31, 1999:
Note E—Devaluation of Brazilian Currency
We hold equity interests in two wireless communications operations in Brazil. During January 1999, the government of Brazil allowed its currency to trade freely against other currencies. As a result, the Brazilian Real experienced a devaluation against the U.S. Dollar. The devaluation resulted in the entities recording exchange losses related to their net U.S. Dollar-denominated liabilities. Our share of the for- eign exchange rate losses for the first quarter was $280. These exchange losses are subject to further upward or downward adjustment based on fluctuations in the exchange rates between the U.S. Dollar and the Brazil- ian Real.
in a press release announcing first quarter 1999 results, BellSouth Corporation provided the following information (as found on the company’s Web site):
BellSouth Corporation (NYSE: BLS) reported a 15-percent increase in first quarter earnings per share (EPS) before special items. EPS was 46 cents before a non-cash expense of 14 cents related to Brazil’s currency devalue
BELLSOUTH CORPORATION
Normalized Earnings Summary ($ in millions, except per share amount
Quarter Ended
Quarter Ended
3/31/99 3/31/98 %Change
Reported Net Income $615 $892 (31.1%)
Foreign currency loss m 280 -
Gain on sale of ITT World Directories - (96)
Normalized Net Income $895 $796 12.4%
Reponed Diluted Earnings per Share $0.32 $0.45 (28.9%)
Foreign currency loss@ 0.14 -
Gain on sale of ITT World Directories _ (0.05)
Normalized Diluted Earnings per Share,0.46 $0.40 15.0%
Required
Given the disclosure provided by BellSouth Corporation, answer the following questions:
1. Why did the company report a foreign currency loss as a result of the devalua- tion of the Brazilian real?
2. What does the company mean when it states: “These exchange losses are sub- ject to further upward or downward adjustment based on fluctuations in the exchange rates between the U.S. Dollar and the Brazilian Real”?
3. What is the company’s objective in reporting “Normalized Net Income”? Do you agree with the company’s assessment that it had a 15 percent increase in first-quarter earnings per share?
Explanation / Answer
Answer:2 The company appears to be saying that the exchange loss is not yet realized. If, subsequent to the January 1999 devaluation, the Brazilian real appreciates against the U.S. dollar, the unrealized loss will become smaller. On the other hand, the loss will become even larger if the real continues to depreciate.
Answer:3 The objective of reporting normalized net income is to remove from net income the effect of one-time only events that do not qualify under U.S. GAAP as extraordinary items or discontinued operations, and therefore are not reported separately in the income statement. The company appears to be signaling its belief that the foreign currency loss is a nonrecurring (extraordinary) item.
This assessment is valid if one compares normalized diluted EPS in the first quarter of 1999, which excluded a large loss, with normalized diluted EPS in the first quarter of 1998, which excluded a large gain. Whether financial analysts would use normalized EPS rather than reported EPS in making decisions about BellSouth is an empirical question.
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