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5
Accounting for Foreign Currency
Transactions and Hedging
Foreign Exchange Risk
Chapter
12-1
Foreign Currency Transactions
Many Country companies engage in international
activities such as:
Exporting or importing goods,
Establishing a foreign branch, or
Holding an equity investment in a foreign company.
Chapter
12-2
Foreign Currency Transactions
Recording and reporting problems with foreign currency
transactions:
Transactions in a foreign currency must be translated
before they can be aggregated with domestic
transactions.
Receivables or payables denominated in foreign
currencies are subject to gains and losses.
Companies use hedging strategies with derivatives to
minimize the impact of exchange rate changes.
Chapter
12-3
Exchange Rates—Means of Translation
Translation - process of expressing amounts stated in
a foreign currency in the currency of the reporting
entity by using an appropriate exchange rate.
Exchange rate - ratio between a unit of one currency
and another currency for which that unit can be
exchanged at a particular time.
Chapter
12-4
Exchange Rates—Means of Translation
Direct Exchange Rate
Units of domestic currency that can be converted
into one unit of foreign currency.
Direct rate = 1.517 ($1.517 U.S. for 1 British pound)
Indirect Exchange Rate
Units of foreign currency that can be converted
into one unit of domestic currency.
Indirect rate = 1.00/1.517 = .6592
($1 U.S. for .6592 British pound)
Chapter
12-5
Exchange Rates—Means of Translation
Spot Rate
Rate at which currencies can be exchanged today.
Forward or Future Rate
Rate at which currencies can be exchanged at some
future date.
Forward Exchange Contract
Contract to exchange currencies of different
countries on a stipulated future date, at a specified
rate (the forward rate).
Chapter
12-6
Exchange Rates—Means of Translation
Floating Rates
Relationship between major currencies is
determined by supply and demand factors.
Increase risk to companies doing business with a
foreign company.
Example – Payable to be settled in 100,000 yen
Yen
Direct rate
Payable
Chapter
12-7
Transaction
Date
100,000
$ 0.00434
$ 434.00
Change
in Rate
Settlement
Date
100,000
$ 0.00625
$ 625.00
Measured Versus Denominated
Transactions are normally measured and recorded in terms
of the currency where the company is located.
Reporting Currency - usually the currency where the
company located.
Transaction between a U.S. firm and a foreign company:
Companies negotiate whether settlement is to be made
in dollars or in the foreign currency.
If settled by foreign currency, U.S. firm measures
the receivable or payable in dollars, but the
transaction is denominated in the foreign currency.
Chapter
12-8
LO 1 Measured versus denominated.
Foreign Currency Transactions
Foreign Currency Transaction - requires payment or
receipt (settlement) in a foreign currency.
U.S. firm exposed to risk of unfavorable changes in
the exchange rate.
Direct exchange rate
increasing, or foreign
currency unit strengthening.
Direct exchange rate
decreasing, or foreign
currency unit weakening.
Chapter
12-9
=
More dollars needed to
acquire the foreign
currency units.
=
Fewer dollars needed to
acquire the foreign
currency units.
LO 2 Foreign Currency Transactions.
Foreign Currency Transactions
Importing or Exporting of Goods or Services
Translating Accounts Denominated in Foreign Currency
Transaction
date
Balance
sheet date
Settlement
date
Units of foreign currency x Current direct exchange rate
Increase or decrease is generally reported as a foreign currency
transaction gain or loss, sometimes referred to as an exchange gain
or loss, in determining net income for the current period.
Chapter
12-10
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 During December of the current year, Teletex
Systems, Inc., a company based in Seattle, Washington,
entered into the following transactions:
Dec. 10 Sold seven office computers to a company located
in Colombia for 8,541,000 pesos. On this date, the
spot rate was 365 pesos per U.S. dollar.
U.S. firm
(Teletex)
Chapter
12-11
Inventory delivered
12/10/2015
Columbia firm
8,541,000 pesos
received on 1/10/2016
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 Dec. 10, Sold seven office computers to a
company located in Colombia for 8,541,000 pesos. On this
date, the spot rate was 365 pesos per U.S. dollar. Prepare the
journal entry on the books of Teletex Systems, Inc.
Accounts receivable
Sales
Sales price in pesos
Pesos per U.S. dollar
Sales price in U.S. dollars
Chapter
12-12
23,400
23,400
8,541,000
/
365
$ 23,400
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 Prepare journal entry necessary to adjust the
accounts as of December 31. Assume that on December 31
the direct exchange rates was Colombia peso $.00268.
Transaction loss
510
Accounts receivable
510
Receivable in pesos
Direct exchange rate to U.S. dollar
Receivable in U.S. dollars
Balance in receivable
Transaction loss
Chapter
12-13
LO 3 Common transactions.
8,541,000
$ .00268
$ 22,890
23,400
$
510
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 Prepare journal entry to record settlement of
the account on January 10. Assume that the direct exchange
rate on the settlement date was Colombia peso $.00320.
Cash (8,541,000 x $.00320)
27,331
Accounts receivable ($23,400 - $510)
Transaction gain
Chapter
12-14
LO 3 Common transactions.
22,890
4,441
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 During December of the current year, Teletex
Systems, Inc., a company based in Seattle, Washington,
entered into the following transactions:
Dec. 12 Purchased computer chips from a Taiwan company.
Contract was denominated in 500,000 Taiwan dollars.
Direct exchange rate on this date was $.0391.
U.S. firm
(Teletex)
Chapter
12-15
Inventory received
12/12/2015
Taiwan firm
500,000 Taiwan dollars
paid on 1/10/2016
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 Dec. 12, Purchased computer chips from a
company domiciled in Taiwan. The contract was denominated
in 500,000 Taiwan dollars. The direct exchange spot rate on
this date was $.0391. Prepare the journal entry on the books
of Teletex Systems, Inc.
Merchandising Inv./Raw Mat.
19,550
Accounts payable
19,550
Purchase price in Taiwan dollars
Direct exchange rate to U.S. dollar
Purchase price in U.S. dollars
Chapter
12-16
500,000
x
$.0391
$ 19,550
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 Prepare journal entry necessary to adjust the
account as of December 31. Assume that on December 31 the
direct exchange rates was Taiwan dollar $.0351.
Accounts payable
2,000
Transaction gain
2,000
Payable in pesos
Direct exchange rate to U.S. dollar
Payable in U.S. dollars
Balance in payable
Transaction gain
Chapter
12-17
LO 3 Common transactions.
500,000
$
.0351
$ 17,550
19,550
$
2,000
LO 4 Three stages of concern.
Importing and Exporting Transactions
Exercise 2 Prepare journal entry to record settlement of
account on January 10. Assume that the direct exchange
rate on the settlement date was Taiwan dollar $.0398.
Transaction loss
2,350
Accounts payable ($19,550 - $2,000)
Cash (500,000 x $.0398)
Chapter
12-18
LO 3 Common transactions.
17,550
19,900
LO 4 Three stages of concern.
Importing and Exporting Transactions
Importing or Exporting of Goods or Services
Foreign currency transaction gains and losses
are included in net income.
Chapter
12-19
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing and Exporting Transactions
Hedging Foreign Exchange Rate Risk
Derivative Instrument - a financial instrument that
provides the holder (or writer) with the right (or obligation)
to participate in some or all of the price changes of another
underlying value of measure, but does not require the holder
to own or deliver the underlying value of measure.
Two broad categories:
Forward-based
Option-based
Chapter
12-20
Derivatives are recognized in the
balance sheet at their fair value,
resulting in a payable position for
one party and a receivable
position for the other.
Importing and Exporting Transactions
Forward Exchange Contracts
A forward exchange contract (forward contract) is an
agreement to exchange currencies of two different countries
at a specified rate (the forward rate) on a stipulated
future date.
Chapter
12-21
LO 5 Forward exchange contracts.
Importing and Exporting Transactions
Which Kind of Forward Contract to Choose?
1. Forward Contract used as a Hedge of a(n):
a. Foreign currency transaction.
b. Unrecognized firm commitment (a fair value hedge).
c. Foreign-currency-denominated “forecasted”
transaction (a cash flow hedge).
d. Net investment in foreign operations.
2. Speculation
Forward contracts used to speculate changes in foreign
currency.
Chapter
12-22
LO 5 Forward exchange contracts.
Using Forward Contracts as a Hedge
Hedge of a Foreign Currency Exposed Liability
Problem 2 Crystal Exporting Co. is a U.S. wholesaler engaged
in foreign trade. The following transaction is representative
of its business dealings. The company uses a periodic
inventory system and is on a calendar-year basis. All
exchange rates are direct quotations.
Dec. 1 Crystal Exporting purchased merchandise from
Chang’s Ltd., a Hong Kong manufacturer. The invoice was for
210,000 Hong Kong dollars, payable on April 1. On this same
date, Crystal Exporting acquired a forward contract to buy
210,000 Hong Kong dollars on April 1 for $.1314.
Chapter
12-23
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 (additional facts)
April 1 Crystal Exporting submitted full payment of 210,000
Hong Kong dollars to Chang’s, Ltd., after obtaining the
210,000 Hong Kong dollars on its forward contract.
Spot rates and the forward rates for the Hong Kong dollar
were as follows:
Forward Rate for
Spot Rate ($) April 1 Delivery ($)
Dec. 1
.1265
.1314
Dec. 29
.1240
.1305
Dec. 31
.1259
.1308
April 1
.1430
Chapter
12-24
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on December 31.
Dec 1
Purchases
26,565
Accounts Payable
26,565
Hong Kong dollars
Chapter
12-25
210,000
Dec. 1 Direct Spot Rate
$
.1265
Payable in U.S. dollars
$
26,565
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on December 1.
Dec 1 FC Receivable from Exch. Dealer
27,594
Dollars Payable to Exch. Dealer
27,594
Hong Kong dollars
Chapter
12-26
210,000
Dec. 1 Forward Rate
$
.1314
Payable in U.S. dollars
$
27,594
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on December 31.
Dec 31 Accounts Payable
126
Transaction Gain
126
Hong Kong dollars
210,000
Dec. 31 Spot Rate
$
.1259
Payable in U.S. dollars
$
26,439
Payable recorded on Dec. 1
Transaction gain
Chapter
12-27
26,565
$
126
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on December 31.
Dec 31 Transaction Loss
126
FC Receivable from Exchange Dealer
Hong Kong dollars
210,000
Dec. 31 Forward Rate
$
.1308
Payable in U.S. dollars
$
27,468
Payable recorded on Dec. 1
Transaction loss
Chapter
12-28
126
27,594
$
(126)
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on Apr 1.
Apr 31 Transaction Loss
3,591
Accounts payable
3,591
Hong Kong dollars
210,000
Apr. 1 Spot Rate
$
.1430
Payable in U.S. dollars
$
30,030
Payable established on Dec. 31
Transaction loss
Chapter
12-29
26,439
$
(3,591)
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on Apr 1.
Apr 1
FC Receivable from Exch. Dealer
2,562
Transaction Gain
2,562
Hong Kong dollars
210,000
Apr. 1 Spot Rate
$
.1430
Payable in U.S. dollars
$
30,030
Payable established on Dec. 31
Transaction loss
Chapter
12-30
27,468
$
2,562
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions
including the necessary adjustments on Apr 1.
Apr 1
Investment in Foreign Currency
30,030
Dollars Payable to Exch. Dealer
27,594
Cash
27,594
FC Receivable from Exch. Dealer
30,030
(payment to dealer and receipt of 210,000 Hong Kong dollars)
Accounts Payable
30,030
Investment in Foreign Currency
30,030
(payment of liability upon transfer of 210,000 Hong Kong dollars)
Chapter
12-31
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Problem 2 Transaction Summary
Transaction
Hedged Item
Balance
Gain/(Loss)
Accounts Payable
Dec. 1
Hedge
Balance
Gain/(Loss)
FC Receivable
$
26,565
Dec. 31
26,439
Apr. 1
30,030
Total gain/(loss)
Transaction
Dec. 1
$
126
(3,591)
$
(3,465)
$ 27,594
Dec. 31
27,468
Apr. 1
30,030
$
(126)
2,562
$
2,436
Thus the net effect is a $1,029 loss when the
forward contract is used.
Chapter
12-32
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Hedge of a Foreign Currency Exposed Asset
Accounting for a forward contract entered into as a hedge of
an exposed receivable position is similar to an exposed
liability position.
Because the U.S. firm will be receiving foreign currency in
settlement of the exposed receivable balance, it will enter
into a forward contract to sell foreign currency for U.S.
dollars.
Chapter
12-33
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Fair Value Hedge—Hedging an Unrecognized Foreign
Currency Commitment
 A U.S. firm, at a date earlier than the transaction date,
may make a commitment to a foreign company to buy or
sell goods at a price established in foreign currency.
 Changes in the exchange rate between the commitment
date and transaction date would be reflected in the cost
or sales price of the asset.
 The U.S. firm may enter a forward contract to hedge its
commitment.
Chapter
12-34
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Exercise 14 Consider the following information:
1. On December 1, 2008, a U.S. firm contracts to sell equipment
(with an asking price of 10,000 pesos) in Mexico. The firm will
take delivery and will pay for the equipment on March 1, 2009.
2. On December 1, 2008, the company enters into a forward
contract to sell 10,000 pesos for $9.48 on March 1, 2009.
3. Spot rates and the forward rates for March 1, 2009,
settlement were as follows (dollars per peso):
December 1, 2008
Balance sheet date (12/31/08)
March 1, 2009
Spot Rate
$9.54
9.49
9.47
Forward Rate
$9.48
9.44
4. On March 1, the equipment was sold for 10,000 pesos. The cost
of the equipment was $40,000.
Chapter
12-35
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Exercise 12-14 Prepare all journal entries needed on December
1, December 31, and March 1 to account for the forward contract,
the firm commitment, and the transaction to sell the equipment.
Dec 1
Receivable from Exchange Dealer*
94,800
FC Payable to Exchange Dealer
Dec 31 FC Payable from Exchange Dealer**
94,800
400
Foreign Exchange Gain
Foreign Exchange Loss
Firm Commitment**
400
400
400
* (10,000 x $9.48 = $94,800)
** [(10,000 x ($9.48 - $9.44)] = $400
Chapter
12-36
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Exercise 14 Prepare all journal entries needed on December 1,
December 31, and March 1 to account for the forward contract,
the firm commitment, and the transaction to sell the equipment.
Mar 1
Foreign Exchange Loss
300
FC Payable from Exchange Dealer*
Firm Commitment*
300
300
Foreign Exchange Gain
300
Investment in FC
94,700
Firm Commitment
100
Sales (10,000 x 9.48)
94,800
* [(10,000 ´ ($9.44 - $9.47)] =$300
Chapter
12-37
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Exercise 12-14 Prepare all journal entries needed on December
1, December 31, and March 1 to account for the forward contract,
the firm commitment, and the transaction to sell the equipment.
Mar 1
Cash
94,800
FC Payable to Exchange Dealer
94,700
Investment in FC
94,700
Dollars Receivable from Exchange Dealer
94,800
Cost of Goods Sold
Inventory
Chapter
12-38
40,000
40,000
LO 7 Forward contracts as a hedge.
Using Forward Contracts as a Hedge
Cash Flow Hedge-A Forecasted Transaction
 Cash Flow Hedge - hedging cash flows for future
transactions that have not yet occurred or for which
there are no firm commitments.
 Cash flow hedges may defer the Income statement
recognition of gains and losses on forecasted transactions
if certain criteria are met.
 Amounts in accumulated other comprehensive income are
reclassified into earnings in the same period which the
hedged forecasted transaction affects earnings.
Chapter
12-39
LO 7 Fair value hedge vs. cash flow hedge.
Using Forward Contracts as a Hedge
Exercise 13 Consider the following information:
1. On December 1, 2008, a U.S. firm plans to purchase a piece of
equipment (with an asking price of 100,000 francs) in
Switzerland during January of 2009. The transaction is
probable, and the transaction is to be denominated in euros.
2. On December 1, 2008, the company enters into a forward
contract to buy 100,000 francs for $1.01 on January 31, 2009.
3. Spot rates and the forward rates for January 31, 2009,
settlement were as follows (dollars per francs):
December 1, 2008
Balance sheet date (12/31/08)
Jan. 31 and Feb. 1, 2009
Spot Rate
$0.99
1.01
1.04
Forward Rate
$1.01
1.02
4. On Feb. 1, the equipment was purchased for 100,000 francs.
Chapter
12-40
LO 7 Fair value hedge vs. cash flow hedge.
Using Forward Contracts as a Hedge
Exercise 12-13 Prepare all journal entries needed on Dec. 1, Dec.
31, Jan. 31, and Feb. 1 to account for the forecasted transaction,
the forward contract, and the transaction to buy the equipment.
Dec.1
FC Receivable from Exchange Dealer
101,000
Dollars Payable to Exchange Dealer*
Dec.31 FC Receivable from Exchange Dealer**
Foreign Exchange Gain – OCI
101,000
1,000
1,000
* (100,000 x $1.01) = $101,000
** [(100,000 x ($1.01- $1.02)] = $1,000
Chapter
12-41
LO 7 Fair value hedge vs. cash flow hedge.
Using Forward Contracts as a Hedge
Exercise 12-13 Prepare all journal entries needed on Dec. 1, Dec.
31, Jan. 31, and Feb. 1 to account for the forecasted transaction,
the forward contract, and the transaction to buy the equipment.
Jan.31 FC Receivable from Exchange Dealer
Foreign Exchange Gain – OCI
2,000
2,000
[(100,000 ´ ($1.02- $1.04)]
Investment in FC
104,000
Dollars Payable to Exchange Dealer
101,000
Cash
FC Receivable from Exchange Dealer
Feb. 1 Equipment
Investment in FC
Chapter
12-42
101,000
104,000
104,000
104,000
LO 7 Fair value hedge vs. cash flow hedge.