Download Foreign Currency Transactions

11-1
Baker / Lembke / King
Multinational
Accounting:
Foreign Currency
Transactions and
Financial
Instruments
McGraw-Hill/ Irwin
11
Electronic Presentation by
Douglas Cloud
Pepperdine University
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Factors Affecting Exchange Rates
• Level of inflation
• Balance of payments
• Changes in interest rate and
investment level
• Stability and process of governance
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11-2
European Monetary Union (EMU)
• Germany
• France
• Italy
• Spain
• Portugal
• Finland
• Ireland
• Belgium
• Netherlands
• Austria
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11-3
11-4
Direct Exchange Rate
U. S. Dollar Equivalent Value
1 Foreign Currency Unit
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11-5
Direct Exchange Rate
$1.20
1 Foreign Currency Unit
= $1.20
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Indirect Exchange Rate
1 Foreign Currency Unit
U. S. Dollar Equivalent Value
1
$1.20
=
0.8333
or
0.8333 = $1
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11-6
Relationships Between Currencies and Rates
January 1
Direct exchange rate:
U.S. dollar relative to
the European Euro
$1.200
Indirect exchange rate:
European Euro relative to
the U.S. dollar
0.8333
Between January 1 and July 1:
July 1
$1.100
December 31
$1.160
0.9090
0.8620
Direct rate decreases
Dollar strengthens
Euro weakens
Indirect rate increases
Foreign goods imported in the
U.S. are less expensive
U.S.-made exports from U.S.
are more expensive
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11-7
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Relationships Between Currencies and Rates
January 1
Direct exchange rate:
U.S. dollar relative to
the European Euro
$1.200
Indirect exchange rate:
European Euro relative to
the U.S. dollar
0.8333
Between July 1 and December 31
McGraw-Hill/ Irwin
July 1
$1.100
11-8
December 31
$1.160
0.9290
0.8620
Direct rate increases
Dollar weakens
Euro strengthens
Indirect rate decreases
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions
 Purchases or sales of goods or services
(imports or exports), the prices of which
are stated in a foreign currency.
 Loans payable or receivable in a foreign
currency.
 The purchase or sale of forward
exchange contracts in a foreign currency.
 Purchase or sale of foreign currency
units.
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11-9
11-10
Foreign Currency Transactions
A U.S. company acquires 5,000 from its
bank on January 1, 20X1; for use in further
purchases from German companies.
January 1, 20X1
Foreign Currency Units ( )
Cash
McGraw-Hill/ Irwin
6,000
6,000
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11-11
Foreign Currency Transactions
On July 1, 20X1, the exchange rate is
$1.100 = 1.
January 1,20X1
(Acquire euros)
$1.200
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July 1, 20X1
Direct exchange rate
$1.100
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Foreign Currency Transaction Gain/Loss
11-12
On July 1, 20X1, the exchange rate is
$1.100 = 1.
Equivalent dollar value of
January 1: 5,000 x $1.200
Equivalent dollar value of 5,000 on
July 1:
5,000 x $1.100
Foreign currency transaction loss
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$6,000
5,500
$ 500
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Foreign Currency Transaction Loss
11-13
Foreign Currency Transaction Loss 500
Foreign Currency Units ( )
500
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Foreign Currency Transactions
11-14
Required accounting for an
import or export foreign currency
transaction on credit for the
following dates:
 Transaction date
 Balance sheet date
 Settlement date
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Foreign Currency Transactions
11-15
Required accounting for an import
or export foreign currency
transaction on credit is as follows:
 Transaction date
 Balance sheet date
 Settlement date
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Record the purchase
or sale transaction at
the U.S. dollar
equivalent value
using the spot rate of
exchange on this date.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions
11-16
Required accounting for an import
or export foreign currency
transaction on credit is as follows:
 Transaction date
 Balance sheet date
 Settlement date
McGraw-Hill/ Irwin
Adjust the payable or
receivable to its U.S.
dollar equivalent ,
end-of-period value
using the current
exchange rate.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions
11-17
Required accounting for an import
or export foreign currency
transaction on credit is as follows:
 Transaction date
 Balance sheet date
 Settlement date
McGraw-Hill/ Irwin
First, adjust the
foreign currency
payable or receivable
for any changes in the
exchange rate from
the balance sheet date
to the settlement date.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions
11-18
Required accounting for an import
or export foreign currency
transaction on credit is as follows:
 Transaction date
 Balance sheet date
 Settlement date
McGraw-Hill/ Irwin
Then, record the
settlement of the
foreign currency
payable or receivable.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-19
Illustration of Foreign Purchase Transaction
On October 1, 20X1, Peerless Products, a U.S. company,
acquired goods on account from Tokyo Industries, a Japanese
company, for $14,000, or 2,000,000 yen. Settlement is made on
April 1, 20X2, in the next fiscal period.
October 1, 20X1
(Direct exchange rate = $.0070)
Inventory
Accounts Payable (¥)
14,000
14,000
¥2,000,000 x $.0070 spot rate = $14,000
If Denominated in Japanese Yen
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11-20
Illustration of Foreign Purchase Transaction
An adjusting entry is needed on the balance sheet date
to reflect the current exchange rate. The direct
exchange rate on December 31, 20X1 is $.0080.
December 31, 20X1
(Direct exchange rate = $.0080)
Foreign Currency Transaction Loss
Accounts Payable (¥)
2,000
2,000
¥2,000,000 x $.0080 Dec. 31 spot rate = $16,000
¥2,000,000 x $.0070 Oct. 1 spot rate = 14,000
$ 2,000
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11-21
Illustration of Foreign Purchase Transaction
Settlement of the payable was made on April 1, 20X2.
April 1, 20X2
(Direct exchange rate = $.0076)
Accounts Payable (¥)
Foreign Currency Transaction Gain
800
800
¥2,000,000 x $.0076 Apr. 1 spot rate = $15,200
¥2,000,000 x $.0080 Dec. 31 spot rate = 16,000
$ 800
Step 1
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11-22
Illustration of Foreign Purchase Transaction
Settlement of the payable was made on April 1, 20X2.
April 1, 20X2
(Direct exchange rate = $.0076)
Foreign Currency Units (¥)
Cash
Accounts Payable (¥)
Foreign Currency Units (¥)
15,200
15,200
15,200
15,200
Step 2
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11-23
Illustration of Foreign Purchase Transaction
Some accountants combine the revaluation and
settlement entries into one entry.
Foreign Currency Units (¥)
Cash
Accounts Payable (¥)
Foreign Currency Transaction Gain
Foreign Currency Units (¥)
McGraw-Hill/ Irwin
15,200
15,200
16,000
800
15,200
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Foreign Currency Payable
11-24
Accounts Payable (¥)
AJE: A/P (¥)
Gain
McGraw-Hill/ Irwin
10/1/X1
14,000
(¥2,000,000 x $.0070)
AJE: Loss
A/P (¥)
2,000
12/31/X1
16,000
(¥2,000,000 x $.0080)
800
4/1/X2
(¥2,000,000 x $.0076) 15,200
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-25
A Derivative Defined
FASB 133 defines a derivative as a financial instrument or
contract possessing all of the following characteristics:
 The financial instrument must contain one or more
underlying, and one or more notional amounts.
An underlying is anyA notional amount is the
financial or physicalnumber of currency units,
variable that has shares, bushels, pounds, or
observable or objectively
other units specified in the
verifiable changes. financial instrument.
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11-26
A Derivative Defined
FASB 133 defines a derivative as a financial instrument or
contract possessing all of the following characteristics:
 The financial instrument must contain one or more
underlying, and one or more notional amounts.
 The financial instrument or other contract requires no initial
net investment that is smaller than would be required for
other types of contracts that would be expected to have a
similar response to changes in market factors.
 The terms of the contract require or permit net settlement,
or provide for the delivery of an asset that puts the recipient
in an economic position not substantially different from net
settlement.
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11-27
FASB 133
1. General rule of valuing at fair value.
2. Embedded derivatives--separate derivative
from host contract.
3. Hedge
a. Documentation to justify hedge at
beginning of contract or hedge.
b. Effectiveness to match changes in value
of hedged item (reassess every three
months).
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Three Types of Hedges in FASB 133
11-28
1. Fair-value hedge: a hedge of changes in the fair value of:
(a) a recognized asset or liability, or
(b) an unrecognized firm commitment
- gain or losses on fair value hedges go to current
earnings
2. Cash-flow hedge: a hedge of the exposure to variability in
the projected cash flows of:
(a) a recognized asset or liability, or
(b) a forecasted transaction
- gains and losses on the effective portion of the hedge go
to OCI; other gains and losses go to current earnings
Continued next slide
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Three Types of Hedges in FASB 133
11-29
3. Foreign currency hedge: a hedge of the foreign currency
exposure of:
(a) an unrecognized firm commitment,
(b) an available-for-sale security.
(c) a forecasted transaction, or
(d) a net investment in a foreign operation
McGraw-Hill/ Irwin
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Forward Exchange Contracts
The FASB recognizes
three major purposes
of forward exchange
contracts.
McGraw-Hill/ Irwin
11-30
 To hedge an exposed
foreign currency net
asset or liability
position.
 To hedge an
identifiable foreign
currency commitment.
 To speculate in foreign
currency markets.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Hedging an Exposed Position: Time Line
10/1/X1
Transaction
date
12/31/X1
Balance sheet
date
• Incur liability
denominated in yen
• Sign 180-day forward
contract to receive yen
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11-31
4/1/X2
Settlement
date
• Obtain yen by settling
forward exchange
contract
• Pay yen to settle
account payable
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11-32
Hedging an Exposed Position: Main Points
 Account payable or receivable denominated in
foreign currency valued at U.S. dollar equivalent
value using the spot exchange rate.
 Foreign exchange contract foreign currency
receivable or payable with exchange broker
valued at fair value using the forward exchange
rate.
 Exchange gain (losses) are recognized in current
earnings in period of change in exchange rates.
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11-33
Example Exchange Rates
Date
Spot Rate
October 1, 20X1
$.0070
December 31, 20X1 $.0080
April 1, 20X2
$.0076
Forward Rate
$.0075 (180-day)
$.0077 (90-day)
¥2,000,000 is the amount of both the accounts
payable and the forward contract receivable
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Hedging Exposed Net Liability Position
11-34
Forward Contract Rec.(¥) Accounts Payable (¥)
10/1 FCRec(¥) 15,000
Inventory 14,000
Doll. Pay 15,000
A/P(¥)
14,000
FERate = $.0075
Spot rate = $.0070
12/31FCRec(¥)
400
FC Gain
400
FERate = $.0077
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FC Loss
2,000
A/P(¥)
2,000
Spot rate = $.0080
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Hedging Exposed Net Liability Position
11-35
Forward Contract Rec.(¥) Accounts Payable (¥)
4/1 Doll. Pay 15,000
Cash
15,000
FERate = $.0075
FCU (¥) 15,200
A/P (¥) 15,200
FCRec(¥) 15,200
FCU (¥)
15,200
Spot rate = $.0076
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Hedging an Identifiable Foreign Currency
Commitment: Major Points
11-36
11-34
 On date of commitment (8/1/X1) FASB 133 specifies
separation of forward exchange contracts into components:
– Financial instrument component (obligation to pay yen)
– Nonfinancial asset component (right to receive
inventory)
 At point of receipt of inventory goods (10/1/X1):
– Revalue forward contract to fair value, recognizing loss
or gain
– Record gain or loss on financial instrument component
of commitment
– Close Firm Commitment account to inventory
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Hedging Foreign Commitment
11-37
Forward Contract Rec.(¥) Firm Commitment
8/1 FCRec(¥) 14,600
Doll. Pay 14,600
FERate = $.0073
10/1 FCRec(¥)
400
FC Loss
400
FC Gain
400
Firm Comm. 400
FERate = $.0075
FERate = $.0075
Inventory 13,600
Firm Comm. 400
A/P(¥)
14,000
Spot rate = $.0070
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Speculation with Forward Contracts:
Time Line
10/1/X1
Enter 180-day
speculative
forward
contract
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12/31/X1
Balance sheet date
11-38
11-36
4/1/X2
Deliver Swiss
francs and
receive dollars
to settle
forward
contract
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Speculation: Forward Exchange Contract
11-39
 Value forward
contract using
forward exchange
rate for remainder of
term
 No separate
accounting for
premium or discount
on forward contracts
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Speculation: Forward Exchange Contract
11-40
Foreign Currency Payable (SFr)
10/1/X1
2,960
(SFr4,000 x $.74 Forward
rate)
AJE: Loss
FC Pay (SFr)
160
12/31/X1
3,120
(SFr4,000 x $.78 Forward
rate)
AJE: FCPay (SFr)
Gain
40
4/1/X2
(SFR4,000 x $.77 Spot)
McGraw-Hill/ Irwin
3,080
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11-41
Foreign Exchange Matrix
Direct Exchange Rate Changes
Transactions or Accounts
Denominated in Foreign
Currency Units
Exchange Rate Increases Exchange Rate Decreases
(dollar has weakened) (dollar has strengthened)
Net monetary asset position,
for example:
(1) Foreign Currency Units
(2) Accounts Receivable
(3) Foreign Currency
Receivable from
Exchange Brokers
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EXCHANGE
EXCHANGE
GAIN
LOSS
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11-42
Foreign Exchange Matrix
Direct Exchange Rate Changes
Transactions or Accounts
Denominated in Foreign
Currency Units
Exchange Rate Increases Exchange Rate Decreases
(dollar has weakened) (dollar has strengthened)
Net monetary liability
position, for example:
(1) Accounts Payable
(2) Bonds Payable
(3) Foreign Currency
Payable to Exchange
Brokers
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EXCHANGE
EXCHANGE
LOSS
GAIN
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11-43
Chapter Eleven
The
End
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