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Foreign Currency Concepts and Transactions Chapter 12
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Learning Objective 1
Introduce foreign currency and definitions.
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Foreign Exchange Concepts and Definitions

Currencies provide a standard of value, a medium of exchange, and a unit of measure
for economic transactions.

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In the case of transactions between business entities of different countries, the amounts receivable and payable are denominated in local currency of either the buying or the selling entity.
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Exchange rates are essentially prices for currencies expressed in units of other currencies.
.0082
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Understand quotation conventions for foreign currency and exchange rates.
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Direct and Indirect Quotation of Exchange Rates

Assume that $1.60 can be exchanged for 1. Direct quotation (U.S. dollar equivalent): $1.60 = $1.60 1 Indirect quotation (foreign currency per U.S. dollar): 1 = 0.625 $1.60
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Floating, Fixed, and Multiple Exchange Rates.

Weakens Floating Strengthens Fixed Multiple
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The Euro
Twelve member states of the European Union chose to participate in the transition to a single currency for Europe, the Euro.
The euro currency is managed by the European Central Bank.
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Spot, Current, and Historical Exchange Rates

Spot rate the exchange rate for immediate delivery of currencies exchanged Current rate the exchange rate at the balance sheet date or the transaction date Historical rate the rate in effect at the date a specific transaction or event occurred
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 10
Learn foreign-currencydenominated transactions accounting.
Foreign Currency Transactions Other Than Forward Contracts

Local transactions Foreign transactions
An entitys functional currency is the currency of an entitys primary economic environment.

Foreign Currency Transactions Other Than Forward Contracts

Foreign currency transactions are stated (denominated) in a currency other than an entitys functional currency.
The provisions of FASB Statement No. 52 apply only to foreign currency transactions and foreign currency financial statements.
Translation at the Spot Rate

A U.S. corporation imports inventory from a Canadian firm when the spot rate for Canadian dollars is $.70 The invoice calls for payment of 10,000 Canadian dollars in 30 days. How does the U.S. importer record the transaction?

Inventory 7,000 Accounts Payable (fc) 7,000 (Translation 10,000 Canadian dollars .70 spot rate)
If the account payable is settled when the spot rate is $.69, how is it recorded?
Accounts payable (fc) 7,000 Exchange Gain 100 Cash 6,900 (Cash required equals 10,000 Canadian dollars the $0.69 spot rate)
Purchases Denominated in Foreign Currency

American Trading Company purchased goods from Kimetz Company on December 1, 2008, for 10,000 euros when the spot rate for euros was $0.6600. AT closed its books at December 31, 2008, when the spot rate for euros was $0.6550, and settled the account on January 30, 2009, when the spot rate was $0.6650.

December 1, 2008 Inventory 6,600 Accounts Payable (fc) 6,600 To record purchase of merchandise from Kimetz Company (10,000 euros $0.6600 rate) December 31, 2008 Accounts Payable (fc) 50 Exchange Gain 50 To adjust accounts payable to exchange rate at year end [10,000 euros ($0.6600 $0.6550)]

January 30, 2009 Accounts Payable (fc) 5,550 Exchange Loss 100 Cash 6,650 To record payment in full to Kimetz Company (10,000 euros $0.6650 spot rate)
Sales Denominated in Foreign Currency

On December 16, 2008, American Trading sold merchandise to Kimetz for 20,000 euros when the spot rate for euros was $0.6600. AT closed its books at December 31, when the spot rate was $0.6550, collected the account on January 15, 2009, when the spot rate was $0.6700, and held the cash until January 20, when it converted the euros into USD at a $0.6725 rate.

December 15, 2008 Accounts Receivable (fc) 13,200 Sales 13,200 To record sales to Kimetz (20,000 euros $0.6600 spot rate) December 31, 2008 Accounts Receivable (fc) 100 Exchange Gain 100 To adjust accounts receivable year end [20,000 euros ($0.6650 $0.6600)]

January 15, 2009 Cash 13,400 Accounts Receivable (fc) Exchange Gain 13,300 100
To record collection in full from Kimetz (20,000 euros $0.6700) and recognize exchange gain for 2009 [20,000 euros ($0.6700 $0.6650)]
January 20, 2009 Cash Exchange Gain Cash (fc)
13,450 50 13,400
To convert 20,000 euros into U.S. dollars (20,000 euros $0.6725)

Comprehend cash flow hedge accounting and fair value hedge accounting.
Foreign Currency Derivatives and Hedging Activities

Derivative is the name given to a broad range of financial securities. The derivative contracts value to the investor is directly related to the fluctuations in price, rate, or some other variable that underlies it.
Derivative Instruments
Options contracts
Forward contracts
Future contracts
Options are rights to take an action, but the holder is not obligated to do so.
A forward contract is negotiated between the parties and not through an exchange.
Futures contracts bind both parties (the writer and the holder) to perform.
A cash flow hedge is designed to limit the companys exposure to price changes in forecasted purchases.
A company signs an option contract on January 15, 2003, at a cost of $1,000. The company can exercise its option to purchase 100,000 gallons of fuel at $1 per gallon. The option expires on May 31, 2003.
January 15, 2003 Fuel Contract Option 1,000 Cash 1,000 The company prepares its quarterly report on March 31, 2003. Market price of fuel is $1.25. The company could exercise the option on this date.
March 31, 2003 Fuel Contract Option Other Comprehensive Income Unrealized Holding Gains on Fuel Option Contract 24,000
24,000
On May 31, 2003, the fuel price is $1.30. The writer of the option must pay the company $0.30 per gallon, or $30,000.
May 31, 2003 Fuel Inventory Cash
130,000
130,000
Cash 30,000 Fuel Contract Option Other Comprehensive Income
25,000 5,000
The fuel inventory is used on June 15, 2003.
June 15, 2003 Cost of Goods Sold Fuel Inventory Other Comprehensive Income Cost of Goods Sold 130,000 130,000 30,000
30,000
Fair Value Hedges
A fair value hedge is a derivative contract that attempts to reduce the price risk of an existing asset or firm purchase commitment.
Summary of Forward Contracts (Speculation)

Purpose To speculate in exchange rate changes Recognition Exchange gains and losses are recognized currently, based on forward exchange rate changes. Expected Effect of Hedge and Related Foreign Currency Item Income effect equals exchange gains and losses recognized.
Summary of Forward Contracts

(Hedge of a Net Asset or Liability Position)
Purpose To offset exposure to existing net asset or liability position Recognition Exchange gains and losses are recognized currently, but they are offset by related gains or losses on net asset or liability position. Expected Effect of Hedge and Related Foreign Currency Item Income effect equals the amortization of premium or discount (gains and losses offset.)

(Hedge of an Identifiable Commitment)
Purpose To offset exposure to a future purchase or sale and thereby lock in the price of an existing contract Recognition Exchange gains and losses are recognized currently, but are offset by related gains or losses in the firm commitment. Expected Effect of Hedge and Related Foreign Currency Item Income effect equals the difference in the change in value of the instrument versus the firm commitment.

(Hedge of an Anticipated Transaction)
Purpose To offset exposure of possible future purchase or sale Recognition Exchange gains or losses on the hedge counted in other comprehensive income until the underlying transaction is complete. Expected Effect of Hedge and Related Foreign Currency Item No immediate income effect. Adjusts underlying transaction.

(Hedge of a Net Investment in a Foreign Entity)
Purpose To offset exposure to an existing net investment in a foreign entity Recognition Exchange gains and losses are recognized as other comprehensive income and will offset translation adjustments recorded on the net investment. Expected Effect of Hedge and Related Foreign Currency Item Income effect equals the change in the future value of the hedge versus the value of the net investment.
The Four Fundamental Decisions

Derivative instruments represent rights or obligations.
Fair value is the most relevant measurement.
The Four Fundamental Decisions

Only items that are assets or liabilities should be reported.
Special accounting should be provided only for qualifying items.
Apply foreign-currencydenominated derivative accounting.
Speculation
Exchange gains or losses on derivative instruments that speculate in foreign currency price movements are included in income in the period in which the forward exchange rates change.
Speculation
On November 2, 2007, U.S. International enters into a 90-day forward contract (future) to purchase 10,000 euros (). The current quotation for 90-day futures is 5,400. The spot rate for euros on November 2 is $0.5440.
Speculation
December 31, 2007 January 30, 2008
30-day futures Spot rate $0.5450 $0.5500 $0.5480 $0.5530
What are the journal entries of U.S. International to account for the speculation?
Speculation
November 2, 2007 Contract Receivable (fc) 5,400 Contract Payable 5,400 To record contract for 10,000 euros $0.5400 exchange rate for 90-day futures
Speculation
December 31, 2007 Contract Receivable (fc) 50 Exchange Gain 50 To adjust receivable from exchange broker and recognize exchange gain 10,000 euros ($0.5450 forward exchange rate for 30-day futures $0.5400 per books)
End of Chapter 12

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Foreign Currency Concepts and Transactions Chapter 12

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Introduce foreign currency and definitions.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Foreign Exchange Concepts and Definitions

for economic transactions.

Foreign Exchange Concepts and Definitions

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Foreign Exchange Concepts and Definitions

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Understand quotation conventions for foreign currency and exchange rates.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Direct and Indirect Quotation of Exchange Rates

Floating, Fixed, and Multiple Exchange Rates.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Spot, Current, and Historical Exchange Rates

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 10

Learn foreign-currencydenominated transactions accounting.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 11

Foreign Currency Transactions Other Than Forward Contracts

An entitys functional currency is the currency of an entitys primary economic environment.

Foreign Currency Transactions Other Than Forward Contracts

Translation at the Spot Rate

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 14

Translation at the Spot Rate

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 15

Translation at the Spot Rate

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 16

Purchases Denominated in Foreign Currency

Purchases Denominated in Foreign Currency

Purchases Denominated in Foreign Currency

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 19

Sales Denominated in Foreign Currency

Sales Denominated in Foreign Currency

Sales Denominated in Foreign Currency

January 20, 2009 Cash Exchange Gain Cash (fc)

To convert 20,000 euros into U.S. dollars (20,000 euros $0.6725)

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 23

Foreign Currency Derivatives and Hedging Activities

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 24

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 26

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 28

Cash 30,000 Fuel Contract Option Other Comprehensive Income

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 31

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 32

Fair Value Hedges

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 33

Summary of Forward Contracts (Speculation)

Summary of Forward Contracts

Summary of Forward Contracts

Summary of Forward Contracts

Summary of Forward Contracts

The Four Fundamental Decisions

Fair value is the most relevant measurement.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 39

The Four Fundamental Decisions

Special accounting should be provided only for qualifying items.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 40

Apply foreign-currencydenominated derivative accounting.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 41

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 42

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 43

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 45