CHAPTER 6

FOREIGN CURRENCY
TRANSACTIONS
AND
HEDGING FOREIGN
EXCHANGE RISK

FOREIGN CURRENCY TRANSACTIONS

Export sales and import purchases are

international transactions. When two parties
from different countries enter into a
transaction, they must decide which of the
two countries' currencies to use to settle the
transaction. For example, if a U.S. computer
manufacturer sells to a customer in Japan, the
parties must decide whether the transaction
will be denominated (i.e., whether payment
will be made) in U.S. dollars or Japanese yen.
In some cases, a third country's currency
might be used to denominate the transaction.

FOREIGN CURRENCY TRANSACTIONS

Assume that a U.S. exporter (Eximco) sells

goods to a Spanish customer with payment to
be made in euros. In this situation, Eximco
has entered into a foreign currency
transaction. It must restate the euro amount
that actually will be received into U.S. dollars
to account for this transaction. This is because
Eximco keeps its books and prepares financial
statements in U.S. dollars. Although the
Spanish importer has entered into an
international transaction, it does not have a
foreign currency transaction (payment will be
made in its home currency) and no
restatement is necessary.

 Assume that as is customary in its industry,

Eximco does not require immediate payment
and allows its Spanish customer three months
to pay for its purchases. By doing this, Eximco
runs the risk that from the date of the sale is
made until the date of payment, the euro
might decrease in value (depreciate) against
the US. dollar and the actual number of U.S.
dollars generated from the sale will be less
than expected. In this situation Eximco is said
to have an exposure to foreign exchange risk.

Accounting Issue

The major issue in accounting for foreign currency

transactions is how to deal with the change in the
domestic currency value of the sales revenue and
account receivable resulting from the export when
the foreign currency changes in value. The corollary
issue is how to deal with the change in the domestic
currency value of the foreign currency account
payable and goods being acquired in an import
purchase.
Assume that Eximco sells goods to a Spanish
customer at a price of 1 million euros () when the
spot exchange rate is $1.50 per euro. If payment
were received at the date of sale, Eximco could have
converted 1,000,000 into $1,500,000 and this
amount clearly would be the amount at which the
sales revenue would be recognized. Instead, Eximco
allows the Spanish customer three months to pay for

Accounting Alternatives
Conceptually, the two methods of accounting for
changes in the value of a foreign currency transaction
are the one-transaction method and the twotransaction method. The one-transaction method
assumes that an export sale is not complete until the
foreign currency receivable has been collected and
converted into U.S. dollars. Any change in the U.S.dollar value of the foreign currency will be accounted
for as an adjustment to Accounts Receivable and to
Sales. Under this method, Eximco would ultimately
report Sales at $1,480,000 and an increase in the
Cash account of the same amount. This approach can
be criticized because it hides the fact that the
company could have received $1,500,000 if the
Spanish customer had been required to pay at the
date of sale. The company incurs a $20,000 loss

Date of sale

Accounts receivable ()

Foreign Sales
To record the sale and euro receivable at
the spot rate $1.5.

Date
payment

of Foreign Sales
Cash
Accounts receivable ()

1.500.0
00

20.000

1.480.0
00

1.500.0
00

1.500.0
00

Under the two-transaction method, Eximco records

the U.S. dollar value of the sale at the date the sale
occurs. At that point the sale has been completed;
there are no subsequent adjustments to the Sales
account. Any difference between the number of U.S.
dollars that could have been received at the date of
sale and the number of U.S. dollars actually received
at the date of payment due to fluctuations in the
exchange rate is a result of the decision to extend
foreign currency credit to the customer. This
difference is treated as a Foreign Exchange Gain or
Loss that is reported separately from Sales in the
income statement. Using the two-transaction
method to account for its export sale to Spain,
Eximco would make the following journal entries:

Date of sale Accounts receivable ()

1.500.00
0
Foreign Sales

1.500.00
To record the sale and euro
0
receivable at the spot rate
$1.5.

Date
of Foreign exchange loss
payment
Cash(1.000.000*1.48)

Accounts receivable ()

20.000

1.480.00
0
1.500.000

The end of
Income summary
20.000

the year
Foreign
exchange
20.000
Sales
are reported in
income
at theloss
amount that
would

Close
entrycustomer had not been

have
been received
if the
given

three months to pay the 1,000,000, that is,

$1,500,000. A separate Foreign Exchange Loss of
$20,000 is reported in income to indicate that because
of the decision to extend foreign currency credit to the
Spanish customer and because the euro decreased in

Balance Sheet Date before Date of Payment

The question arises as to what accounting should be

done if a balance sheet date falls between the date of
sale and the date of payment. For example, assume
that Eximco shipped goods to its Spanish customer on
December 10, Year 1, with payment to be received on
March 1, Year 2. Assume that at December 10 the spot
rate for euros is $1.50, but by December 31 the euro
has appreciated to $1.51. Is any adjustment needed at
December 31, Year 1, when the books are closed to
account for the fact that the foreign currency receivable
has changed in U.S. dollar value since December 10?
The general consensus worldwide is that a foreign
currency receivable or foreign currency payable should
be revalued at the balance sheet date to account for
the change in exchange rates. Under the twotransaction method, this means that a foreign exchange
gain or loss arises at the balance sheet date. The next

12/1

Accounts receivable ()(1,000,000*1.5)

Foreign Sales

1.500.00
0

To record the sale and euro receivable at

the spot rate of $ 1.50

12/31y Accounts receivable () (1,000,000*0.01)

10.000
1

Foreign exchange gain

Foreign exchange gain

10.000
Income summary

3/1

Foreign exchange loss

Cash (1,000,000*1.48)
Accounts

receivable

1.500.00
0

10.000

10.000

30.000

1.480.00
0
()
1.510.00
includes Sales 0of

The net impact

on income in Year 1
(1,000,000*1.51)
$1,500,000 and a Foreign Exchange Gain of $10,000; in
12/31y2
summary
30000
Year
2, aIncome
Foreign
Exchange Loss of $30,000
is recorded.
Foreign exchange loss

30000

Summary for unsettled transaction accordance with IAS 21

Journal entries for importer 's
Journal entries for exporter's
X Foreign purchases
X

A/P(spot rate)

X A/R(spot rate)
X

X F.E. loss
X X A/P(spot rate at the balance

X F.E. loss
X X A/R(Spot rate at the balance

sheet date)

F.E. Gain

Foreign sales

sheet date)

revalued A/P at the balance

sheet date

F.E. Gain

X F.E. Gain

X x Income summary

X X Income summary

F.E. loss

X A/P(After revalued)

X Cash(spot rate)

X F.E. loss

X F.E. loss

Cash(spot rate)

A/R(After revalued)

F.E. Gain

F.E. Gain

X F.E. Gain

End of
the
year1

revalued A/R at the balance sheet

date

X F.E. Gain
F.E. loss

Date
of
sales

X F.E. Gain

Date
of payment

End of

Example No :1

On November 21, 2014. TAHRIR Company from Egypt had acquiredinventories from XDB Corporation from South Korea for 3 million US
.Dollars, settlement is due on January 18, 2015
- On December 10, 2014. 80% of inventories had sold to Delta
Trading Group for 5 million US Dollars and settlement is due after 15
days.
- On December 25, 2014. The rest of inventories had sold to an
Egyptian company for 6 million EGP. In cash.
The Exchange rates between EGP. And US Dollar were as follows:
Required:
Journalize the foreign currency transactions in Tahrir's co. records in
accordance with IAS 21. (You may omit explanations).
Date 2014
Nov. 21
Dec. 10
Dec. 25
Dec. 31
2015
Jan. 18
Dec. 31

EGP (for
each $)
5.5
5.6
5.3
5.4
5.7
5.3

solution

(amount in millions)

Nov.21/y Foreign purchases

1

Accounts payable ($3 * 5.5=16.5)

Dec.10/ Accounts receivable ($5 * 5.6=28)
y1
Foreign sales
Dec.25/y Cash($5*5.3)
1

Foreign exchange loss

Accounts receivable ($)

Cash

sales

Dec.31/y Accounts payable ($3 * (5.5-5.4=0.1)=.3)

1
Foreign exchange gain
Income summary
Foreign exchange loss

16.5

28

16.5

26.5

28

1.5

0.3

28

0.3
1.2
1.2

Example No: 2
On May 5, 2014 king-star company from Egypt has ordered new
machineries from OTA manufacturing Corporation from France
for 20 million Euro, the settlement will be through two payments
the first 40% after two months from transaction date and the
second after four months from the date of the first payment. On
. June 30 the order has been shipped
Required:
Make the appropriate journal entries on King-Star Company
records until Dec. 31, 2014 in accordance with IAS (21). The
exchange rates between EGP and Euro were as follows:
Date 2014
May 5
June 30
Aug. 30

Exch.
Rate
9.35
9.25
9.15

Date 2014 Exch. Rate

Oct. 30
Dec. 30
Dec. 31
Jan.
30,2015

9.30
9.44
9.20
9.10

solution

(amount in millions)

185
185

machines
*A/P ( 20(

74

Jun 30
185=9.25

A/P((74=9.25*8 =40%*20

73.2

cash( 8*9.15=73.2)

0.8

foreign exchange gain

111

A/P((111=9.25*12 =60%*20

2.28

foreign exchange loss

113.28

Dec. 30

cash( 12*9.44=113.28)

1.48
1.48

Aug 30

Income summary
foreign exchange loss

Dec 31

Example No:3

On May 5, 2014 king-star company from Egypt

has ordered new machineries from OTA
manufacturing Corporation from France for 30
million Euro, the settlement will be through two
payments the first 30% after two months from
transaction date and the second after five months
from the date of the first payment. On June 30 the
. order has been shipped
:Required
Make the appropriate journal entries on KingStar Company records until Dec. 31, 2015 in
accordance with IAS (21). The exchange rates
between EGP and Euro were as follows:

Solution
277.5
277.5

(amount in millions)

machines
*A/P ( 30(

83.25

Jun 30
277.5=9.25

A/P((83.25=9.25*9 =30%*30

82.35

cash( 9*9.15=82.83)

0.9

foreign exchange gain

1.05

1.05

A/P((1.05=(9.25-9.2*)21

Aug
30

Dec.
31

foreign exchange gain

1.95
1.95

foreign exchange gain

Income summary

193.2

A/P((193.2=9.2* 21

2.1

foreign exchange gain

191.1

cash( 21*9.1=191.1)

Jan.
30

HEDGING FOREIGN EXCHANGE RISK

In the preceding example, Eximco has an asset exposure

in euros when it sells goods to the Spanish customer and it
allows the customer three months to pay for its purchase. If
the euro depreciates over the next three months, Eximco
incurs a foreign exchange loss. For many companies, the
uncertainty of not knowing exactly how much domestic
currency will be received on this export sale is of great
concern. To avoid this uncertainty, companies often use
foreign currency derivatives to hedge against the effect of
unfavorable changes in the value of foreign currencies. The
two most common derivatives used to hedge foreign
exchange risk are foreign currency forward contracts and
foreign currency options. Through a forward contract,
Eximco can lock in the price at which it will sell the euros it
receives in three months. An option establishes a price at
which Eximco will be able, but is not required, to sell the
euros it receives in three months. If Eximco enters into a

FORWARD CONTRACT USED TO HEDGE A RECOGNIZED FOREIGN CURRENCY DENOMINATED

We now return to the Eximco example in which the

company has a foreign currency account receivable to
demonstrate the accounting for a hedge of a recognized
foreign-currency-denominated asset. In the preceding
example, Eximco has an asset exposure in euros when it
sells goods to the Spanish customer and allows the
customer three months to pay for its purchase. To hedge its
exposure to a decline in the U.S. dollar value of the euro,
Eximco decides to enter into a forward contract.
Assume that on the date of sales, the three-month
forward rate for euros is $1.485 and Eximco signs a contract
with First National Bank to deliver 1,000,000 in three
months in exchange for $1,485,000. No cash changes hands
on this date. Given that the spot rate on this date is $1.50,
the euro is selling at a discount in the three-month forward
market (the forward rate is less than the spot rate). Because
the euro is selling at a discount of $0.015 per euro, Eximco
receives $15,000 less than if payment had been received at

FORWARD CONTRACT USED TO HEDGE A RECOGNIZED FOREIGN CURRENCY DENOMINATED

Conceptually, this expense is similar to the transaction loss

that arises on the export sale. It exists only because the
transaction is denominated in a foreign currency. The major
difference is that Eximco knows the exact amount of the
discount expense at the date of sale, whereas, if the receivable
is left unhedged, Eximco does not know the size of the
transaction loss until three months pass. In fact, it is possible
that the unhedged receivable could result in a transaction gain
rather than a transaction loss.
Given that the future spot rate turns out to be only $1.48,
selling euros at a forward rate of $1.485 is obviously better
than leaving the euro receivable unhedgedEximco will
receive $5,000 more as a result of the hedge. This can be
viewed as a gain resulting from the use of the forward contract.
Unlike the discount expense, the exact size of this gain is not
known until three months pass. (In fact, it is possible that use
of the forward contract could result in an additional loss. This
would occur if the spot rate on date of payment is higher than
the forward rate of $1.485.)

Journal entries in eximco

Date of sales

A / R (1 1.5)

1.5

Foreign sales

1.5

Forward contract receivable (1 1.485)

1.485

Deferred loss

0.015
1.5

Forward contract (1 1.5)

Date
payment

of Cash (1 1.48)
Foreign Exchange loss

1.48
0.02
1.5

A / R (1 1.5)
Forward contract

1.5

Forward contract gain

0.02

cash (1 1.48)

1.48

Cash
Forward contract receivable

1.485
1.485

End of Forward contract Exp

the year
Deferred loss

0.015
0.015

Forward contract gain

0.02

Income summary

0.015

Forward contract Exp

0.015

Foreign Exchange loss

0.02

Summary for forward contract

Journal entries for importer

Journal entries for exporter

X Foreign purchases
X

A/P(spot rate)

X A/R(spot rate)
X

Foreign sales

X Forward contract (spot rate)

X Forward contract receivable (forward rate)

X Deferred loss

X Deferred loss

Forward contract payable(F. rate)

Forward contract (spot rate)

Deferred Gain

Deferred Gain

X Forward contract payable(F. rate)

X

X Cash(spot rate)
X Foreign Exchange loss

Cash(F.rate)

A/R(rate at date of sales)

Foreign Exchange Gain

cash(spot rate)

X Forward contract (rate at date of sales)

X x F.c. loss

X X F.c. loss

Forward contract (rate at date of

sales)
F.c. Gain

cash(spot rate)
F.c. Gain

Dat
e of
sale
s

Dat
e of
paymen
t

Summary for forward contract

Journal entries for importer
X Forward contract Exp
X

Deferred loss

Journal entries for exporter

X Forward contract Exp
Deferred loss

X Forward contract gains

X Forward contract gains

X Income summary

X Income summary

Forward contract Exp

Forward contract Exp

Foreign Exchange loss

Foreign Exchange loss

Deferred gain

Deferred gain

Forward contract Rev

Forward contract Rev

X Forward contract gains

X Forward contract gains

X Forward contract Rev

Forward contract Rev

Income summary

Income summary

Foreign Exchange loss

Foreign Exchange loss

NOTE : -Red colour means OR

En
d
of
the
ye
ar

or

Example 4 (settled transaction)

On June 21, 2014 FUTURE Co. From Egypt had ordered industrial
products from LON Group from France for 20 million USD which are to
be paid through two equal payments after one and three months from
the transaction date. The products have been shipped on July 31, 2014.
At that time FUTURE Co, entered into a forward contract with Misr Bank
to buy 20 million Dollar divided into two amounts on August 31 and Oct.
31 at the forward rate (7.5) EGP. and LON Group, entered into a
forward contract with France Bank to sell 20 million Dollar divided into
.two amounts on August 31 and Oct. 31 at the forward rate ( 1.3)
Required:
Prepare the accounting entries in FUTURE Co & LON Group.
The exchange rates were as follows:
Date
June 21, 2014
July 31, 2014
Aug. 31, 2014
Oct. 31, 2014
Nov. 30, 2014
Dec. 31, 2014

Rate of exchange (L.E for each

USD)
7.6
7.3
7.9
7.2
7.1
7.4

Rate of exchange ( for each

USD)
1.5
1.4
1.6
1.5
1.5
1.3

the accounting entries in LON Group

July

A / R ($ 20 1.4)

28

31
Foreign sales

28

Forward contract receivable ($20 1.3)

26

Deferred loss

2
28

Forward contract ($ 20 1.4)

Aug 31 Cash ($10 1.6)

16

A / R ($ 10 1.4)

14

Foreign Exchange gains

Forward contract

2
14

Forward contract loss

2
16

cash($ 10 1.6)
Cash($ 10 1.3)
Forward contract receivable

13
13

Oct. 31

Cash ($10 1.5)

15

A / R($ 10 1.4)

14

Foreign Exchange gain

Forward contract

14

Forward contract loss

Cash($ 10 1.5)
Cash

15
13

Forward contract receivable.

Dec 31

Forward contract Exp

13
2

Deferred loss

Foreign Exchange gain

Income summary

Forward contract Exp

Forward contract loss

the accounting entries in FUTURE Co

July

Foreign purchases

146

31
146

A / P ($207.3)
Forward contract ($20 7.3)
Deferred loss
Forward contract payable ($20 7.5)
Aug 31 Forward contract payable
Cash
Cash ($10 7.9)
Forward contract

146
4
150
75
75
79
73

Forward contract gain

A / P ($107.3)
Foreign Exchange loss
Cash ($10 7.9)

73
6
79

Oct 30

Forward contract payable

75

Cash

75

Cash ($10 7.2)

72

Forward cont. loss

Forward contract
A/P ($107.3)

Dec. 31

73
73

Foreign Exchange gain

Cash($107.2)

72

Forward cont. exp

Deferred loss

Forward contract gains

Income summary

Forward contract Exp

Foreign Exchange loss

Example 5 (unsettled transaction)

On June 21, 2014 FUTURE Co. From Egypt had ordered industrial
products from LON Group from France for 20 million USD which are to
be paid through two equal payments after one and three months from
the transaction date. The products have been shipped on July 31, 2014.
At that time FUTURE Co, entered into a forward contract with Misr Bank
to buy 20 million Dollar divided into two amounts on August 31 and mar.
31,2015 at the forward rate (7.5) EGP. and LON Group, entered into a
forward contract with France Bank to sell 20 million Dollar divided into
.two amounts on August 31 and mar. 31,2015 at the forward rate ( 1.3)
Required:
Prepare the accounting entries in FUTURE Co & LON Group.
The exchange rates were as follows:
Date
June 21, 2014
July 31, 2014
Aug. 31, 2014
Oct. 31, 2014
Nov. 30, 2014
Dec. 31, 2014

Rate of exchange (L.E for each

USD)
7.6
7.3
7.9
7.2
7.1
7.4

Rate of exchange ( for each

USD)
1.5
1.4
1.6
1.5
1.5
1.3

the accounting entries in LON Group

July

A / R ($ 20 1.4)

28

31
2014

Foreign sales
Forward contract receivable ($20 1.3)
Deferred loss
Forward contract ($ 20 1.4)

Aug 31 Cash ($10 1.6)

2014
A / R ($ 10 1.4)

28
26
2
28
16
14

Foreign Exchange gains

Forward contract

2
14

Forward contract loss

2
16

cash($ 10 1.6)
Cash($ 10 1.3)
Forward contract receivable

13
13

the accounting entries in LON Group

Dec.31 Foreign Exchange loss
2014
A / R ($ 10 (1.4-1.3)

Forward contract
Forward contract gain
Forward contract exp

1
1
1.25

Deferred loss(2*5/8)
Foreign Exchange gain

1.25
1

Income summary

1..25

Forward contract loss

Forward contract exp

1.25

mar.31

Cash ($10 1.5)

2015

15

A / R($ 10 1.3)

13

Foreign Exchange gain

Forward contract

13

Forward contract loss

2
15

Cash($ 10 1.5)
Cash

13
Forward contract receivable.

Dec 31
2015

Forward contract Exp

13
.75

Deferred loss

.75

Foreign Exchange gain

Income summary

.75

Forward contract Exp

.75

Forward contract loss

the accounting entries in FUTURE Co

July

Foreign purchases

146

31
146

A / P ($207.3)
Forward contract ($20 7.3)
Deferred loss
Forward contract payable ($20 7.5)
Aug 31 Forward contract payable
Cash
Cash ($10 7.9)
Forward contract

146
4
150
75
75
79
73

Forward contract gain

A / P ($107.3)
Foreign Exchange loss
Cash ($10 7.9)

73
6
79

the accounting entries in LON Group

Dec.31 Foreign Exchange loss
2014
A / R ($ 10 (7.4-7.3)

Forward contract
Forward contract gain
Forward contract exp

1
1
2.5

Deferred loss(4*5/8)
Forward contract gain

2.5
7

Income summary

2.5

Foreign Exchange loss

Forward contract exp

2.5

mar. 30
2015

Forward contract payable

75

Cash

75

Cash ($10 7.2)

72

Forward cont. loss

Forward contract
A/P ($107.4)

Dec. 31
2015

74
74

Foreign Exchange gain

Cash($107.2)

72

Forward cont. exp

1.5

Deferred loss

1.5

Foreign Exchange gains

Income summary

1.5

Forward contract Exp

1.5

F. Cont. loss