161103151-foreign-currency.pdf

8/14/2019 161103151-foreign-currency.pdf

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Dr. Mohammad S. Bazaz

Foreign Currency Transaction

Factors cause foreign currency exchange rates to change: The price of a foreign currency (the exchange rate) is governed by the laws of supply anddemand. The following factors affect supply and demand:

o Relative domestic inflation rates

Foreign inflation pushes the direct exchange rate down omestic inflation pushes the direct exchange rate up.

o !nterest Rates

"ountries may increase their interest rates to attract capital# therebycreating demand for their currencies.

o Trade deficit or trade surplus

!n recent years# $% has approximately &' billion annual trade deficit.o %ervice deficit or service surplus

$% has roughly & billion service surplus a year *ver +# foreign students attending $% colleges# which brings about

&,- billion. early + million foreigners visit the $nited %tates annually# spending over

&-- billion.

o !nvestment deficit or investment surplus.

The $% has had si/able annual investment surpluses $0# 1apan# the etherlands# and "anada are primary investors in the $%.

o Federal deficitso 2overnment3imposed restrictions on currency transfers.

o "ivil disorders and wars.

The interrelationship between foreign trade and foreign investmento 1apanese dealers (for example) can use their accumulated dollars from their trade

surplus in various ways such as: 4c5uire $.%. 6roducts. 4c5uire $% services 4c5uire $% real estate 4c5uire $% companies

4c5uire $% treasury securities Trade and investment relationship can be formuli/ed as:

Trade deficit - Service surpus ! "nvestment Surpus


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#ccounting for Foreign Currency

'787 '7-8 '78 '7- '7,' '77,

#$B %&. '99#$B %o. '(99SF#S %o. )99 SF#S %o. *99SF#S %o. +,!!SF#S %o.

)((

Transation Methods:3"urrent 3 "on3current method

3;onetary3 on monetary ;ethod

3Temporal ;ethod

3"urrent Rate method

&/ective of Transation ($nder %F4% o. -ocal (recording) currency

Reporting (parent) currency

Functional currency

Functiona Currency: is the currency of the primary environment in which it operates# (sub?ect todecision of management).


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Factors 0hen functiona currency is not ovious:

3%ales 6rice 33 >ocal ".

3%ales mar@et 33 6arent ".

3Axpenses 33 >ocal ".

3Financing 33 >ocal ".

3Bigh volume of trade 33 6arent ".

1xchange $ates: %pot Rate 2S$3

Bistorical Rate 24$3

"urrent (Calance sheet) Rate 2C$3

Forward Rate 2F$3

Floating# Fixed# and ;ultiple Axchange rates

The 1uro: 1anuary '# '777# the Auro became the common currency for most of the counties (4ustria#

Celgium# Finland# France# 2ermany# !reland# !taly# >uxembourg# the etherlands#6ortugal# %pain# and more).

1anuary '#


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Foreign Currency Transaction: &ne-transaction perspective

o "onsider the original amount recorded for a foreign merchandise purchase as an

estimate# sub?ect to ad?ustment when the exact cash outlay re5uired for thepurchase is @nown. Thus# this perspective emphasi/es the cash-paymentaspect#

rather than the bargain-priceaspect# of the transaction.o F4%C re?ected this approach

T0o-transaction perspective

o %upporters argue that an importer=s or exporter=s assumption of a ris@ of

fluctuations in the exchange rate for a foreign currency is a financingdecision# nota merchandisingdecision.

o This approach was sanctioned by the F4%C# %F4% o. -


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SF#S %o. +,:

3o forward contract:34t the date of Transaction 3 record at %R

34t each balance sheet date. 3ad?ust to the "R

34ny gainsDlosses recogni/ed in the current income.

1xampes:'. *n ov. '#


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Foreign Currency Derivatives and 4edging #ctivities

$nder F#SB Statement %o. )((# E4ccounting for erivative !nstruments and Bedging4ctivities# %uch contracts are considered derivativeinstruments.

Cased on %F4% '88# derivative instruments represent rights or obligations and should be reportedon the financial statements. Fair value is considered the only relevant measure for derivativeinstruments.

Three situationsin which forward exchange contacts are used (%F4% '88):

'. To speculate in foreign currency exchange price movements


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Specuation:3a forward contract is valued at F$throughout the life of the

contract. FR is considered as fair value of the contract atany time.

3Axchange gains or osseson forward contracts are includedin the income statementof the period in which the forwardexchange rate changes.

1xampe:

*n ov. '#


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1xampe:

*n ov. '# '777 a $% firm %old "&'# to a "anadian company to receive in 7 days.

#ssuming: ov. '# '77- ec. 8' 1an 8'# oss &


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F" commitment is a contract or agreement denominated in F" that will result in foreigncurrency transaction at a later date.

4n identifiable foreign currency commitment differs from an exposed assets or liabilityposition because the commitment does not meet the accounting tests for recording therelated asset or liability in the accounts.

4 forward contract that is a hedge of a firm commitment is based on the forward rate# notthe spot rate.

There is no re5uirement that the life of the forward contract has to be at the foreigncurrency commitment dateI however# the re5uired accounting for the forward contractmust begin at the designation date.

1xampe:*n *ctober


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"ontract Receivable (fc) & '#+G8

This loss is offset by the increase in the value of the underlying firm commitment shown below:

'


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4edging a net investment in a foreign entity:

2ains and losses are recorded as translation ad?ustments of stoc@holders= e5uity

This is necessary because Translation gains and losses also reported as translation

ad?ustments to stoc@holders= e5uity.

Bedges of investment in foreign subsidiary with $% dollar functional currency isconsidered as specuation.

1xampe:

%uppose a $% firm has investment in +J of $0 firm. *n ecember 8'# '777 the balance ofinvestment is &'#


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%ummary of $0 firm=s A5uity:

British 9ounds =S Doar*wners= A5uity on 1an '#


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Cash Fo0 4edge of an #nticipated Foreign Currency Transation

4 committed transaction 5ualifies as a foreign currency fair value hedge# where as an

anticipated foreign currency transaction is considered a foreign currency cash fo0hedge.

4 cash flow hedge Eapplies to a derivative designated as a hedge of the foreign currencyexposure of a foreign3currency3denominated forecasted transaction (%F4% o. '88)

Nith an anticipated foreign currency transaction# there is no basis for ad?usting the Evalue

of underlying transaction as was done with the committed transaction.

Therefore# the offset to the change in the value of the derivative contract (which still must

be carried at fair value (F$)# per %F4% o. '88) is to other comprehensive income(e5uity ad?ustment).

4ny Einefficiency in the derivative contract will show up in the current income# as with

any other derivative contract.

1xampe:

$sing the data under the example of foreign currency commitment above but assuming ananticipated; rather committed# transaction re5uires the following ?ournal entries.

'D


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Nith this entry# the gain or loss would effectively become part of regular income whenthe underlying purchases are sold or used.

+. 4ccounts 6ayable (fc) 8#"ash (fc) &8#


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$eferencesCa@er# R.# O. >emb@e# and T. 0ing# 4dvanced Financial 4ccounting# -thedition#


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9roem >) Transactions 0ith Foreign CompaniesBarris !nc. had the following transactions:

'. *n %eptember '# Barris !nc. purchased parts from a 1apanese company for a $.%.dollar e5uivalent value of &,## to be paid on February


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9roem >, @ain or oss on Specuative For0ard 1xchange Contract*n ecember '#


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9roem > (9urchase 0ith For0ard 1xchange Contract and "ntervening Fisca Aear-1nd.

6umped $p "ompany 6urchased e5uipment from %wit/erland for '+# francs on ecember'G#


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9roem >' 4edge of a purchase 2Commitment 0ithout and 0ith Time aue of MoneyConsiderations3:

*n ovember '#

161103151-foreign-currency.pdf

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