session vii & viii foreign currency. international accounting & financial reporting-2005 7-2...

Session VII & VIII

Foreign Currency

INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005

7-2

Foreign Exchange Basics

Exchange rates Conversion values Exchange rate factors

Inflation Interest rates Balance of payments


7-3

FX Gains and Losses

Realized gains and losses Result of FX transactions Exchange of currency takes place

Unrealized gains and losses Result of FX translations Conversion for F/S purposes


7-4

FX Transactions

Two-transaction approach for US GAAP Gain or loss recognized in the income

statement


7-5

Forward Exchange Contracts

Agreement to exchange currency at a specified time at a specified rate

Forward rate Spot rate


7-6

FX Translations

Current Rate Method (Modified Current Rate Method)

Temporal Method Only approaches approved under US GAAP


7-7

Current Rate Method

Local currency is the functional currency Method

Assets and liabilities translated at current rate Capital accounts translated at historical rate Dividends translated at current rate upon

declaration Revenue and expense translated at weighted

average rate Balancing amount recorded in OCI


7-8

Temporal Method Home currency is functional currency Method

Cash, A/R and A/P translated at current rate Other assets and liabilities translated at historical

rates Capital accounts translated at historical rate Revenue and expense other than items dependent

on non-monetary items translated at weighted average rate

Balancing amount recorded in income statement


7-9

Translation and Remeasurement

When local currency is functional currency, it is TRANSLATED into the home currency

When the local currency is not the functional currency, it is REMEASURED into the functional currency, which is usually the home currency


7-10

FX Risk Management

Self-sustaining operations support the local currency as the functional currency

Integrated operations support the home currency as the functional currency

Fixed rate currency Floating rate currency Intervention Arbitrage


7-11

Mundell-Fleming Model

Capital mobility offsets the ineffective nature of monetary and fiscal policy

Ineffective monetary policy with fixed rate currency

Ineffective fiscal policy with floating rate currency


7-12

FX Risk Exposure

CA > CL = positive exposure CA < CL = negative exposure Positive exposure & appreciation yields gain Negative exposure & depreciation yields gain FX risk includes both translations and

transactions


7-13

Transaction Risk Exposure

Transaction denominated in FX Settlement date is different from transaction

date Results from actual exchange of cash Results from actual changes in exchange rates Plan FX strategies and execute them

See Exhibit 2.7


7-14

Hedging Strategies

FX forward contract: most common Transaction denomination: US $ billing Risk sharing: agreed rate and price Price adjustment: price protection Currency options contract Cross-currency swap Currency swap

Contract based

strategies


7-15

Forward Exchange Contract Accounting

A/R

Sales revenue Deferred FX expense

Deferred credit FX expense

Deferred FX expense Cash

Deferred credit

A/R


7-16

The Euro

Legal tender for most of EU members Removal of exchange rate risk Lowers transaction costs Benefits consumer


7-17

Translation Risk Exposure

Accounting exposure only Increase net assets under appreciation Increase net liabilities under depreciation


7-18

Managing Economic Exposure

Consider location of operations Use the portfolio approach Use flexible planning Use pricing and promotional strategies


7-19

FX Forecasting

Implement effective information systems Consider all relevant factors on a collective basis

Political and social environment Political risk Economic growth Inflation Balance of payments Interest rates


7-20

US GAAP versusInternational Actg.

Stds. SFAS 52-FX Translation

If functional currency is US $, remeasure F/S If functional currency is local currency, translate

F/S Use two-transaction approach for FX transactions

SFAS 133-Derivatives and Hedging Report derivatives at fair value Hedging gains & losses are recognized

immediately


7-21

US GAAP versusInternational Actg.

Stds.-continued IAS 21-Foreign Currency

Temporal method required for integrated ops. Current method required for self-sustaining ops. Recommends two-transaction approach for FX

transactions IAS 39-Hedging

Similar to SFAS 133 (note the convergence!!)

Session IX

Changing Prices


7-23

General and Specific Price Increases

General price level increases (GPI) Based on market basket of goods & services

Specific price level increases (SPI) Relates to a particular item


7-24

Tight Money Policy

Monetary policy influence both inflation and economic growth

See Figure 3.1 on page 87


7-25

Constant Money Restatement

(Current Purchase Power Accounting) Balance sheet

I/D items as monetary or nonmonetary Extend monetary items at their face amount Adjust nonmonetary items for changes in purchasing power Roll-forward prior year balances

Income statement Adjust items based date of occurrence Compute depreciation based on adjusted historical cost Adjust other items based upon weighted average Compute cost of goods sold based on adj. Inventory items Calculate purchasing power gain or loss

See comprehensive example on pages 90 - 97.


7-26

Current Value Accounting

See pages 97 - 102 We will place limited focus on this topic due to

its subjective nature and lack of universal application


7-27

IASC and Inflation

IAS 15: Price level accounting disclosures IAS 29: Hyperinflation report

Requirement for IAS countries Hyperinflation exists when 3-year cumulative

inflation exceeds 100 percent Restatement for GPI changes in primary

financial statements Hotly debated issue without firm resolution

session vii & viii foreign currency. international accounting & financial reporting-2005 7-2...

Documents

remeasurement n

home currency n

n fx risk

historical rate n revenue

historical rate n dividends

declaration n revenue

positive exposure n

us gaap n gain