Advanced accounting, 5th edition international student version ch12

12
12
Accounting for Foreign Currency
Transactions and Hedging Foreign
Exchange Risk

Advanced Accounting, Fifth Edition
Slide
12-1


Learning
Learning Objectives
Objectives
1.

Distinguish between the terms “measured” and
“denominated.”

2.

Describe what is meant by a foreign currency transaction.

3.

Understand some of the more common foreign currency
transactions.

4.

Identify three stages of concern to accountants for foreign

currency transactions, and explain the steps used to
translate foreign currency transactions for each stage.

5.

Slide
12-2

Describe a forward exchange contract.


Learning
Learning Objectives
Objectives

Slide
12-3

6.

Explain the use of forward contracts as a hedge of an
unrecognized firm commitment.

7.

Identify some of the common situations in which a
forward exchange contract can be used as a hedge.

8.

Describe a derivative instrument and understand how
it may be used as a hedge.

9.

Explain how exchange gains and losses are reported
for fair value hedges and cash flow hedges.


Foreign
Foreign Currency
Currency Transactions
Transactions
Many U.S. companies engage in international
activities such as:
Exporting or importing goods,
Establishing a foreign branch, or
Holding an equity investment in a foreign
company.

Slide
12-4


Foreign
Foreign Currency
Currency Transactions
Transactions
Recording and reporting problems with foreign
currency transactions:

Transactions in a foreign currency must be
translated (expressed in dollars) before they can
be aggregated with domestic transactions.
Receivables or payables denominated in foreign
currencies are subject to gains and losses.
Companies use hedging strategies with
derivatives to minimize the impact of exchange
rate changes.
Slide
12-5


Exchange
Exchange Rates—Means
Rates—Means of
of Translation
Translation
Translation - process of expressing amounts
stated in a foreign currency in the currency of the
reporting entity by using an appropriate exchange
rate.
Exchange rate - ratio between a unit of one
currency and another currency for which that unit
can be exchanged at a particular time.

Slide
12-6


Exchange

Exchange Rates—Means
Rates—Means of
of Translation
Translation
Direct Exchange Rate
Units of domestic currency that can be converted
into one unit of foreign currency.
Direct rate = 1.517 ($1.517 U.S. for 1 British
pound)

Indirect Exchange Rate
Units of foreign currency that can be converted
into one unit of domestic currency.
Indirect rate = 1.00/1.517 = .6592
($1 U.S. for .6592 British pound)
Slide
12-7


Exchange
Exchange Rates—Means
Rates—Means of
of Translation
Translation
Spot Rate
Rate at which currencies can be exchanged today.

Forward or Future Rate
Rate at which currencies can be exchanged at
some future date.

Forward Exchange Contract
Contract to exchange currencies of different
countries on a stipulated future date, at a
specified rate (the forward rate).
Slide
12-8


Exchange
Exchange Rates—Means
Rates—Means of
of Translation
Translation
Floating Rates
Relationship between major currencies is
determined by supply and demand factors.
Increase risk to companies doing business with a
foreign company.

Example – Payable to be settled in 100,000 yen

Yen
Direct rate
Payable
Slide
12-9

Transaction
Date

100,000
$ 0.00434
$ 434.00

Change
in Rate

Settlement
Date
100,000
$ 0.00625
$ 625.00


Measured
Measured Versus
Versus Denominated
Denominated
Transactions are normally measured and recorded in
terms of the currency in which the reporting entity
prepares its financial statements.
Reporting Currency - usually the currency where the
company is located.

Transaction between a U.S. firm and a foreign
company:
Companies negotiate whether settlement is to be made
in dollars or in the foreign currency.
If settled by foreign currency, U.S. firm measures the
receivable or payable in dollars, but the transaction is

denominated in the foreign currency.
Slide
12-10

LO 1 Measured versus denominated.


Foreign
Foreign Currency
Currency Transactions
Transactions
Foreign Currency Transaction - requires payment or
receipt (settlement) in a foreign currency.
U.S. firm exposed to risk of unfavorable changes in
the exchange rate.
Direct exchange rate
increasing, or foreign
currency unit
strengthening.
Direct exchange rate
decreasing, or foreign
currency unit
weakening.
Slide
12-11

=

More dollars needed to
acquire the foreign

currency units.

=

Fewer dollars needed to
acquire the foreign
currency units.

LO 2 Foreign Currency Transactions.


Foreign
Foreign Currency
Currency Transactions
Transactions
Importing or Exporting of Goods or
Services

Translating Accounts Denominated in Foreign
Currency

Transaction
date

Balance
sheet date

Settlement
date

Units of foreign currency x Current direct exchange rate
Increase or decrease is generally reported as a foreign currency
transaction gain or loss, sometimes referred to as an
exchange gain or loss, in determining net income for the
current period.
Slide
12-12

LO 3 Common transactions.
LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: During December of the current year,
Teletex Systems, Inc., a company based in Seattle,
Washington, entered into the following transactions:
Dec. 10 Sold seven office computers to a company
located in Colombia for 8,541,000 pesos. On this date,
the spot rate was 365 pesos per U.S. dollar.

U.S. firm
(Teletex)

Inventory delivered
12/10/Year 1

Columbia firm
8,541,000 pesos
received on 1/10/Year 2

Slide
12-13

LO 3 Common transactions.
LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: Dec. 10, Sold seven office computers
to a company located in Colombia for 8,541,000 pesos.
On this date, the spot rate was 365 pesos per U.S. dollar.
Prepare the journal entry on the books of Teletex
Systems, Inc. (periodic method)
Accounts receivable
23,400
Sales
23,400

Slide
12-14

Sales price in pesos

8,541,000

Pesos per U.S. dollar
Sales price in U.S. dollars

/

365
$ 23,400

LO 3 Common transactions.
LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: Prepare journal entry necessary to
adjust the accounts as of December 31. Assume that on
December 31 the direct exchange rates was Colombia
peso $.00268.
Transaction loss
510
Accounts receivable
510
Receivable in pesos

Slide
12-15

Direct exchange rate to U.S. dollar$
Receivable in U.S. dollars
$
Balance in receivable
Transaction loss
$

8,541,000
.00268
22,890
23,400
510

LO 3 Common transactions. LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: Prepare journal entry to record
settlement of the account on January 10. Assume that
the direct exchange rate on the settlement date was
Colombia peso $.00320.
Cash (8,541,000 x $.00320)

27,331

Accounts receivable ($23,400 - $510)
Transaction gain

Slide
12-16

22,890
4,441

LO 3 Common transactions. LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: During December of the current year,
Teletex Systems, Inc., a company based in Seattle,
Washington, entered into the following transactions:
Dec. 12
Purchased computer chips from a Taiwan
company.
Contract was denominated in 500,000 Taiwan
dollars. Direct exchange rate on this date was $.0391.

U.S. firm
(Teletex)

Inventory received
12/12/Year 1

Taiwan firm
500,000 Taiwan dollars
paid on 1/10/Year 2

Slide
12-17

LO 3 Common transactions.
LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: Dec. 12, Purchased computer chips
from a company domiciled in Taiwan. The contract was
denominated in 500,000 Taiwan dollars. The direct
exchange spot rate on this date was $.0391. Prepare the
journal entry on the books of Teletex Systems, Inc.
Purchases

19,550

Accounts payable

19,550
Purchase price in Taiwan dollars

500,000

Direct exchange rate to U.S. dollar x
$.0391
Purchase price in U.S. dollars
$ 19,550
Slide
12-18

LO 3 Common transactions.
LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: Prepare journal entry necessary to
adjust the account as of December 31. Assume that on
December 31 the direct exchange rates was Taiwan dollar
$.0351.
Accounts payable
2,000
Transaction gain
Payable in pesos

Slide
12-19

Direct exchange rate to U.S. dollar$
Payable in U.S. dollars
$
Balance in payable
Transaction gain
$

2,000
500,000
.0351
17,550
19,550
2,000

LO 3 Common transactions. LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: Prepare journal entry to record
settlement of account on January 10. Assume that the
direct exchange rate on the settlement date was Taiwan
dollar $.0398.
Transaction loss

2,350
Accounts payable ($19,550 - $2,000)17,550
Cash (500,000 x $.0398)

Slide
12-20

19,900

LO 3 Common transactions. LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Importing or Exporting of Goods or
Services

Foreign currency transaction gains and losses are
included in net income.
Two-transaction approach:
The sale or purchase is viewed as a transaction
separate from the financing arrangement.
The dollar amount recorded (in Sales or in Purchases)
is determined by the exchange rate on the transaction
date.
Adjustments to the foreign-currency-denominated
receivable or payable are recorded directly to the

transaction gain or loss and included in net
income.

Slide
12-21

LO 3 Common transactions. LO 4 Three stages of concern.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Hedging Foreign Exchange Rate Risk
Derivative Instrument - a financial instrument that
provides the holder (or writer) with the right (or
obligation) to participate in some or all of the price
changes of another underlying value of measure, but
does not require the holder to own or deliver the
underlying value of measure.
Two broad categories:
Forward-based
Option-based
Slide
12-22

Derivatives are recognized in
the balance sheet at their fair
value, resulting in a payable

position for one party and a
receivable position for the
other.

LO 8 Derivatives as a hedge.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Forward Exchange Contracts
A forward exchange contract (forward contract) is an
agreement to exchange currencies of two different
countries at a specified rate (the forward rate) on a
stipulated
future date.

Slide
12-23

LO 5 Forward exchange contracts.


Importing
Importing and
and Exporting
Exporting Transactions
Transactions

Which Kind of Forward Contract to
Choose?

1. Forward Contract used as a Hedge of a(n):
a. Foreign currency transaction.
b. Unrecognized firm commitment (a fair value
hedge).
c. Foreign-currency-denominated “forecasted”
transaction (a cash flow hedge).
d. Net investment in foreign operations.
2. Speculation
Forward contracts used to speculate changes in
foreign currency.
Slide
12-24

LO 5 Forward exchange contracts.


Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Hedge of a Foreign Currency Exposed
Liability

Problem 12-2: Christel Exporting Co. is a U.S.
wholesaler engaged in foreign trade. The following

transaction is representative of its business dealings.
The company uses a periodic inventory system and is on
a calendar-year basis. All exchange rates are direct
quotations.
Dec. 1 Christel Exporting purchased merchandise from
Chang’s Ltd., a Hong Kong manufacturer. The invoice
was for 210,000 Hong Kong dollars, payable on April 1.
On this same date, Christel Exporting acquired a forward
contract to buy 210,000 Hong Kong dollars on April 1 for
Slide
LO 7 Forward contracts as a hedge.
12-25 $.1314.