Chapter 10

Accounting for Foreign Currency

Basics in Foreign Exchange

Foreign

Over-the-counter (OTC)

exchange is traded

Made up of commercial and investment banks

On an exchange
Over the Internet

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Basics in Foreign Exchange

Foreign exchange instruments include

Spot transaction exchange takes place within 2 days of a

trade agreement; uses the spot rate
Outright forwards exchange takes place 3 or more days
after the date of a trade agreement; uses forward rate
FX swap one currency is exchanged for another on one
date and then swapped back at a future date
Future an agreement to trade currency at a specific price
on a specific date
Option the right, but not the obligation, to trade foreign
currency in the future

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Spot Market
Rates

are normally quoted from a traders

perspective in two rates

Example - $1.9072/82

Bid - $1.9072
Ask - $1.9082
Sometimes given as a mid-rate ($1.9077)

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Foreign Currency Transactions

Denominated

in currency other than the

reporting currency of the firm
No problems if transactions are denominated
in the firms domestic currency
If transaction is settled immediately, the
transaction is recorded at the spot rate

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Foreign Currency Transactions

If

a transaction is denominated in a foreign

currency and settled at a subsequent balance
sheet date, four problems arise involving

Initial recording of the transaction

Recording of foreign currency balances at
subsequent balance sheet dates
Treatment of any foreign exchange gains and
losses
Recording of the settlement of foreign currency
receivables and payables when they come due

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Foreign Currency Transactions

Have

two components

Monetary component cash received/paid or

accounts receivable/payable
Nonmonetary component equipment or
inventory purchased or sold

IAS

21 and SFAS 52 recognize gains and

losses in income at the balance sheet date

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Foreign Currency Transactions

IAS 21 and SFAS 52

Example Equipment and A/P are recorded at the
spot rate on the transaction date Why?

Transaction is divided into 2 parts purchase of equipment

and decision to finance through A/P
At balance sheet date, equipment remains at historical
cost, A/P changes to reflect new spot rate
Any difference between the spot rates is a gain or loss,
reflected in the period in which the rate changed

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

IAS 21
Requirements

Monetary items are recorded at the closing rate

Nonmonetary items should recorded at the
historical exchange rate
Nonmonetary items carried at fair value should be
recorded at the rate in effect when the fair values
were determined

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Illustration
U.S. firm imports equipment from Germany on
March 1 for 200,000 when the exchange rate
is $1.3112 per euro. Payment in Euro does not
have to be made until April 30. Assume that on
March 31, the exchange rate is $1.35 and on
April 30 is $1.33. The firms books are closed
at the end of the calendar quarter.

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Illustration Journal Entries

March 1
Purchases
262,240
A/P
262,240
200,000 x 1.3112
March 31 Foreign exchange loss
A/P
7,760
200,000 (1.3112 1.35)
April 30
A/P
270,000
Foreign exchange gain
Cash
266,000

7,760

4,000

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Illustration: Accounting for

Debt in a Foreign Currency
On January 1, a U.S. firm borrows 2 million
Swiss francs for 5 years at 3% interest paid
semiannually in Swiss francs. The principal
does not have to be repaid until the end of the
loan. The loan is adjusted for exchange rate
changes every 6 months. Exchange rates are:
January 1$.8064
June 30 $.7901
December 31 $.8839
Average (1st 6 months)
$.79825
Average (2nd 6 months)
$.8370
International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Illustration: Accounting for

Debt in a Foreign Currency
January 1

June 30

Cash
Notes Payable

1,612,800

Notes Payable
32,600
Foreign Exchange Loss
(CHF.7901 -.8064) x CHF 2 million

1,612,800

32,600

Interest Expense
23,948
Foreign exchange gain
245
Cash
23,703
CHF2,000,000 x (.03/2) = 30,000 x .79825 = $23,948
CHF30,000 x .7901 = $23,703
International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Illustration: Accounting for

Debt in a Foreign Currency
Dec. 31

Foreign exchange loss 187,600

Notes Payable
187,600
(.7901-.8839) x CHF 2million
Interest Expense
25,110
Foreign exchange loss 1,407
Cash
26,517
CHF30,000 x .8370 = $25,110
CHF30,000 x .8839 = $26,517

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Translation terminology

Functional currency currency of the primary economic

environment in which the company operates
Reporting currency currency in which the parent company
prepares its financial statements
Foreign currency any currency other than the functional
currency of the company
Local currency currency of a particular country being referred
to
Exchange difference difference resulting from translating a
given number of units of one currency into another currency at
different exchange rates
Foreign operation a subsidiary, associate, joint venture, or
branch whose activities are based in a country other than that of
the reporting enterprise

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Key issues for translation

Exchange

rates at which various accounts

are translated from one currency into another
Subsequent treatment of gains and losses

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Current/Noncurrent Method

Current assets and liabilities are translated at

current exchange rates
Noncurrent assets and liabilities and stockholders
equity are translated at historical exchange rates
Anything due to mature in one year or less or within
the normal business cycle should be translated at
the current rate
Everything else should be carried at the rate in
effect when the translation was originally recorded
Accounts should be grouped according to maturity

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Translation Exchange Rates

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Monetary/Nonmonetary
Method
Accounts

are considered as monetary or

nonmonetary
Monetary assets and liabilities translated at
the current rate
Nonmonetary assets and liabilities and
stockholders equity translated at historical
rates
Assets and liabilities are translated on the
basis of attributes instead of time
International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Temporal Method

Cash, receivables, and payables are translated at

the current rate
Other assets and liabilities may be translated at
current or historical rates, depending on their
characteristics
Assets and liabilities carried at past exchange prices
are translated at historical rates
Assets and liabilities carried at current purchase or
sales exchange prices or future exchange prices
would be translated at current rates
This flexible method ensures that parent currency is
the single unit of measure

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Current Rate Method

(Closing Rate Method)
All

assets and liabilities are translated at the

current exchange rate
Net worth is translated at the historical rate
Results in translated statements that retain
the same ratios and relationships that exist in
the local currency

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

International Accounting
Standards

IAS 21

If foreign operations are integral to the operations of the

reporting company, the temporal method is used
Exchange gains and losses are taken to income
If foreign operations are considered to be foreign entities,
the closing rate method is used
Exchange differences are taken to equity until investment
disposal
Financial statements in hyperinflationary economies must
be adjusted for price level changes according to IAS 29,
then translated into the reporting currency

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

U.S. Accounting Standards

FASB

Statement No. 52 objectives

Provide information that is generally compatible

with the expected economic effects of a rate
change on an enterprises cash flows and equity
Reflect in consolidated statements the financial
results and relationships of the individual
consolidated entities as measured in their
functional currencies in conformity with U.S.
GAAP

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Translation Process SFAS 52

Functional

currency must be established

Functional currency can only change if operating

criteria used in its selection have changed

Current

rate or temporal method is used

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

The Temporal Method

Used to remeasure financial statements from a

foreign currency to the functional currency
Requirements are as follows

Remeasure cash, receivables, and liabilities at the current

balance sheet rate
Remeasure inventory, fixed assets, and capital stock at the
appropriate historical exchange rates
Remeasure most revenues and expenses at the average
rate for the year; cost of sales and depreciation expense
are translated at the appropriate historical exchange rates
Take all remeasurement gains or losses directly to the
income statement

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

The Temporal Method

Easier

to remeasure the balance sheet

before the income statement
Translation adjustment is taken to the income
statement

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

How Remeasurement Works

Lower-of-cost

or market values of inventory

should be calculated first
Cost = Historical cost in foreign currency x
Exchange rate in effect when inventory was
acquired
Market = Market value in foreign currency x
Exchange rate in effect when market was
determined
Test is performed in the reporting currency
International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

The Current Rate Method

Used when the functional currency is defined as the

foreign currency
Steps in the current rate method

Total assets and liabilities are translated at the current

exchange rate
Stockholders equity accounts are translated at the
appropriate historical rate for the period
All revenue and expense items are translated at the
average exchange rate for the period
Dividends are translated at the exchange rate in effect
when they were issued
Translation gains and losses are taken to a accumulated
translation adjustment account in stockholders equity

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

The Current Rate Method

Better

to translate the income statement first

because the translation gain or loss becomes
a balance sheet plug figure
Translation adjustment is taken to
stockholders equity

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Translation Choices

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Foreign Currency and

Intercompany Transactions
Gains

and losses on foreign currency debt

are often adjusted to interest expense
Intercompany transactions are both long and
short-term
Intercompany profits can arise when the
parent sells goods or services to the sub
A portion of these profits can be related to
exchange rate changes
International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Long-term Investment
Settlement

is not planned in the near future

If, for example, a loan is given from a parent
to a sub and is expected to be paid back, the
exchange gain or loss is recognized in the
income statement of the subsidiary
If the loan is long-term, the exchange gain or
loss is taken to

Stockholders Equity Current rate method

Income Statement Temporal method

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Elimination of Intercompany
Profits
Profits

must be eliminated upon

consolidation, combination, or the equity
method
Profits are based on the exchange rates at
the dates of the sales or transfers
Temporal method inventory is carried at
historical cost, so inventory balance remains
the same

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Statement of Cash Flows

Guidelines

are given in SFAS 95 and IAS 7

Example U.S. parent and British subsidiary

The British sub 1st prepares its own statement of

cash flows in British pounds.
The cash flows are translated into dollars using
the actual exchange rate in effect when the cash
flows took place or the average exchange rate for
the year.
The translated cash flows are consolidated with
the parent companys cash flow statement.

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Statement of Cash Flows

Starts

with Net Income

Foreign exchange gains or losses must be
excluded from cash flows from operating
activities (non-cash item)

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

The Impact of IAS 21

Requires disclosure of the following

Amount of exchange differences included in the net profit

or loss for the period
Net exchange differences classified as equity as a
separate component of equity; a reconciliation of the
amount of such differences at the beginning and end of the
period
If the reporting currency is different from the currency of the
country in which the enterprise is domiciled, must disclose
the reason for using a different currency
The reason for any change in reporting currency
A change in the functional currency of either the reporting
entity or a significant foreign operation and the reason
therefore

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

IAS 21
Convenience Translations
Requirements

include the following

Identify supplementary information to distinguish it

from the information that complies with IFRS
Disclose the currency in which the supplementary
information is displayed
Disclose the entitys functional currency and the
method of translation used to determine the
supplementary information

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,

Disclosure of the Impact of

Statement 52

Requires disclosure of the following

Aggregate transaction gain or loss included in income

Analysis of changes in stockholders equity, including
Beginning and ending cumulative translation adjustments
Aggregate adjustment for the period resulting from
translation adjustment and gains and losses from certain
hedges and intercompany balances
Amount of income taxes for the period allocated to the
translation adjustments
Amounts transferred from cumulative translation
adjustments and included in determining net income for the
period as a result of the sale or complete or substantially
complete liquidation of an investment in a foreign entity

International Accounting & Multinational Enterprises Chapter 10 Radebaugh,