Baker / Lembke / King 11-1

Multinational
Accounting:
Foreign Currency
Transactions and
Financial
11
Electronic Presentation by
Douglas Cloud
Instruments Pepperdine University

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 11-2
Factors Affecting Exchange Rates

•• Level
Level of
of inflation
inflation
•• Balance
Balance ofof payments
payments
•• Changes
Changes in in interest
interest rate
rate and
and
investment
investment level
level
•• Stability
Stability and
and process
process ofof governance
governance

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 11-3
European Monetary Union (EMU)

• Germany
• France
• Italy
• Spain
• Portugal
• Finland
• Ireland
• Belgium
• Netherlands
• Austria

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Direct Exchange Rate 11-4

U. S. Dollar Equivalent Value

1 Foreign Currency Unit

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Direct Exchange Rate 11-5

$1.20
1 Foreign Currency Unit

= $1.20

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Indirect Exchange Rate 11-6

1 Foreign Currency Unit

U. S. Dollar Equivalent Value
1
$1.20

= 0.8333
or
0.8333 = $1

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 11-7
Relationships Between Currencies and Rates
January 1 July 1 December 31

Direct exchange rate:

U.S. dollar relative to
the European Euro $1.200 $1.100 $1.160
Indirect exchange rate:
European Euro relative to
the U.S. dollar 0.8333 0.9090 0.8620
Between January 1 and July 1: Direct rate decreases
Dollar strengthens
Euro weakens
Indirect rate increases
Foreign goods imported in the
U.S. are less expensive
U.S.-made exports from U.S.
are more expensive
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 11-8
Relationships Between Currencies and Rates
January 1 July 1 December 31

Direct exchange rate:

U.S. dollar relative to
the European Euro $1.200 $1.100 $1.160
Indirect exchange rate:
European Euro relative to
the U.S. dollar 0.8333 0.9290 0.8620
Between July 1 and December 31 Direct rate increases
Dollar weakens
Euro strengthens
Indirect rate decreases

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Foreign Currency Transactions 11-9

 Purchases or sales of goods or services

(imports or exports), the prices of which are
stated in a foreign currency.
 Loans payable or receivable in a foreign
currency.
 The purchase or sale of forward exchange
contracts in a foreign currency.
 Purchase or sale of foreign currency units.

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Foreign Currency Transactions 11-10

AAU.S.
U.S. company
company acquires
acquires 5,000
5,000 from
from its
its
bank
bank on
on January
January 1,
1, 20X1;
20X1; for
for use
use in
in further
further
purchases
purchases from
from German
German companies.
companies.

January 1, 20X1
Foreign Currency Units ( ) 6,000
Cash 6,000

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Foreign Currency Transactions 11-11

On
On July
July 1,
1, 20X1,
20X1, the
the exchange
exchange rate
rate isis
$1.100
$1.100 == 1.1.

January 1,20X1 July 1, 20X1

(Acquire euros)

$1.200 Direct exchange rate $1.100

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 11-12
Foreign Currency Transaction Gain/Loss

On
On July
July 1,
1, 20X1,
20X1, the
the exchange
exchange rate
rate isis
$1.100
$1.100 == 1.1.

Equivalent dollar value of

January 1: 5,000 x $1.200 $6,000
Equivalent dollar value of 5,000 on
July 1: 5,000 x $1.100 5,500
Foreign currency transaction loss $ 500

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Foreign Currency Transaction Loss 11-13

Foreign Currency Transaction Loss 500

Foreign Currency Units ( ) 500

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Foreign Currency Transactions 11-14

Required accounting for an

import or export foreign currency
transaction on credit for the
following dates:

 Transaction date
 Balance sheet date
 Settlement date

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Foreign Currency Transactions 11-15

Required accounting for an import

or export foreign currency
transaction on credit is as follows:
Record
Record the the purchase
purchase
 Transaction date or
or sale
sale transaction
transaction at at
the
the U.S.
U.S. dollar
dollar
 Balance sheet date
equivalent
equivalent valuevalue
 Settlement date using
using the
the spot
spot rate
rate of
of
exchange
exchange on on this
this date.
date.

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Foreign Currency Transactions 11-16

Required accounting for an import

or export foreign currency
transaction on credit is as follows:
Adjust
Adjust the
the payable
payable or or
 Transaction date receivable
receivable toto its
its U.S.
U.S.
 Balance sheet date dollar
dollar equivalent
equivalent ,,
end-of-period
end-of-period value
value
 Settlement date using
using the
the current
current
exchange
exchange rate.
rate.

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Foreign Currency Transactions 11-17

Required accounting for an import

or export foreign currency
transaction on credit is as follows:

 Transaction date First,

First, adjust
adjust thethe
 Balance sheet date foreign
foreign currency
currency
payable
payable or or receivable
receivable
 Settlement date for
for any
any changes
changes in in the
the
exchange
exchange rate rate from
from
the
the balance
balance sheet
sheet date
date
to
to the
the settlement
settlement date.
date.
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Foreign Currency Transactions 11-18

Required accounting for an import

or export foreign currency
transaction on credit is as follows:

 Transaction date
 Balance sheet date Then,
Then, record
record the
the
 Settlement date settlement
settlement of
of the
the
foreign
foreign currency
currency
payable
payable or
or receivable.
receivable.

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 11-19
Illustration of Foreign Purchase Transaction
On
OnOctober
October1,
1,20X1,
20X1,Peerless
PeerlessProducts,
Products,aaU.S.
U.S.company,
company,
acquired
acquiredgoods
goodson onaccount
accountfrom
fromTokyo
TokyoIndustries,
Industries,aaJapanese
Japanese
company,
company,for
for$14,000,
$14,000,or or2,000,000
2,000,000yen.
yen. Settlement
Settlementisismade
madeon
on
April
April1,1,20X2,
20X2,ininthe
thenext
nextfiscal
fiscalperiod.
period.
October
October1,1,20X1
20X1
(Direct
(Directexchange
exchangerate
rate==$.0070)
$.0070)
Inventory 14,000
Accounts Payable (¥) 14,000

¥2,000,000 x $.0070 spot rate = $14,000

IfIfDenominated
Denominatedin
inJapanese
JapaneseYen
Yen

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 11-20
Illustration of Foreign Purchase Transaction
An
An adjusting
adjusting entry
entry isis needed
needed on
on the
the balance
balance sheet
sheet date
date
to
to reflect
reflect the
the current
current exchange
exchangerate.
rate. The
Thedirect
direct
exchange
exchange raterate on
on December
December 31,
31, 20X1
20X1 isis $.0080.
$.0080.

December
December 31,
31, 20X1
20X1
(Direct
(Direct exchange
exchange rate
rate == $.0080)
$.0080)
Foreign Currency Transaction Loss 2,000
Accounts Payable (¥) 2,000
¥2,000,000 x $.0080 Dec. 31 spot rate = $16,000
¥2,000,000 x $.0070 Oct. 1 spot rate = 14,000
$ 2,000

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 11-21
Illustration of Foreign Purchase Transaction

Settlement
Settlement of
of the
the payable
payable was
was made
made on
onApril
April 1,
1, 20X2.
20X2.
April
April 1,
1, 20X2
20X2
(Direct
(Direct exchange
exchange rate
rate ==$.0076)
$.0076)
Accounts Payable (¥) 800
Foreign Currency Transaction Gain 800
¥2,000,000 x $.0076 Apr. 1 spot rate = $15,200
¥2,000,000 x $.0080 Dec. 31 spot rate = 16,000
$ 800
Step 1

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 11-22
Illustration of Foreign Purchase Transaction

Settlement
Settlement of
of the
the payable
payable was
was made
made on
onApril
April 1,
1, 20X2.
20X2.
April
April 1,
1, 20X2
20X2
(Direct
(Direct exchange
exchange rate
rate ==$.0076)
$.0076)

Foreign Currency Units (¥) 15,200

Cash 15,200
Accounts Payable (¥) 15,200
Foreign Currency Units (¥) 15,200

Step 2

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 11-23
Illustration of Foreign Purchase Transaction

Some
Someaccountants
accountants combine
combine the
the revaluation
revaluation and
and
settlement
settlement entries
entriesinto
into one
one entry.
entry.

Foreign Currency Units (¥) 15,200

Cash 15,200
Accounts Payable (¥) 16,000
Foreign Currency Transaction Gain 800
Foreign Currency Units (¥) 15,200

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 11-24
Foreign Currency Payable
Accounts Payable (¥)
10/1/X1 14,000
(¥2,000,000 x $.0070)
AJE: Loss
A/P (¥) 2,000
12/31/X1 16,000
(¥2,000,000 x $.0080)
AJE: A/P (¥)
Gain 800
4/1/X2
(¥2,000,000 x $.0076) 15,200

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 11-25
A Derivative Defined
FASB 133 defines a derivative as a financial instrument or
contract possessing all of the following characteristics:
 The financial instrument must contain one or more
underlying, and one or more notional amounts.

An
An underlying
underlying isis any
anyA
Anotional
notional amount
amount isis the
the
financial
financial or
or physical
physicalnumber
number of
of currency
currency units,
units,
variable
variable that
that has
hasshares,
shares, bushels,
bushels, pounds,
pounds, or or
observable
observable oror objectively
other
other units
objectively units specified
specified in
in the
the
verifiable
verifiable changes.
changes. financial
financial instrument
instrument..

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 11-26
A Derivative Defined
FASB 133 defines a derivative as a financial instrument or
contract possessing all of the following characteristics:
 The financial instrument must contain one or more
underlying, and one or more notional amounts.
 The financial instrument or other contract requires no initial
net investment that is smaller than would be required for
other types of contracts that would be expected to have a
similar response to changes in market factors.
 The terms of the contract require or permit net settlement,
or provide for the delivery of an asset that puts the recipient
in an economic position not substantially different from net
settlement.

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 11-27
FASB 133

1. General rule of valuing at fair value.

2. Embedded derivatives--separate derivative
from host contract.
3. Hedge
a. Documentation to justify hedge at
beginning of contract or hedge.
b. Effectiveness to match changes in value
of hedged item (reassess every three
months).

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 11-28
Three Types of Hedges in FASB 133
1. Fair-value hedge: a hedge of changes in the fair value of:
(a) a recognized asset or liability, or
(b) an unrecognized firm commitment
- gain or losses on fair value hedges go to current
earnings
2. Cash-flow hedge: a hedge of the exposure to variability in
the projected cash flows of:
(a) a recognized asset or liability, or
(b) a forecasted transaction
- gains and losses on the effective portion of the hedge go
to OCI; other gains and losses go to current earnings
Continued
Continuednext
nextslide
slide
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 11-29
Three Types of Hedges in FASB 133
3. Foreign currency hedge: a hedge of the foreign currency
exposure of:
(a) an unrecognized firm commitment,
(b) an available-for-sale security.
(c) a forecasted transaction, or
(d) a net investment in a foreign operation

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 11-30
Forward Exchange Contracts

 To hedge an exposed
The
TheFASB
FASBrecognizes
recognizes
three foreign currency net
threemajor
majorpurposes
purposes
of
offorward
forwardexchange
exchange asset or liability
contracts.
contracts. position.
 To hedge an
identifiable foreign
currency commitment.
 To speculate in foreign
currency markets.

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 11-31
Hedging an Exposed Position: Time Line
10/1/X1 12/31/X1 4/1/X2

Transaction Balance sheet Settlement

date date date

• Incur liability • Obtain yen by settling

denominated in yen forward exchange
• Sign 180-day forward contract
contract to receive yen • Pay yen to settle
account payable

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 11-32
Hedging an Exposed Position: Main Points


 Account
Account payable
payableor or receivable
receivabledenominated
denominated in in
foreign
foreign currency
currency valued
valued atat U.S.
U.S. dollar
dollar equivalent
equivalent
value
value using
using thethe spot
spot exchange
exchange rate.
rate.

 Foreign
Foreign exchange
exchange contract
contract foreign
foreign currency
currency
receivable
receivable oror payable
payable with
with exchange
exchange broker
broker
valued
valued at
at fair
fair value
valueusing
using the
the forward
forward exchange
exchange
rate.
rate.

 Exchange
Exchange gaingain (losses)
(losses) are
are recognized
recognized in in current
current
earnings
earnings inin period
period ofof change
changein in exchange
exchangerates.
rates.

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Example Exchange Rates 11-33

Date Spot Rate Forward Rate

October 1, 20X1 $.0070 $.0075 (180-day)
December 31, 20X1 $.0080 $.0077 (90-day)
April 1, 20X2 $.0076

¥2,000,000 is the amount of both the accounts

payable and the forward contract receivable

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 11-34
Hedging Exposed Net Liability Position

Forward Contract Rec.(¥) Accounts Payable (¥)

10/1 FCRec(¥) 15,000 Inventory 14,000
Doll. Pay 15,000 A/P(¥) 14,000
FERate = $.0075 Spot rate = $.0070
12/31FCRec(¥) 400 FC Loss 2,000
FC Gain 400 A/P(¥) 2,000
FERate = $.0077 Spot rate = $.0080

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 11-35
Hedging Exposed Net Liability Position

Forward Contract Rec.(¥) Accounts Payable (¥)

4/1 Doll. Pay 15,000
Cash 15,000

FCU (¥) 15,200

FC Loss 200 A/P (¥) 16.000
FCRec(¥) 15,400 FCU (¥) 15,200
Spot rate = $.0076 FC Gain 800

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 11-36 11-34
Hedging an Identifiable Foreign Currency Currency
Commitment: Major Points
 On date of commitment (8/1/X1) FASB 133 specifies
separation of forward exchange contracts into components:
– Financial instrument component (obligation to pay yen)
– Nonfinancial asset component (right to receive
inventory)
 At point of receipt of inventory goods (10/1/X1):
– Revalue forward contract to fair value, recognizing loss
or gain
– Record gain or loss on financial instrument component
of commitment
– Close Firm Commitment account to inventory

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 11-37
Hedging Foreign Commitment
Forward Contract Rec.(¥) Firm Commitment
8/1 FCRec(¥) 14,600
Doll. Pay 14,600
FERate = $.0073
10/1 FCRec(¥) 400 FC Loss 400
FC Gain 400 Firm Comm. 400
FERate = $.0075 FERate = $.0075
Inventory 13,600
Firm Comm. 400
A/P(¥) 14,000
Spot rate = $.0070
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 11-36
Speculation with Forward Contracts: Contracts:11-38
Time Line
10/1/X1 12/31/X1 4/1/X2

Enter 180-day Balance sheet date Deliver Swiss

speculative francs and
forward receive dollars
contract to settle
forward
contract

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 11-39
Speculation: Forward Exchange Contract

 Value
Value forward
forward
contract
contract using
using
forward
forward exchange
exchange
rate
rate for
for remainder
remainder of
of
term
term
 No
No separate
separate
accounting
accounting for for
premium
premium or or discount
discount
on
on forward
forward contracts
contracts
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 11-40
Speculation: Forward Exchange Contract
Foreign Currency Payable (SFr)
10/1/X1 2,960
(SFr4,000 x $.74 Forward
rate)
AJE: Loss
FC Pay (SFr) 160
12/31/X1 3,120
(SFr4,000 x $.78 Forward
rate)
AJE: FCPay (SFr)
Gain 40
4/1/X2
(SFR4,000 x $.77 Spot) 3,080
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 11-41
Foreign Exchange Matrix

Direct Exchange Rate Changes

Transactions or Accounts
Denominated in Foreign Exchange Rate Increases Exchange Rate Decreases
Currency Units (dollar has weakened) (dollar has strengthened)
Net monetary asset position,
for example:
(1) Foreign Currency Units
(2) Accounts Receivable EXCHANGE EXCHANGE
(3) Foreign Currency
Receivable from
GAIN LOSS
Exchange Brokers

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 11-42
Foreign Exchange Matrix

Direct Exchange Rate Changes

Transactions or Accounts
Denominated in Foreign Exchange Rate Increases Exchange Rate Decreases
Currency Units (dollar has weakened) (dollar has strengthened)
Net monetary liability
position, for example:
(1) Accounts Payable
(2) Bonds Payable EXCHANGE EXCHANGE
(3) Foreign Currency LOSS GAIN
Payable to Exchange
Brokers

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Chapter Eleven 11-43

The
End
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 11-44

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