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ACCOUNTING FOR CURRENCY EXCHANGE

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... that provides the right to trade a foreign currency at a set exchange rate on ... The value of the currency is allowed to fluctuate / float freely according to ... – PowerPoint PPT presentation

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Title: ACCOUNTING FOR CURRENCY EXCHANGE


1
ACCOUNTING FOR CURRENCY EXCHANGE RATE CHANGES
2
  • OVERVIEW
  • In previous chapters we discussed diversity of
  • International Accounting as well as the
    associated difficulties.
  • The history of international commerce was build
    on
  • exchange of goods for goods, or payments for
    goods
  • and services in form of gold or silver.
  • The removal of Gold cover made currencies
  • exchange more sensitive to the fluctuation in
    other
  • currencies which, added difficulties.
  • In the forthcoming slide we will define selected
    terms and terminologies prior to discussing the
    chapter in details.

3
  • TERMINOLOGIES I
  • FOREIGN EXCHANGE.
  • Is the currency of another country and it may
    comes in various forms.
  • FOREIGN EXCHANGE RATE.
  • Is when two parties agree to exchange one
    currency for another at specific rate of
    exchange.
  • SPOT MARKET / RATE.
  • Is the price at which a foreign currency can be
    purchased / sold immediately.

4
  • TERMINOLOGIES II
  • Forward Market / Market.
  • Inversely, it is a present contract for future
    delivery of foreign currency.
  • CURRENCY OPTIONS
  • Is a contract that provides the right to trade a
    foreign currency at a set exchange rate on or
    before a future given date.
  • CURRENCY SWAP
  • This is a concurrent sale purchase of two
    different currencies. The purchase is effective
    at once. However, the transaction could be
    completed at future date. (PG 59)

5
  • CURRENCY ARRANGEMENTS
  • Independent Float.
  • The value of the currency is allowed to fluctuate
    / float freely according to the market forces
    without intervention from the central bank.
  • Pegged to another Currency.
  • Allowing a currency to be fixed (pegged) in terms
    of another currency and the central bank will
    intervenes to maintain the fixed value (i.e.
    Syria USA).
  • European Monetary System.
  • In 2002, EU used a common currency Euro and
    allowed it to float against US Dollar. IATH

6
  • FOREIGN CURRENCY TRANSACTION EXPOSURE
  • i
  • EXPORT SALES Exposure.
  • These transactions take place when the exporter
    (SELLER) allows the buyer to pay in Foreign
    currency and at sometime after the sale has been
    made.
  • IMPORT PURCHASES Exposure.
  • These transactions take place when the importer
    (BUYER) was allowed to pay the seller in Foreign
    currency and at sometime after the sale has been
    made.
  • These transactions cause two issues to be
    addressed 1) how to report the rate adjustment
    and 2) should the adjustments made at balance
    sheet date. In addition, there are two approaches
    to record these transactions a) single entry and
    b) two transactions approach.

7
  • FOREIGN CURRENCY TRANSACTION EXPOSURE
  • PG 62-63 In (000)

One transaction One transaction Two transactions Two transactions
Transaction Date Dr. Cr. Dr. Cr.
A / R U 10,000 U 10,000
Revenues U 10,000 U 10,000
Payment Date
Cash U 9, 696 U 9, 696
Revenues (Neg) U 303
Loss on F. Exch. U 303
A / R U 10,000 U 10,000
8
  • FOREIGN CURRENCY TRANSLATIONS
  • ii
  • TRANSLATION/ACCOUNTING EXPOSURE.
  • Translation/ accounting exposure, takes place
    when the corporate office is located in a country
    and it has to translate all subsidiaries
    financial statements to corporate office's
    country currency.
  • This is the definition of FUNCTIONAL CURRENCY,
    is the primary currency of the foreign entitys
    operating environment. Thus, it can be the
    parents currency or a foreign currency (local).

9
  • FOREIGN CURRENCY TRANSACTIONS
  • iii
  • TRANSACTION EXPOSURE.
  • Transaction exposure, is very sensitive or
    vulnerable to the changes (fluctuate) in exchange
    rate. Transaction exposure is very similar to
    the translation as far as its impact on financial
    reporting except, when the foreign transaction or
    obligation will be fulfilled (paid ) in foreign
    currency and or will be paid over a period of
    time (i.e. 60 days).
  • NOTE Then we can say the corporation is exposed
    to foreign risk.

10
  • FOREIGN CURRENCY TRANSACTIONS
  • iv
  • ECONOMIC / OPERATING EXPOSURE.
  • Economic exposure refers to the risk and the
    negative affect on a corporations Cash Flows.
    Other examples of risks such as decrease in
    exports due to appreciation of corporate home
    currency, or the depreciation of corporate home
    currency.

11
  • TRANSLATION METHODS
  • 1 - 5
  • There are several statements from FASB and FAS
    addressing the treatments for changes in exchange
    rate such as FASB statements 8, 52, and SFAS
    statements 52, 133.
  • The following is summary of these methods
  • Current / Non-Current Method
  • Current assets and current liabilities are
    translated at the current exchange rate
    non-current assets, non-current liabilities, and
    stockholders' equity accounts are translated at
    historical exchange rates. Although once the
    predominant method, the current/non-current
    method has been unacceptable in the United States
    and has never been allowed under International
    Financial Reporting Standards

12
  • 2 - 5
  • Monetary/Non- Monetary Method
  • Under this method, MONETARY assets and
    liabilities are translated at the current
    exchange rates NON-MONETARY assets,
    non-monetary liabilities, and stockholders'
    equity accounts are translated at historical
    exchange rates.
  • NON-MONETARY assets are assets whose monetary
    value can fluctuate. They consist of marketable
    securities, inventory, prepaid expenses,
    investments, fixed assets, and intangible assets
    that is, all assets other than cash and
    receivables.
  • MONETARY LIABILITIES are those liabilities whose
    monetary value cannot fluctuate over time, which
    is true for most payables.

13
  • 3 - 5
  • Temporal Method
  • Temporal method of translation is to produce a
    set of parent currency translated financial
    statements as if the foreign subsidiary had
    actually used the parent currency in conducting
    its operations.
  • Assets and liabilities reported on the foreign
    operation's balance sheet at historical cost
    are translated at historical exchange rates
  • Conversely, assets and liabilities reported on
    the foreign operation's balance sheet at a
    current (or future) value are translated at the
    current exchange rate to yield an equivalent
    current value in parent currency terms. (As is
    true under any translation method, equity
    accounts are translated at historical exchange
    rates.)

14
  • 4 - 5
  • Temporal Method
  • Income statement items are translated at
    exchange rates that exist when the revenue is
    generated or the expense is incurred. For most
    items, an assumption can be made that the revenue
    or expense is incurred evenly throughout the
    accounting period and an average-for-the-period
    exchange rate can be used for translation. Some
    expenses such as cost of goods sold, depreciation
    of fixed assets, and amortization of intangibles
    are related to assets carried at historical cost.
    Because these assets are translated at historical
    exchange rates, the expenses related to them must
    be translated at historical exchange rates as
    well.

15
  • 5 - 5
  • Additional issues
  • Translation of Retained Earning
  • Stockholders' equity items are translated at
    historical exchange rates under both the
    temporal and current rate methods. This creates
    somewhat of a problem in translating retained
    earnings, which is a composite of many previous
    transactions revenues, expenses, gains, losses,
    and declared dividends occurring over the life of
    the company.

16
  • DISPOSITION OF TRANSLATION ADJUSTMENT (i)
  • The first issue related to the translation of
    foreign currency financial statements is
    selection of the appropriate method. The second
    issue in financial statement translation relates
    to where the resulting translation adjustment
    should be reported in the consolidated financial
    statements.
  • Concerning the second issue there are two schools
    of thought with regard to this issue
  • (1) Translation gain or loss in net income. Under
    this treatment, the translation adjustment is
    considered to be a gain or loss similar to the
    gains and losses that arise from foreign currency
    transactions and should be reported in income in
    the period in which the fluctuation in exchange
    rate occurs .

17
  • DISPOSITION OF TRANSLATION ADJUSTMENT (ii)
  • (2) Cumulative translation adjustment to be
    included in stockholders' equity (other
    comprehensive income). And as a component of
    other comprehensive income. In effect, this
    treatment defers the gain or loss in
    stockholders' equity until it is realized in some
    way. As a balance sheet account, other
    comprehensive income is not closed at the end of
    the accounting period and will fluctuate in
    amount over time.
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