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Accounting for Foreign Currency


... Accounting for Debt in a Foreign Currency Translation terminology Key issues for translation Current/Noncurrent Method Translation Exchange Rates Monetary ... – PowerPoint PPT presentation

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Title: Accounting for Foreign Currency

Chapter 10
  • Accounting for Foreign Currency

Basics in Foreign Exchange
  • Foreign exchange is traded
  • Over-the-counter (OTC)
  • Made up of commercial and investment banks
  • On an exchange
  • Over the Internet

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
  • 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

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)

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

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
  • Recording of the settlement of foreign currency
    receivables and payables when they come due

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

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
  • Any difference between the spot rates is a gain
    or loss, reflected in the period in which the
    rate changed

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

  • 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.

Illustration Journal Entries
  • March 1 Purchases 262,240
  • A/P 262,240
  • 200,000 x 1.3112
  • March 31 Foreign exchange loss 7,760
  • A/P 7,760
  • 200,000 (1.3112 1.35)
  • April 30 A/P 270,000
  • Foreign exchange gain 4,000
  • Cash 266,000

Illustration Accounting for Debt in a Foreign
  • 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

Illustration Accounting for Debt in a Foreign
  • January 1 Cash 1,612,800
  • Notes Payable
  • June 30 Notes Payable 32,600
  • Foreign Exchange Loss
  • (CHF.7901 -.8064) x CHF 2 million
  • Interest Expense 23,948
  • Foreign exchange gain
  • Cash
  • CHF2,000,000 x (.03/2) 30,000 x .79825
  • CHF30,000 x .7901 23,703

Illustration Accounting for Debt in a Foreign
  • Dec. 31 Foreign exchange loss 187,600
  • Notes Payable
  • (.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

Translation terminology
  • Functional currency currency of the primary
    economic environment in which the company
  • 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

Key issues for translation
  • Exchange rates at which various accounts are
    translated from one currency into another
  • Subsequent treatment of gains and losses

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
  • Accounts should be grouped according to maturity

Translation Exchange Rates
Monetary/Nonmonetary Method
  • Accounts are considered as monetary or
  • Monetary assets and liabilities translated at the
    current rate
  • Nonmonetary assets and liabilities and
    stockholders equity translated at historical
  • Assets and liabilities are translated on the
    basis of attributes instead of time

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
  • 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
  • This flexible method ensures that parent currency
    is the single unit of measure

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 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

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

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

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
  • 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

The Temporal Method
  • Easier to remeasure the balance sheet before the
    income statement
  • Translation adjustment is taken to the income

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
  • Market Market value in foreign currency x
    Exchange rate in effect when market was
  • Test is performed in the reporting currency

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

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

Translation Choices
Foreign Currency and Intercompany Transactions
  • Gains and losses on foreign currency debt are
    often adjusted to interest expense
  • Intercompany transactions are both long and
  • 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

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

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

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.

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)

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

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

Disclosure of the Impact of Statement 52
  • Requires disclosure of the following
  • Aggregate transaction gain or loss included in
  • Analysis of changes in stockholders equity,
  • Beginning and ending cumulative translation
  • 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