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Multinational
Accounting:
Foreign Currency
Transactions and
Financial
11
Electronic Presentation by
Douglas Cloud
Instruments Pepperdine University
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-3
European Monetary Union (EMU)
• Germany
• France
• Italy
• Spain
• Portugal
• Finland
• Ireland
• Belgium
• Netherlands
• Austria
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Direct Exchange Rate 11-4
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Direct Exchange Rate 11-5
$1.20
1 Foreign Currency Unit
= $1.20
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Indirect Exchange Rate 11-6
= 0.8333
or
0.8333 = $1
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11-7
Relationships Between Currencies and Rates
January 1 July 1 December 31
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions 11-9
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transaction Loss 11-13
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions 11-14
Transaction date
Balance sheet date
Settlement date
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions 11-15
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions 11-16
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Currency Transactions 11-17
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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
IfIfDenominated
Denominatedin
inJapanese
JapaneseYen
Yen
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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)
Step 2
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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..
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-27
FASB 133
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-31
Hedging an Exposed Position: Time Line
10/1/X1 12/31/X1 4/1/X2
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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.
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Example Exchange Rates 11-33
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11-34
Hedging Exposed Net Liability Position
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11-35
Hedging Exposed Net Liability Position
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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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-36
Speculation with Forward Contracts: Contracts:11-38
Time Line
10/1/X1 12/31/X1 4/1/X2
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/ Irwin
11-41
Foreign Exchange Matrix
McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-42
Foreign Exchange Matrix
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Chapter Eleven 11-43
The
End
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11-44
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