ACCT 530 Advanced Financial Accounting

Which of the following statements is false? - Most currency exchange rates are determined by brokers on a daily basis. - Economic factors rarely affect exchange rates. - Some countries maintain control over their exchange rates. - When the U.S. dollar strengthens, it has greater buying power overseas and can buy more units of foreign currencies. - A spot rate is the exchange rate for immediate delivery of a currency.

- Economic factors rarely affect exchange rates.

A derivative

- is a financial instrument or other contract whose value is "derived from" some other item that has a variable value over time.

Functional currency

-"The currency of the primary economic environment in which the entity operates; normally that is the currency of the environment in which an entity primarily generates and expends cash." -Used to differentiate between foreign operations that are self-contained and integrated into a local environment, and those that are an extension of the parent and integrated with the parent.

Cash flow hedges

-Changes in the fair market value are separated into an effective portion and an ineffective portion. -The net gain or loss on the effective portion of the hedging instrument should be reported in other comprehensive income. -The gain or loss on the ineffective portion is reported in current earnings on the income statement.

ASC 815 establishes a basic rule of fair value for accounting for forward exchange contracts

-Changes in the fair value are recognized in the accounts, but the specific accounting for the change depends on the purpose of the hedge. -For forward exchange contracts, the basic rule is to use the forward exchange rate to value the forward contract.

Exchange rates that may be used in converting foreign currency values to the U.S. dollar:

-Current rate -Historical rate -Average rate for the period

Which of the following statements is false? -Foreign currency transactions of a U.S. Firm involve the exchange of goods from a foreign country denominated in $ U.S. -The purchase or sale of an item is a separate transaction from the foreign currency commitment under the two transaction approach. -Foreign currency exchange gains or losses from the revaluation of assets or liabilities denominated in a foreign currency must be recognized in the period when the exchange rate changes

-Foreign currency transactions of a U.S. Firm involve the exchange of goods from a foreign country denominated in $ U.S.

Benefits of adoption of a single set of globally accepted accounting standards

-Increased quality of information available to investors. -Reduced costs of compliance for companies that are currently using multiple reporting frameworks. -Enhanced global capital markets. -Improved access to capital in the global markets. -Enhanced comparability across companies for users.

Factors causing fluctuations in exchange rates

-Level of inflation -Balance of payments -Changes in interest rate -Changes in investment levels -Stability and process of governance

Characteristics of derivatives The contract terms:

-Require or permit net settlement, -Provide for the delivery of an asset that puts the recipient in an economic position not substantially different from net settlement, or -Allow for the contract to be readily settled net by a market or other mechanism outside the contract.

Which of the following is NOT one of the criteria for a hedge to be considered effective? -The hedge is based on an effective interest rate. -Documentation of the objective, strategy, and effectiveness of the hedge. -The hedge must be highly effective through its term. -The effectiveness of the hedge is assessed on an ongoing basis

-The hedge is based on an effective interest rate.

Characteristics of derivatives: The financial instrument must contain one or more underlyings and one or more notional amounts, which specify the terms of the financial instrument.

-Underlying: -Notional amount: -The financial instrument/contract requires no initial net investment or an initial net investment that is smaller than required for other types of contracts expected to have a similar response to changes in market factors.

Foreign Currency Import and Export Transactions two-transaction approach

-Views the purchase or sale of an item as a separate transaction from the foreign currency commitment. -The FASB established that foreign currency exchange gains or losses resulting from the revaluation of assets or liabilities denominated in a foreign currency must be recognized currently in the income statement of the period in which the exchange rate changes. *There are a few exceptions to this general rule.

Strengthening of the U.S. dollar

-direct exchange rate decreases. -Taking less U.S. currency to acquire one foreign currency unit. -One U.S. dollar acquiring more foreign currency units. -Example: DER decreases from $1.45/€ to $1.26/€.

Weakening of the U.S. dollar

-direct exchange rate increases -Taking more U.S. currency to acquire one foreign currency unit. -One U.S. dollar acquiring fewer foreign currency units. -Example: DER increases from $1.33/€ to $1.45/€.

A financial instrument

-is cash, evidence of ownership, or a contract that both: 1.Imposes on one entity a contractual obligation to deliver cash or another instrument, and 2.Conveys to the second entity that contractual right to receive cash or another financial instrument. wA derivative is a financial instrument or other contract whose value is "derived from" some other item that has a variable value over time.

Types of Foreign currency transactions

1.Purchases or sales of goods or services (imports or exports), the prices of which are stated in a foreign currency. 2.Loans payable or receivable in a foreign currency. 3.Purchase or sale of foreign currency forward exchange contracts. 4.Purchase or sale of foreign currency units.

Reasons why a parent company couldn't consolidates a foreign subsidiary, due to U.S. company owning a foreign company may not be able to exercise the necessary level of economic control:

1.Restrictions on foreign exchange in the foreign country. 2.Restrictions on transfers of property in the foreign country. 3.Other governmentally imposed uncertainties.

Two criteria must be met for a derivative instrument to qualify as a hedging instrument:

1.Sufficient documentation must be provided at the beginning of the hedge term to identify the objective and strategy of the hedge, the hedging instrument, and the hedged item, and how the hedge's effectiveness will be assessed on an ongoing basis. 2.The hedge must be highly effective throughout its term. *Effectiveness is measured by evaluating the hedging instrument's ability to generate changes in fair value that offset the changes in value of the hedged item.

When does the translation adjustment account have a credit balance?

A credit balance usually results when the dollar is weakening relative to the foreign currency, and the current exchange rate is higher than the historical exchange rate.

When does the translation adjustment account have a debit balance?

A debit balance usually means that the current exchange rate is less than the historical rate used to translate the stockholders' equity accounts. This means the dollar is strengthening relative to the foreign currency.

Explain why a difference usually exists between a currency's spot rate and forward rate.

A difference usually exists between a currency's spot rate and forward rate because of the different economic factors involved in the determination of a future versus present rate of exchange. This difference is usually positive because of uncertainty and conservatism toward the future.

Differentiate between a foreign transaction and a foreign currency transaction. Give examples.

A foreign transaction is a transaction that does not involve the exchange of currencies on the part of the reporting entity. A foreign currency transaction is a transaction that does involve the exchange of currencies on the part of the reporting entity.

What is the main difference in accounting for a forward exchange contract that may be used to speculate in foreign currency markets?

A speculative forward contract is not a hedge, but rather is a derivative that is valued at fair value by using the forward exchange rate for the remainder of the forward contract's term. Gains or losses on these forward contracts are recognized in income in the period in which they occur.

How are assets and liabilities denominated in a foreign currency measured on the balance sheet date?

ASC 830 specifies that the valuation at the transaction date and each subsequent balance sheet date should be at the local currency equivalent using the spot rate of exchange. Forward exchange contracts are valued at fair value, typically by using the forward rate for the remainder of the term of the forward contract.

Which of the following statements is false? - Income statement items are generally translated at the average rate for the year. - Assets and liabilities are normally translated at the current rate on the balance sheet date. - Equity accounts are usually translated at historical rates. - After translating all items, the trial balance must balance by definition

After translating all items, the trial balance must balance by definition

Give an example of a foreign currency transaction.

An example of a foreign currency transaction is the sale of equipment by a U.S. company (the reporting entity) to a Japanese firm that is denominated in Japanese yen.

Give an example of a foreign transaction.

An example of a foreign transaction is the sale of equipment by a U.S. company (the reporting entity) to a Japanese firm that is denominated in U.S. dollars.

Distinguish between an exposed net asset position and an exposed net liability position.

An exposed net asset position occurs when a company's trade receivables and other assets denominated in a foreign currency are greater than its liabilities denominated in that currency. An exposed net liability position occurs if a company's liabilities denominated in a foreign currency exceed receivables denominated in that currency.

How are assets and liabilities denominated in a foreign currency measured on the transaction date?

Assets and liabilities denominated in a foreign currency are measured according to the requirements in ASC 830 for those arising from normal purchase and sale transactions, and by ASC 815 for forward exchange contracts and hedging activities.

What are some ways a U.S. company can manage the risk of changes in the exchange rates of foreign currency?

Four ways a U.S. company can manage the risk of changes in the exchange rates for foreign currencies are to (1) use a forward contract to offset an exposed foreign currency position, (2) hedge a firm foreign currency commitment as a fair value hedge, (3) hedge an anticipated foreign transaction as a cash flow hedge, or (4) speculate in foreign currency markets. One example of a U.S. company hedging against the risk of changes in the exchange rates for foreign currencies is to use a forward exchange receivable contract to partially offset the effects of changes in the exchange rates of the foreign currency liability.

How widely used are IFRS?

IFRS are already mandated or permitted in over 100 countries around the world. Beginning with 2005, the European Union mandated the use of IFRS for companies listing on stock exchanges in the EU, although the EU also continues to accept statements prepared according to US GAAP.

Which of the following defines a foreign-based entity that uses a functional currency different from the recording currency? I. A U.S. subsidiary in Britain maintains its accounting records in pounds sterling, with the majority of its transactions denominated in pounds sterling. II. A U.S. subsidiary in Peru conducts virtually all of its business in Latin America, records transactions in the respective local currencies, and uses the U.S. dollar as its major currency. - I. - II. - Both I and II. - Neither I nor II.

II.

Sun Company, a U.S. corp. has an AP of $200,00 denominated in Canadian dollars. If the direct exchange rate increases, will Sun experience a foreign currency transaction gain or loss on this payable?

If the direct exchange rate increases, the Sun Company will experience a foreign currency transaction loss on its $200,000 account payable that is denominated in Canadian dollars. The increase in the direct exchange rate shows that the U.S. dollar has weakened relative to the Canadian dollar, requiring more U.S. dollars be used to pay the debt owed.

Explain the difference between indirect and direct exchange rates.

Indirect and direct exchange rates differ by which currency is desired to be expressed in another currency. An indirect exchange rate is the number of foreign currency units that may be obtained for one local currency unit. The indirect exchange rate has the foreign currency unit in the numerator.

IASB

International Accounting Standards Board

IFRS

International Financial Reporting Standards

Give examples of a change in economic factors that results in weakening of local currency units versus a foreign currency unit.

One example of an economic factor that results in a weakening of the U.S. dollar versus the European euro is a higher level of inflation in the U.S. relative to the inflation in Europe.

highly inflationary economy

One that has a cumulative inflation of approximately 100 percent or more over a 3-year period. ASC 830 provides six indicators to be used to determine a foreign entity's functional currency: (1) cash flows, (2) sales prices, (3) sales markets, (4) expenses, (5) financing, and (6) intercompany transactions and arrangements.

Breifly discuss the International Accounting Standards Board (IASB).

The IASB is an independent privately funded accounting standards-setting body.

Where is the IASB located?

The IASB is based in London.

What is the composition of the IASB membership and how long do members server?

The IASB is composed of 15 members who each serve a five-year term subject to one reappointment. Members are required to sever all employment relationships that might compromise their independent judgment in setting accounting standards.

The IASB promulgates International Financial Reporting Standards (IFRS). Breifly describe the standard-setting process used by the IASB.

The IASB solicits input from the public when evaluating potential standards and publishes a discussion paper and/or an exposure draft which are subject to comment before issuing a final standard.

Which of the following statements is true regarding the SEC's timeline for convergence? - The SEC has no immediate plans to converge GAAP reporting with IFRS standards. - The SEC has a plan in place to allow firms to begin filing in the United States based on IFRS during the next several years. - The SEC has a plan in place to allow companies to choose to file statements under GAAP reporting or IFRS standards indefinitely. - The SEC currently allows domestic companies to choose to file financial statements under either GAAP or IFRS reporting standards.

The SEC has no immediate plans to converge GAAP reporting with IFRS standards.

foreign currency transaction gain or loss

The adjustment in equivalent U.S. dollar values for the entity when exchange rates have changed.

local currency unit

The currency used locally; that is, the currency used in the country in which the company is located.

Reporting currency

The currency used on the financial statements of the business entity. The reporting currency for US-based entities is the U.S. Dollar.

Recording currency

The currency used to record the economic activities in the journals and ledger of the business entity. The recording currency is typically the local currency, but may be some other currency.

Why is there interest in the adoption of a single set of high-quality accounting standards?

There is interest because of the expected benefits of adopting a single set of high-quality accounting standards, which include: 1) Continued expansion of capital markets across national borders. 2) More rapid development of stable, liquid capital markets. 3)Increased economic growth. 4)Improve ability of investors to evaluate opportunities across national borders. 5)Improve the efficient use of global capital. 6)Reduce reporting costs for corporations that wish to access capital in markets outside of their home country. 7)Increase confidence of financial statement users in the quality of financial reporting.

Where are foreign currency transactions gains or losses reported in the financial statements?

These gains or losses are reported on the income statement.

What are translation adjustments?

Translation adjustments are the balancing items to make the debit and credit items equal in the translated trial balance measured in U.S. dollars. The parent company records its share of the translation adjustment in its books through an adjusting entry. The change during the period in the translation adjustment is reported as a component of other comprehensive income in the Statement of Comprehensive Income. The accumulated other comprehensive income is reported as a separate item of stockholders' equity in the balance sheet.

Which of the following statements is true? - Foreign subsidiaries are always consolidated. - U.S. GAAP does not allow for the complete liquidation of foreign investments. - U.S. GAAP permits the hedging of a net investment in foreign subsidiaries. - The statement of cash flows is always translated at historical costs. - Translated intercompany transactions are not eliminated like normal intercompany transactions

U.S. GAAP permits the hedging of a net investment in foreign subsidiaries.

Average rate for the period

Usually a simple average for a period of time and is usually the exchange rate used to measure revenues and expenses.

What is the main difference in accounting for a forward exchange contract that may be used to manage an exposed foreign currency position?

When an exposed foreign currency position exists, either an exposed net asset or net liability position is created. The forward contract is valued at fair value, usually by the forward exchange rate for the remainder of the term of the forward contract. The underlying payable or receivable from the foreign currency transaction is valued at the spot rate at the time of the transaction and adjusted to the current spot rate at each balance sheet date.

The U.S. $ strengthened against the Euro. Will imports from Europe into the U.S. be more expensive or less expensive in U.S. $? Explain why.

When the U.S. dollar strengthens against the European euro, imports from Europe into the U.S. will be less expensive in U.S. dollars. The direct exchange rate decreases, indicating that it takes fewer dollars to acquire European euros.

A Canadian-based subsidiary of a U.S. parent uses the Canadian dollar as its functional currency. Describe the methodology for translating the sub's financial statements into the parent's reporting currency.

When the local currency is the foreign entity's functional currency, the translation method is used to convert the foreign entity's financial statements into U.S. dollars, the parent company's reporting currency. The translation method uses the current exchange rate for converting all assets and liabilities. The appropriate historical exchange rate is used to convert the Canadian entity's stockholders' equity accounts. The weighted average exchange rate is used to convert the Canadian entity's income statement accounts. The change in the translation adjustment during the period is reported as an element of other comprehensive income on the Statement of Comprehensive Income, and is then accumulated with the other elements of comprehensive income and reported within the stockholders' equity section of the consolidated balance sheet. The translation adjustment may have a debit or credit balance, depending on the relative change in the exchange rate since the parent acquired the subsidiary.

What is the attitude towards the possible use of IFRS in the U.S.?

While foreign registrants are still able to file IFRS financial statements with the SCE, the attitude toward the possible use of IFRS for domestic companies in the United States is waning.

Direct Exchange Rate Equation

DER= (U.S.$ -equivalent value of 1FCU)/1FCU

Current rate

Exchange rate at the end of the trading day on the balance sheet date.

Historical rate

Exchange rate that existed when an initial transaction took place.

What is the main difference in accounting for a forward exchange contract that may be used to hedge a forecasted foreign currency transaction?

For a cash flow hedge of a forecasted transaction, the forward contract is valued at the forward rate, but the effective portion of the change in the fair value of the forward contract is recognized in other comprehensive income. The gain or loss on the re-measured foreign currency denominated account payable or receivable is offset from a reclassification of other comprehensive income so that there is no net exchange gain or loss from this hedge.

What is the main difference in accounting for a forward exchange contract that may be used to hedge an identifiable foreign currency commitment?

For a hedge of an identifiable foreign currency commitment, both the financial instrument and the forward contract aspects of the hedge are valued at the forward rate. An account, termed firm commitment, is created during the term of the forward contract to recognize the change in value of the financial instrument aspect of the firm commitment.

Give two reasons this difference in spot and forward rates is usually positive when a company enters into a contract to receive foreign currency at a future date.

For example, if inflation is assumed to continue into the future in the foreign country whose currency is being acquired, the forward rate will be higher than the spot rate because of the decreasing purchasing power of the currency. In addition, the time value of money factor will typically result in a higher forward exchange rate than the spot exchange rate.

What is an example of for which a company's local currency many not be its functional currency?

For subsidiaries of U.S. entities operating in highly inflationary economies, the functional currency is designated as the U.S. dollar regardless of the actual currency used for cash functions.

When are foreign currency transactions gains or losses recognized in the financial statements?

Foreign currency transaction gains or losses are recognized in the financial statements in the period in which the exchange rate changes.

What major change did the SEC allow in 2008 with respect to IFRS? - U.S. registrants are required to use IFRS. - Foreign registrants are now required to use U.S. GAAP if their shares are traded in the U.S. - U.S. registrants may use IFRS without reconciliation to U.S. GAAP. - Foreign registrants may use IFRS without reconciliation to U.S. GAAP.

Foreign registrants may use IFRS without reconciliation to U.S. GAAP.

Underlying:

any financial or physical variable that has observable or objectively verifiable changes.

Fair value hedges

are designated to hedge the exposure to potential changes in the fair value of a)A recognized asset or liability such as available-for-sale investments, or b)An unrecognized firm commitment for which a binding agreement exists. -The net gains and losses on the hedged asset or liability and the hedging instrument are recognized in current earnings, and since they are always offsetting, there will be no net impact on earnings.

Foreign currency transactions

are economic activities denominated in a currency other than the entity's recording currency.

Notional amount:

the number of currency units, shares, bushels, pounds, or other units specified in the financial instrument.

Translation

the process of restating foreign currency transactions to their U.S. dollar-equivalent values.

indirect exchange rate (IER) European terms

the reciprocal of the direct exchange rate

Effectiveness:

there will be an approximate offset, within the range of 80 to 125 percent, of the changes in the fair value of the cash flows or changes in fair value to the risk being hedged.

Cash flow hedges are designated

to hedge the exposure to potential changes in the anticipated cash flows, either into or out of the company, for a)A recognized asset or liability such as future interest payments on variable-interest debt, or b)A forecasted cash transaction such as a forecasted purchase or sale. *A forecasted cash transaction is a transaction that is expected to occur but for which there is not yet a firm commitment.

harmonize

to standardize the accounting principles used around the world

Foreign currency transactions

transactions of a U.S. company include sales, purchases, and other transactions giving rise to a transfer of foreign currency or the recording of receivables or payables that are denominated in a foreign currency.

When the local currency of a foreign subsidiary is the functional currency, the foreign subsidiary's income statement accounts would be converted to U.S. dollars by: - translation using historical exchange rates. - remeasurement using current exchange rates at the time of statement preparation. - translation using average exchange rate for the period. - remeasurement using the current exchange rate at the time of statement preparation

translation using average exchange rate for the period.

When the local currency of a foreign subsidiary is the functional currency, the foreign subsidiary's inventory carried at cost would be converted to U.S. dollars by: - translation using historical exchange rates. - remeasurement using historical exchange rates. - remeasurement using the current exchange rate. - translation using the current exchange rate.

translation using the current exchange rate.

An unconsolidated foreign subsidiary is reported as

wan investment on the U.S. parent company's balance sheet.

spot rate

is the exchange rate for immediate delivery of currencies.

Direct Exchange Rate (DER) American term

is the number of local currency units (LCUs) needed to acquire one foreign currency unit (FCU).

terms currency

is the numerator

Can IFRS be used for listings on the U.S. stock exchange?

Beginning in 2008, foreign private issuers who list their shares on US stock exchanges may use IFRS in their financial statements without reconciliation to US GAAP.

What potential benefits might be achieved if U.S. firms are allowed to use IFRS?

Potential benefits include: · Improve global competitive position of US corporations. · Increase the quality of information available to investors. · Reduce costs of compliance for companies that are currently using multiple reporting frameworks. · Enhance global capital markets. · Companies would have easier access to raising capital in the global markets. · Because the SEC now permits foreign private issuers to file their financial reports using IFRS without reconciliation, not allowing US companies to report under IFRS could result in US companies bearing costs not incurred by foreign private issuers. · Enhance comparability across companies for users. SEC chairman Cox noted that two-thirds of US investors own securities of foreign companies, a 30 percent increase in the last five years.

Describe the methodology for remeasuring a Spanish (using U.S. $ as functional currency) branch's financial statements into the U.S. company's reporting currency.

Remeasurement is used when the functional currency of the foreign entity is something other than the recording currency. So there is no remeasurement.

Which of the following statements is false? - Translation is always into U.S. dollars. - Remeasurement results in a change of accounting principle. - After remeasurement into the functional currency, it is sometimes necessary to translate to U.S. dollars if the functional currency is not the U.S. dollar. - Translation is more common than remeasurement. - Translation uses the current rate method.

Remeasurement results in a change of accounting principle.

Which of the following is NOT an indicator that a U.S. parent's currency should be the functional currency? - Sales contracts denominated in U.S dollars. - Raw materials purchased from vendors in the U.S. - Sales contracts denominated in subsidiary's currency. - Labor costs of factory workers in the U.S. producing inventory.

Sales contracts denominated in subsidiary's currency.

What factors are used to determine a reporting entity's functional currency?

The functional currency is normally the currency in which the foreign entity performs most of its cash functions.

How might harmonization result in better financial reporting for a U.S. parent company with many foreign investments?

The harmonization of accounting principles around the world would eliminate many of the problems of combining and consolidating multinational entities. A U.S. company with international investments could then be assured of essentially the same accounting principles being applied; therefore, revenues, profits, and investments in these foreign investments could effectively be compared and contrasted.

Which of the following is the appropriate test of hedge effectiveness? -The hedge offsets between 80-100% of the cash flows or risk of the item hedged. -The hedge offsets between 100-125% of the cash flows or risk of the item hedged. -The hedge offsets between 80-125% of the cash flows or risk of the item hedged. -The hedge offsets between 80-150% of the cash flows or risk of the item hedged.

The hedge offsets between 80-125% of the cash flows or risk of the item hedged.

What is the direct exchange rate if a U.S. Company receives $1.3623 in Canadian currency in exchange for $1.00 in U.S. $.

The inverse of the indirect exchange rate is: $1.00 (U.S. dollars) = C$1.36 (Canadian dollars) $0.7340

What is the IASB's mission?

The mission of the IASB is to develop a single set of high-quality, understandable, and enforceable global accounting standards.

Which of the following statements is false? - Exchange rates used for remeasurement differ from those used in translation. - The only difference in exchange rates between remeasurement and translation of the balance sheet is for the nonmonetary accounts. - The rates used to remeasure the income statement are all the same as those used in translation. - After remeasuring all items, the trial balance usually won't balance.

The rates used to remeasure the income statement are all the same as those used in translation.

In cases of operations located in highly inflationary economies: - The reporting currency of the U.S. parent—the U.S. dollar—should be used as the foreign entity's functional currency. - The foreign currency should be used as the functional currency with a footnote to the financials displaying what the earnings would have been using the U.S. dollar as the functional currency. - The foreign currency should be used as the functional currency with a single line item—foreign translation—reporting the adjustment using the U.S. dollar as the functional currency. - None of the choices are correct.

The reporting currency of the U.S. parent—the U.S. dollar—should be used as the foreign entity's functional currency.

What types of economic factors affect currency exchange rates?

There are many types of economic factors that affect currency exchange rates, among which are the level of inflation, the balance of payments, changes in interest rates and investment levels, and the stability and process of governance.

The volatility of hyperinflationary currencies

distorts the financial statements if the local currency is used as the foreign entity's functional currency.

Remeasurement gain or loss is included in the current period income statement because

if the transaction had originally been recorded in U.S. dollars, the exchange gains and losses would have been recognized this period as part of the adjustments required for valuation of foreign transactions denominated in a foreign currency

Severe inflation

inflation exceeding 100 percent over a three-year period.

current rate

is defined simply as the spot rate on the entity's balance sheet date.

base currency

is the denominator in the exchange rate ratio.