FAR - C8 - Foreign Currency Denominated Transactions

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Translate (convert) FC units to reporting currency (U.S. dollars) by: Dollar amount to Settle =

# FC Units × by Spot Exchange Rate Record transaction at Dollar amount to Settle.

Gordon Ltd., a 100% owned British subsidiary of a U.S. parent company, reports its financial statement in local currency, the British pound. A local newspaper published the following U.S. exchange rates to the British pound at year end: Current rate $1.50 Historical rate (acquisition) 1.70 Average rate 1.55 Inventory (FIFO) 1.60 Which currency rate should Gordon use to convert its income statement to U.S. dollars at year end?

$1.55 Since Gordon prepares its financial statements in its local currency, the British pound, and since the British economy has not been in hyperinflation, Gordon's functional currency would be the British pound, and its financial statements would be converted to U.S. dollars using translation, not remeasurement. Under the translation method of converting, income statement items are converted using the average exchange rate for the period.

Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. Sapco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 20X8: Statement of Net Income and FCUs Comprehensive Income (20X8) (in 000) Sales 12,000 COGS (4,000) Depreciation Expense (1,000) Other Expenses (3,000) Net Income 4,000 Other Comprehensive Income 0 Comprehensive Income 4,000 Retained Earnings (20X8) Beginning Retained Earnings (end 20X7) 6,000 Add: Net Income (20X8) 4,000 Deduct: Dividends (20X8) (1,000) Ending Retained Earnings 9,000 Balance Sheet (12/31/20X8) Cash and Account Receivable 2,000 Inventory at cost, acquired evenly in 20X8 6,000 Fixed Assets 10,000 Total Assets 18,000 Liabilities 2,000 Common Stock 7,000 Retained Earnings 9,000 Subtotal 18,000 Accumulated Other Comprehensive Income 0 Total Liabilities + Equity 18,000 The following exchange rates were available: Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200 Historic exchange rate when Sanco's fixed assets were acquired: 1 FCU = $1.250 Weighted average exchange rate for 20X8: 1 FCU = $1.300 Spot exchange rate at date dividend declared: 1 FCU = $1.290 Spot exchange rate at December 31, 20X8: 1 FCU = $1.310 Which one of the following is the amount (in 000) of Sapco's sales in U.S. dollars?

$15,600 Since remeasurement should be used to convert Sapco's financial statements expressed in FCUs to U.S. dollars, and since sales is not an income statement item derived from a balance sheet item remeasured using a historic cost, sales should be converted using the current exchange rate in effect when each sale took place or the weighted average exchange rate for the period. In this case, the weighted average exchange rate for the period is given as 1 FCU = $1.300. Therefore, the correct dollar amount of Sapco's sales would be 12,000 FCUs x $1.300 = $15,600.

Park Co.'s wholly‐owned subsidiary, Schnell Corp., maintains its accounting records in pounds sterling. Because all of Schnell's branch offices are in Germany, its functional currency is the Euro. Remeasurement of Schnell's 20X8 financial statements resulted in a $7,600 gain, and translation of its financial statements resulted in an $8,100 gain. What amount should Park report as a foreign exchange gain in its income statement for the year ended December 31, 20X8?

$7,600 Gains and losses from remeasurement enter into the determination of net income in the period in which the gains and losses occur. Gains and losses from translation do not enter into the determination of net income, but are recognized in other comprehensive income (outside of net income) in the period in which the gains and losses occur. Therefore, the correct answer is $7,600, the gain from remeasurement.

$7,800 Since remeasurement should be used to convert Sapco's financial statements expressed in FCUs to U.S. dollars, inventory should be converted using the historic exchange rate in effect when the inventory was acquired. In this case, the inventory was acquired evenly during 20X8 and the weighted average exchange rate for the year was $1.300. Therefore, the correct dollar amount of Sapco's inventory would be 6,000 FCUs x $1.300 = $7,800.

Park Co.'s wholly‐owned subsidiary, Schnell Corp., maintains its accounting records in Pounds Sterling. Because all of Schnell's branch offices are in Germany, its functional currency is the Euro. Remeasurement of Schnell's 20X8 financial statements resulted in a $7,600 gain, and translation of its financial statements resulted in an $8,100 gain. What amount should Park report as a foreign exchange gain in its other comprehensive income for the year ended December 31, 20X8?

$8,100 Gains and losses from translation are recognized in other comprehensive income (outside of net income) in the period in which the gains and losses occur; gains and losses from remeasurement enter into the determination of net income in the period in which the gains or losses occur. Therefore, the correct answer is $8,100, the gain from translation.

Hedging Foreign Investment in Foreign Operations Example: Hedge the risk that the dollar value of an investment in a foreign subsidiary will fluctuate as a result of exchange rate changes. Translation (conversion from foreign currency units to dollars) of accounts on the financial statements of the foreign subsidiary requires use of changing exchange rates, which subject the investment carried by the parent to fluctuate solely as a result of exchange rate changes. The U.S. parent could

(1) borrow in the foreign currency of the subsidiary (a liability) to offset (hedge) the effects of changes in the exchange rate on conversion of the financial statements (a net asset), (2) acquire a foreign currency call option to offset (hedge) the effects of changes in exchange rate on the conversion of the financial statements (a net asset).

(500,000 x .75 = 375,000). DR: Accounts Receivable (FC) $375,000 CR: Sales $375,000

On October 1, 20X2 we agreed to sell goods with the receivable to be paid in euros on February 1, 20X3, for 1 FC worth of merchandise. The exchange rates are as follows: Transaction date: October 1 $2.00 = 1 FC Balance sheet date: December 31 $1.00 = 1 FC Settlement date: February 1 $3 = 1 FC December 31: The entry to record the change in the exchange rate.

(We will now receive only $1 worth of FC instead of $2). DR: Foreign currency transaction G/L (IS) $1 CR: Accounts Receivable (FC) $1 Note: Foreign currency transaction gain/loss (G/L could be a debit (loss) or credit (gain) depending on the changes in the exchange rates. Also, this account is recognized in earnings on the Income Statement (IS).

Functional Currency = Another Foreign Currency

(other than local foreign Recording Currency or the Reporting Currency) If the foreign entity generates most of its cash flows in the currency of another foreign country or if required by law or contract.

At Date Transaction Is Settled Record Difference As:

-- Adjustment to Recorded Account Balance (Receivable/Payable), and - Loss or Gain for the Period. Record Settlement of Adjusted Account Balance. Report Loss or Gain in Current-Period Income Statement as Component of Income from Continuing Operations.

On October 1, 20X2 we entered into a transaction to purchase goods payable in a Foreign Currency (FC) on January 31, 20X3. The purchase was for 1 FC worth of merchandise. The exchange rates are as follows: Transaction date: October 1 $2.00 = 1 FC (direct quotation) Balance sheet date: December 31 $1.00 = 1 FC Settlement date: January 31 $1.50 = 1 FC January 31: The FC is worth $1.5. Below are the following entries to: 1) record the change in the exchange rate, 2) the purchase of the FC, and 3) settle the transaction.

1) DR: Foreign currency transaction G/L (IS) $.50 CR: Accounts Payable (FC) $.50 2) DR: Investment in FC $1.50 CR: Cash $1.50 3) DR: Accounts Payable (FC) $1.50 CR: Investment in FC $1.50

The first three types of hedges listed above can occur as a sequence of events (hedges). In sequence of occurrences, these hedges are of:

1) A forecasted transaction, which may become; 2) An identifiable foreign currency commitment, which results in a recorded transaction that creates; 3) A recognized asset (receivable) or liability (payable).

Hedging Foreign Currency Denominated Asset or Liability, Accounting Treatment: If to hedge cash flow, the treatment would include:

1) Adjusting the hedged item (receivable or payable) to fair value each balance sheet date using the spot exchange rate and recognizing the change in fair value as a gain or loss in comprehensive income. 2) Adjusting the hedging instrument to fair value each balance sheet date using the forward exchange rate and recognizing the change in fair value as follows: a) An amount up to the amount equal to the gain or loss recognized on the hedged item is recognized as a loss or gain in comprehensive income to offset the gain or loss on the hedged item. b) The amount greater than the gain or loss on the hedged item is recognized in current income (income or expense). Typically this excess is the current-period amortization of any premium or discount on the hedging instrument.

Hedging Foreign Currency Denominated Asset or Liability, Accounting Treatment: If to hedge fair value, the treatment would include:

1) Adjusting the hedged item (receivable or payable) to fair value each balance sheet date using the spot exchange rate and recognizing the change in fair value as a gain or loss in current income. 2) Adjusting the hedging instrument to fair value each balance sheet date using the forward exchange rate and recognizing the change in fair value as a gain or loss in current income. 3) To the extent the change in fair value of the hedging instrument and the change in the fair value of the hedged item are different there will be a net effect in current income.

Determine Difference between Recorded Dollar amount to Settle and New (current) Dollar amount at Balance Sheet Date. Record Difference as

1) Adjustment to Recorded Receivable/Payable; 2) Exchange Loss or Gain.

The conversion could be needed in order to:

1) Apply equity method by U.S. Investor; 2) Combine with other Entities; 3) Consolidate with U.S. Parent (and other subs).

Revenue and expenses related to assets and liabilities converted at Historic Rate (only) Examples:

1) COGS (when Inventory at cost); 2) Depreciation; 3) Amortization of Intangibles (Not GW!).

The conversion of financial statements from one currency to another currency, involves two major steps:

1) Determining the functional currency of the entity that prepared the original financial statements, and 2) Applying the correct conversion process based on the functional currency of the entity that prepared the original financial statements.

Hedging minimizes or prevents losses from exchange rate changes (per se), but usually involves some costs of doing so, including:

1) Fees or other charges imposed by the other party to the forward contract, and 2) Differences between spot rates and forward rates at the date the forward contract is initiated.

GAAP identifies the following types/purposes of using forward contracts for hedging purposes when the item hedged is denominated in a foreign currency:

1) Forecasted Transaction 2) Unrecognized, Firm Commitment 3) Recognized Assets or Liabilities 4) Available-for-Sale Investment 5) Net Investment in Foreign Operation

Functional Currency = U.S. Reporting Currency

1) If operations are a direct and integral component or extension of a U.S. entity's (e.g., Parent's) operations, or 2) When the foreign entity is located in a country with a highly inflationary economy, defined as cumulative inflation of 100% or more over a three-year period.

Translation adjustments resulting from each of the conversion processes will be reported as follows:

1) Remeasurement (Translation) Adjustment—In income statement. 2) Translation (Translation) Adjustment—In other comprehensive income for reporting purposes and, subsequently, in accumulated other comprehensive income in the shareholders' equity section of the balance sheet.

Current Exchange Rates (CR) to use

1) Revenues, Expenses, Gains, and Losses 2) Assets and Liabilities 3) Paid-In Capital 4) Retained Earnings

Examples of Past Price Valuation:

1) Securities Carried at Cost, if any; 2) Inventories Carried at Cost; 3) Prepaid Costs; 4) Fixed Assets/Accumulated Depreciation; 5) Intangibles (Goodwill, etc.); 6) Deferred Revenue; 7) Paid-In Capital.

Amount needed to make the trial balance debit and credits (expressed in Dollars) balance is amount of Remeasurement Adjustment:

1) The Remeasurement Adjustment is reported as a Gain or Loss in the Income from Continuing Operations section of the Income Statement (expressed in Dollars). 2) The remeasurement adjustment "flows through" the Income Statement to Retained Earnings.

The objectives of Foreign Currency Conversion are:

1) To provide information that is generally compatible with the expected economic effects of rate changes on an enterprise's cash flows and equity, and 2) To reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional primary currencies in conformity with U.S. GAAP.

At what dates can a gain or loss be recognized on a foreign currency denominated operating transaction account balance?

1. At balance sheet date, if one occurs between the date the transaction is initiated and settled. 2. At settlement date of the foreign currency denominated account balance.

What is the general rule for handling a foreign currency denominated account at the settlement date of the account?

1. Determine Dollar Amount to Settle Transaction at Balance Sheet Date (# of foreign currency units X exchange rate/Spot = $ Value). 2. Determine Difference Between Recorded Amount and Settlement Amount. 3. Record Difference as adjustment to foreign currency denominated account and as exchange gain/loss for the period. 4. Record settlement of foreign currency denominated account

List the criteria for designation of hedging recognized assets/liabilities.

1. The asset or liability is denominated in a foreign currency and has already been booked; 2. The gain or loss on the hedged asset or liability must be recognized in earnings.

List the criteria for designation of hedging foreign currency commitments.

1. The commitment being hedged must be firm, be identified, and present exposure to foreign currency price changes; 2. The forward contract must be designated and effective as a hedge of a commitment and must be in an amount that does not exceed the amount of the commitment.

List the criteria for designation of hedging forecasted transactions

1. The forecasted transaction must be identified, probable of occurring, and present an exposure to foreign currency price changes; and 2. Use of a forward contract to hedge must be consistent with company risk management policy.

List the criteria for designation of hedging investments available for sale.

1. The securities being hedged must be identified and must not be traded in the investor's currency; 2. The forward contract must be designated and highly effective as a hedge of the investment, and in an amount that does not exceed the amount of the investment being hedged.

What is the general rule for recording a foreign currency operation transaction at the date the transaction is initiated?

1. Translate Transaction into Dollars using Current Spot Exchange Rate (# of foreign currency units X exchange rate/Spot = $ Value). 2. Record Asset, Liability, Revenue, Expense, Loss and/or Gain at Dollar Amount.

What kind of a hedge is the hedge of a forecasted transaction?

A Cash Flow Hedge.

What kind of hedge is a hedge of an investment availableforsale?

A Fair Value Hedge.

Hedging Foreign Currency Denominated Available-for-Sale Security, Nature of Designation:

A Hedge Of An Investment Available for Sale Is A FAIR VALUE HEDGE; the hedge is to offset changes in (dollar) fair value of an investment.

Which one of the following would be a foreign currency transaction for the U.S. entity?

A U.S. entity purchases goods from a British entity to be settled in pounds sterling. If a U.S. entity purchases goods from (or sells goods to) a British entity and the U.S. entity is to settle in a currency other than the dollar (pounds sterling), it is a foreign currency transaction to the U.S. entity (but would not be to the British entity). A foreign currency transaction occurs when a domestic entity agrees to settle a transaction in a foreign currency.

Which one of the following is a direct quotation for a U.S. entity when buying Japanese Yen (JPY)? I. 0.89 JPY per $1.00. II. $.011 per 1.00 JPY.

A direct quotation, or direct exchange rate, states the domestic price of one unit of a foreign currency. In this case, each JPY costs $.011, which is a direct quotation.

Which of the following statements concerning foreign exchange forward contracts is/are correct? I. A foreign currency forward exchange contract will result in the exchange of currencies. II. All forward contracts require the exchange of currencies.

A foreign currency forward exchange contract will result in the exchange of currencies (Statement I). Unlike foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, foreign currency forward exchange contracts establish an obligation to exchange currencies.

Another Foreign Currency

A foreign currency other than the Recording Currency.

On September 1, 20X5, Cano & Co., a U.S. corporation, sold merchandise to a foreign firm for 250,000 francs. Terms of the sale require payment in francs on February 1, 20X6. On September 1, 20X5, the spot exchange rate was $.20 per franc. At December 31, 20X5, Cano's year end, the spot rate was $.19, but the rate increased to $.22 by February 1, 20X6, when payment was received. How much should Cano report as a foreign exchange gain or loss in its 20X6 income statement?

A foreign exchange gain or loss is recognized for any change in value of a monetary debt denominated in a foreign currency. This is true at balance sheet time as well as when it is realized. Thus, a $2,500 loss would have been recognized at December 31, 20X5 (250,000 francs * [.20 ‐ .19]). Then, in 20X6, the full difference between the $.19 and $.22 (250,000 francs * .03) would be realized for a total gain of $7,500.

On November 2, 20X5, Platt Co. entered into a 90 day futures contract to purchase 50,000 Swiss francs when the contract quote was $.70. The purchase was for speculation in price movement. The following exchange rates existed during the contract period: 30 day futures Spot rate November 2, 20X5 $.62 $.63 December 31, 20X5 .65 .64 January 30, 20X6 .65 .68 What amount should Platt report as foreign currency exchange loss in its income statement for the year ended December 31, 2005?

A futures contract entered into for speculative purposes (not to hedge) is valued using futures rates, and any gain or loss as a result of changes in futures rates is recognized in net income in the period during which the rate changed. At initiation of Platt's contract, the 90‐day futures rate was $.70, as quoted in the contract. On December 31, 20X5, 30 days before Platt's contract was to be settled, the 30‐day futures rate was $.65. Platt's loss would be computed as follows: November 2, 20X5, 50,000 Swiss francs x $.70 = $35,000 December 31, 20X5, 50,000 Swiss francs x $.65 = $32,500 Loss in dollar value of futures contract = $2,500

Toigo Co. purchased merchandise from a vendor in England on November 20 for 500,000 British pounds. Payment was due in British pounds on January 20. The spot rates to purchase one pound were as follows: November 20 $1.25 December 31 1.20 January 20 1.17 How should the foreign currency transaction gain be reported on Toigo's financial statements at December 31?

A gain of $25,000 should be reported in the current income statement. The gain was computed as: November 20 $1.25 x 500,000 British pounds = $625,000 December 31 $1.20 x 500,000 British pounds = $600,000 Gain $ 25,000 And, gains (and losses) on foreign currency transactions should be reported in current income.

Hedging Firm Commitments, Nature of Designation:

A hedge of a firm commitment can be either a FAIR VALUE HEDGE (the hedge is to offset changes in (dollar) fair value of the firm commitment); or a CASH FLOW HEDGE (the hedge is to offset changes in expected cash flow associated with settling the firm commitment).

Hedging Forecasted Transactions, Nature of Designation:

A hedge of a forecasted transaction is a CASH FLOW HEDGE; the hedge is to offset changes in cash flow associated with the forecasted transaction.

Hedging Foreign Investment in Foreign Operations, Nature of Designation:

A hedge of a net investment in a foreign operation is accounted for like a cash flow hedge with the effective portion recorded in Other Comprehensive Income.

Hedging Foreign Currency Denominated Asset or Liability, Nature of Designation:

A hedge of a recognized asset or liability can be either a cash flow hedge or a fair value hedge. 1) To qualify as a cash flow hedge, the hedging instrument must completely offset the variability in (dollar) cash flows associated with the receivable or payable. 2) If the instrument does not qualify as a cash flow hedge, or if management so designates, the hedging instrument will be a fair value hedge.

A hedge to offset the risk of exchange rate changes on converting the financial statements of a foreign subsidiary to the domestic (functional) currency would be the hedge of:

A net investment in a foreign operation. A hedge to offset the risk of exchange rate changes on converting the financial statements of a foreign subsidiary to the domestic (functional) currency would be the hedge of a net investment in a foreign operation. Changes in exchange rates will result in changes in the amount of domestic (functional) currency that will result from converting (translating) financial statements from a foreign currency. Hedges of net investments in a foreign operation are intended to offset that risk.

Define "hedging".

A risk management strategy which generally involves offsetting or counter transactions so that a loss on one transaction would be offset (at least in part) by a gain on the other transaction.

What is a foreign currency operating transaction?

A transaction that is denominated (will be settled) in a foreign currency (i.e., other than the recording entity's currency).

HEDGE OF: Net Investment in Foreign Operation: to offset risk of exchange rate changes on conversion of financial statements. Type of Hedge:

ASC 815-35 does not classify this hedge - the accounting is similar to CF hedge because effective portion of gains/loss are reported in OCI

HEDGE OF: Forecasted Transaction: to offset risk of exchange rate changes on planned (forecasted) transaction. Basic Approach:

Adjust Forward Contract to Fair Value

HEDGE OF: Net Investment in Foreign Operation: to offset risk of exchange rate changes on conversion of financial statements. Basic Approach:

Adjust carrying value of Forward Contract to Fair Value

HEDGE OF: SPECULATION: Entered into for profit; Not hedging an exposure to currency risk. Basic Approach:

Adjust carrying value of Forward Contract to Fair Value

HEDGE OF: Investment in Available-For-Sale Securities: to offset risk of exchange rate changes on investment. Basic Approach:

Adjust carrying value to Fair Value for Forward Contract and Investment

HEDGE OF: Unrecognized Firm Commitment: to offset risk of exchange rate changes on a firm commitment: Basic Approach:

Adjust carrying value to Fair Value for both Forward Contract and Firm Commitment (recognize asset or liability)

HEDGE OF: Recognized Asset or Liability: to offset risk of exchange rate changes on booked assets or liabilities. Basic Approach:

Adjust carrying value to Fair Value for both Forward Contract and Recognized Asset or Liability

How is the conversion adjustment reported when the remeasurement (not translation) method of converting financial statements from one currency to another is used?

Adjustment is reported as a Translation Gain or Loss in the Income from the Continuing Operations section of the Income Statement.

Define "forward exchange contract".

Agreement to exchange units of currencies at a specified future date at an exchange rate set now.

What is a forward contract?

Agreements (contracts) to buy or sell (or that give the right to buy or sell) a specified commodity in the future at a price (rate) determined at the time the forward contract is executed.

Forward Contracts:

Agreements (contracts) to buy or sell (or which give the right to buy or sell) a specified commodity in the future at a price (rate) determined at the time the forward contract is executed.

On December 12, Year 1, Imp Co. entered into three forward exchange contracts, each to purchase 100,000 francs in 90 days. The relevant exchange rates are as follows: Spot rate Forward rate (for March 12, Year 2) December 12, Year 1 $.88 $.90 December 31, Year 1 .98 .93 Imp entered into the third forward contract for speculation. At December 31, Year 1, what amount of foreign currency gain should Imp include in income from this forward contract?

All gains and losses in a speculative forward foreign exchange contract are included in income of the period in which the forward exchange rate changes. Gains and losses are measured based on the purchase price of the contract and its current settlement value using forward rates. In this case, those rates are the $.90 purchase price (forward rate December 12) and the $.93 settlement price (forward rate December 31). Thus, this $3,000 amount is correct [($.93‐$.90)100,000].

Use Current Exchange Rates for:

All other (Monetary) Assets and Liabilities; All other Revenue, Expense, Gain, and Loss Items.

A Hedge of a Net Investment in a Foreign Operation is what type of hedge?

An Economic Hedge.

Foreign Currency Option Contracts (FCO):

An agreement that gives the right (option) to buy (call option) or sell (put option) a specified amount of a foreign currency at a specified (forward) rate during or at the end of a specified time period.

What is the nature of a foreign currency option contract?

An agreement that gives the right (option) to buy or sell a specified amount of a foreign currency at a specified (forward) rate during or at the end of a specified time period.

Foreign Currency Forward Exchange Contracts (FXFC):

An agreement to buy or sell a specified amount of a foreign currency at a specified future date at a specified (forward) rate.

What are characteristics associated with foreign currency transactions?

Are denominated in a foreign currency. Can include contracts to exchange currencies. Are affected by changes in currency exchange rates.

When a foreign entity's financial statements are converted to a reporting currency using remeasurement, how will the adjustment needed to make the converted balance sheet balance (the "translation adjustment") be reported?

As an item in income from continuing operations. When remeasurement is used to convert financial statements expressed in a foreign currency to a reporting currency, any resulting translation adjustment (gain or loss) is reported as an item in income from continuing operations.

If a foreign currency exchange gain results from the effects of a change in exchange rates on an account receivable, where will the exchange gain be reported in the financial statements?

As an item of income from continuing operations. Foreign currency exchange gains (or losses) on accounts receivable are reported in current income as an item of income from continuing operations.

Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. After remeasuring Sapco's financial statements from the foreign currency to Papco's reporting currency, Papco determined that it had a loss on the remeasurement. How should Papco report the loss in its consolidated financial statements?

As income from continuing operations. Under the remeasurement method of converting from a foreign currency to a reporting currency, any resulting loss (or gain) is reported as an item of income from continuing operations in current income.

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Cash:

Assets are valued at the current rate at year‐end. Year‐end 12/31/Y3

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Inventory that had been purchased evenly throughout the year

Assets are valued at the current rate at year‐end. Year‐end 12/31/Y3

Which one of the following is not a characteristic of hedging?

Assures no gain or loss on the item being hedged. While the intent of hedging is to mitigate the risk of loss (or gain) attributable to the item being hedged, hedging does not assure that no gain or loss will be incurred on the hedged item. Only in a perfect hedge does no gain or loss occur. In order to be a perfect hedge, the hedging instrument would need to have a 100% inverse correlation to the hedged item. Such an outcome is rare.

At Date Transaction Initiated: (#FC units × ER/Spot = $ Value)

At Balance Sheet Date, If Before Settlement Date : (#FC units × ER/Spot = $ Value) At Date Transaction Is Settled: (#FC units × ER/Spot = $ Value)

At Date Transaction Initiated: Record Asset, Liability, Revenue, Expense, Loss and/or Gain on Transaction at Dollar Amount.

At Balance Sheet Date, If Before Settlement Date : Determine Difference Between Recorded Amount and Settlement Amount. At Date Transaction Is Settled: Determine Difference Between Recorded Amount and Settlement Amount.

On June 19, Don Co., a U.S. company, sold and delivered merchandise on a 30‐day account to Cologne GmbH, a German corporation, for 200,000 euros. On July 19, Cologne paid Don in full. Relevant currency exchange rates were: June 19 July 19 Spot rate $ .988 $ .995 30‐day forward rate .990 1.000 What amount should Don record on June 19 as an account receivable for its sale to Cologne?

At the date Don Co. entered into the transaction, June 19, and agreed to accept euros in satisfaction of its account receivable, it should record the transaction (sale and account receivable) at the (then exiting or current) spot exchange rate of .988. Thus, the dollar amount of the account receivable (and sale) would be computed as 200,000 E x .988 = $197,600, which also is the dollar value that would be received if the transaction were settled at that date.

Hedging a recognized asset is intended to offset the risk of exchange rate changes between which of the following dates?

Between the dates an asset is recognized and when the asset is fully satisfied. The time between when an asset is recognized and when the asset is fully satisfied would be intended to offset the risk of changes in the exchange rate on a recognized asset (or liability).

Which of the following actions would an entity most likely take to hedge an investment in a foreign operation?

Borrow from another foreign entity with the same foreign currency as the operation being hedged. Borrowing from another foreign entity with the same foreign currency as the operation being hedged would hedge the (equity) investment in the foreign operation. Since the equity investment in a foreign operation is an asset and the borrowing would be a liability, both in the same foreign currency, a change in the exchange rate would have offsetting effects. Thus, if an exchange rate change caused a decrease in the value of the investment (asset), it would cause an increase in the value of the borrowing (liability).

Determining a foreign subsidiary's functional currency will take into account which of the following? I. The extent to which the subsidiary operates, and generates and expends cash in the local foreign economy in which it is located. II. The cumulative inflation rate in the local foreign economy in which it is located.

Both I and II. Determining a foreign subsidiary's functional currency will take into account both the extent to which the subsidiary operates, and generates and expends cash in the local foreign economy in which it is located and the cumulative inflation rate of that economy.

Even if the use of a forward contract for hedging prevents a loss (or gain) from exchange rate changes on the hedged item, which of the following may result in a cost to an entity that uses forward contracts for hedging purposes? I. Fees imposed by the counterparty to the forward contract. II. A difference between the spot rate and the forward rate when the forward exchange contract is executed.

Both I and II. A firm that engages in a forward contract will both incur fees imposed by the counterparty and incur the cost of the difference between the spot rate and the forward rate at the time the forward contract is executed. The difference between the spot rate and the forward rate is the premium (or discount) on the forward contract and must be amortized over the life of the contract as a financing expense, not an exchange gain or loss.

If a firm commitment denominated in a foreign currency is hedged with a forward exchange contract, which of the following statements is/are correct? I. Even though the firm commitment is hedged, a net gain or loss can be reported. II. As a result of hedging the firm commitment, an otherwise unrecognized asset or liability may have to be recognized.

Both Statement I and Statement II are correct. Even though a firm commitment is hedged, a net gain or loss can be reported (Statement I) if the changes in value of the firm commitment (hedged item) and the forward contract (hedging instrument) are not identical. Additionally, as a result of hedging a firm commitment, an otherwise unrecognized asset or liability may have to be recognized (Statement II) to offset any gain or loss recognized on the forward contract.

Which of the following statements concerning the use of a forward contract to hedge a foreign currency investment held available‐for‐sale is/are correct? I. The investment security must not be traded in the investor's functional currency. II. The forward contract used as the hedging instrument must be highly effective in hedging the investment.

Both Statement I and Statement II are correct. In hedging a foreign currency investment held available‐for‐sale, the investment security must not be traded in the investor's functional currency, and the forward contract used as the hedging instrument must be highly effective in hedging the investment.

Retained Earnings

Calculated as Beginning R/E (end of prior period) + Translated N/I - Dividends declared converted at spot rate at date of declaration = Ending R/E ($).

HEDGE OF: Forecasted Transaction: to offset risk of exchange rate changes on planned (forecasted) transaction. Type of Hedge:

Cash Flow

HEDGE OF: Recognized Asset or Liability: to offset risk of exchange rate changes on booked assets or liabilities. Type of Hedge:

Cash Flow OR Fair Value

HEDGE OF: Unrecognized Firm Commitment: to offset risk of exchange rate changes on a firm commitment: Type of Hedge:

Cash Flow OR Fair Value

HEDGE OF: Unrecognized Firm Commitment: to offset risk of exchange rate changes on a firm commitment: Treat Gain/Loss:

Cash Flow: Effective Portion deferred in "Other Comprehensive Income," Ineffective portion in Current Income Fair Value: Recognize in current income for both forward contract and firm commitment; any difference will affect net income

HEDGE OF: Recognized Asset or Liability: to offset risk of exchange rate changes on booked assets or liabilities. Treat Gain/Loss:

Cash Flow: Effective portion in "Other Comprehensive Income;" Ineffective portion in Current Income. Fair Value Recognize in current income for both forward contract and recognized asset or liability; any difference will affect net income.

What kind of hedge can be used to hedge a foreign currency firm commitment?

Cash Flow: Yes Fair Value: Yes A forward contract used to hedge a foreign currency firm commitment can be either a cash flow hedge (as permitted by the FASB's Derivatives Implementation Group) or a fair value hedge (as permitted by FASB #133).

What general kind of hedge is the hedge of a forecasted transaction to be denominated in a foreign currency?

Cash flow hedge. The hedge of a forecasted transaction to be denominated in a foreign currency is a cash flow hedge. The risk being hedged is the variability in expected cash flows (inflows or outflows) on the planned transaction that would result from changes in the exchange rate.

Which one of the following could not be translated using the weighted average exchange rate for the fiscal year?

Cash. When converting financial statements from a foreign currency to a reporting currency using translation, assets and liabilities are translated using the spot (or current) exchange rate as of the balance sheet date, not the weighted average exchange rate for the period. Therefore, cash could not be translated using the weighted average exchange rate for the fiscal year.

Which one of the following would be translated using either the spot exchange rate as of the balance sheet date or the weighted average exchange rate for the period?

Cash. Accounts payable. Investments held‐for trading.

Which one of the following would be translated using the spot (or current) exchange rate as of the balance sheet date?

Cash. Accounts payable. Investments held‐for‐trading.

Which one of the following would not be remeasured using a historic exchange rate?

Cash. Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, monetary assets and liabilities are converted using the current exchange rate, not a historic exchange rate. Therefore, cash (the most monetary of assets) would be converted using the current exchange rate, not a historic exchange rate.

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Common stock

Common stock is valued at the historical rate when it was issued. Company begins 12/31/Y1

Which one of the following would not be translated using either the spot exchange rate as of the balance sheet date or the weighted average exchange rate for the period?

Common stock. When converting financial statements from a foreign currency to a reporting currency using translation, paid‐in capital accounts are translated using the historic exchange rate in effect when the account amount arose (or when the investment was made, if later). Therefore, common stock would not be translated using either the spot (or current) exchange rate as of the balance sheet date or the weighted average exchange rate for the period, but the historic exchange rate for the common stock.

Which one of the following would not be translated using the spot (or current) exchange rate as of the balance sheet date?

Common stock. When converting financial statements from a foreign currency to a reporting currency using translation, paid‐in capital accounts are translated using the historic exchange rate in effect when the account amount arose (or when the investment was made, if later). Therefore, common stock would not be translated using the spot (or current) exchange rate as of the balance sheet date, but the historic exchange rate for the common stock.

What is the name of the method used when financial statements are remeasured?

Conversion Method Used to Convert Accounts from Foreign Currency Units to Dollars.

Use Remeasurement to convert from foreign currency to reporting currency (the $):

Convert Accounts from Foreign Currency Units (FCU) to Dollars using (Temporal Method): 1) For Monetary Items - Current Exchange Rate (CR). 2) For Non-Monetary Items - Historical Exchange Rate (HR), i.e., exchange rate in existence when account item arose. Monetary items are those where value is fixed by contract (examples: cash, accounts receivable, accounts payable, bonds and notes, etc.)

Use Translation to convert from foreign currency to reporting currency (the $):

Convert Accounts from Foreign Currency Units (FCU) to Dollars using a current exchange rate (CR) - also called spot rate. Example: Conversion: FCU X CR = $

What exchange rate or rates should be used to remeasure (not translate) monetary accounts from one currency to another currency?

Current (spot) exchange rate.

For Monetary Items -

Current Exchange Rate (CR).

Operating transactions denominated in a foreign currency are converted to the functional currency using the:

Current exchange rate. Operating transactions denominated in a foreign currency are converted to the functional currency using the current (or spot) exchange rate. The current (or spot) exchange rate is the exchange rate in effect at the current time (or as close thereto as possible); that is, at the time of the transaction or revaluation.

Pumped Up Company purchased equipment from Switzerland for 140,000 francs on December 16, 20X7, with payment due on February 14, 20X8. On December 16, 20X7, Pumped Up also acquired a 60-day forward contract to purchase francs at a forward rate of SFr 1 = $.67. On December 31, 20X7, the forward rate for an exchange on February 14, 20X8, is SFr 1 = $.695. The spot rates were: December 16, 20X7 1 SFr = $.68 December 31, 20X7 1 SFr = .70 February 14, 20X8 1 SFr = .69 February 14th Entries with Company:

DR: AP (SFr) 1,400 CR: Fx G/L (IS) 1,400 140,000 x (.70 - .69) = 1,400 Spot Rate: $.69 Foward Rate: $.69 DR: AP (SFr) 96,600 CR: Invest In (SFr) 96,600 (Pay Swiss Company) .140,000 x .69 = 96,600

DR: AP (SFr) 3,500 CR: Fx G/L (IS) 3,500 140,000 x (0.67-.70) = 3,500 Spot Rate: $.70 Foward Rate: $.695

Alman Company sold pharmaceuticals to a Swedish company for 200,000 kronor (SKr) on April 20, with settlement to be in 60 days. On the same date, Alman entered into a 60-day forward contract to sell 200,000 SKr at a forward rate of 1 SKr = $.167 in order to manage its exposed foreign currency receivable. The forward rate on May 31 was 1 SKr = $.168. The forward contract is not designated as a hedge. The spot rates were: April 20 SKr 1 = $.170 May 31 SKr 1 = .172 June 19 SKr 1 = .165 June 19th Entries with Company:

DR: AP (SKr) 1,400 CR: AR (SFr) 1,400 200,000 x (.172 - .165) = 1,400 Spot Rate: $.165 Foward Rate: $- DR: Invest in SKr 33,000 CR: AR SKr 33,000 (Receive SKr) 200,000 x .165 = 33,000

DR: AP (SKr) 600 CR: FX G/L (IS) 600 200,000 x (.168 - .165) = 600 Spot Rate: $.165 Foward Rate: $- DR: AP SKr 33,000 CR: Invest in SKr 33,000 (Pay Broker) DR: Cash 33,400 CR: AR 33,400 (Receive $)

DR: AR (SKr) 33,400 CR: Sales 33,400 200,000 x .167 = 32,400 Spot Rate (SKr): $.17 Foward Rate: $.167

DR: AR (SKr) 34,000 CR: Sales 34,000 200,000 x .17 = 34,000 Spot Rate (SKr): $.17 Foward Rate: $.167

DR: AR (SKr) 400 CR: FX G/L (IS) 400 200,000 x (.17-.172) = 400 Spot Rate (SKr): $.172 Foward Rate: $.168

DR: AR 93,800 CR: AP ($) 93,800 140,000 x 0.67 = 93,800 Spot Rate: $.68 Foward Rate: $.67

DR: Equipment 95,200 CR: AP (SFr) 95,200 140,000 x 0.68 = 95,200 Spot Rate: $.68 Foward Rate: $.67

DR: FX G/L (IS) 200 CR: AP (SKr) 200 200,000 x (.167-.168) = 200 Spot Rate (SKr): $.172 Foward Rate: $.168

On November 2, year 1, Usco, Inc. enters into a call option contract to buy 10,000 euros (€) in 90 days with a strike price of $1.21. The exchange rates and option premiums for the option period are: Spot Rate Forward Rates (to Jan 31, Yr2) Option Premium November 2, year 1 $1.20 $1.25 $200 December 31, year 1 1.22 1.23 350 January 31, year 2 1.24 1.24 300 November 2 - Contract Initiated: Usco paid a premium of $200 for the contract; that is its fair value at that date. December 31 - Balance Sheet Date: The option premium, as quoted by option sellers for a contract with comparable terms, has increased from $200 to $350, an increase (gain) of $150. January 31 - Settlement Date: The option premium is $300, the intrinsic value of the option at that date, computed as 10,000€ x ($1.24 - $1.21) = 10,000€ x .03 = $300. At the settlement date, there is no time value associated with the contract; it has only intrinsic value. Entry:

DR: Foreign Currency (Euros) $12,400 DR: Loss on Foreign Currency Option 50 CR: Cash (10,000€ x $1.21) $12,100 CR: Foreign Currency Option 350 The net effect over the life of the contract is a $150 gain in 2009 and a $50 loss in year 2, or a net gain of $100. Thus, the difference between the cost of euros if purchased January 31 of $12,400 (10,000€ x $1.24) and the cost of the euros purchased under the option contract of $12,100 (10,000€ x $1.21) of $300 is reflected in the $200 cost of the option and a net gain of $100.

DR: Foreign Currency Option $150 CR: Foreign Currency Option Gain $150 If the contract was entered into for speculative purposes (i.e., to make a profit), the gain would be recognized in current (year 1) income. If the contract was entered into as a qualified hedge, the treatment of the gain would depend on the nature of the hedge (see subsequent lessons).

DR: Foreign Currency Option $200 CR: Cash $200

Assume for a period the following changes occurred in the present value (PV) of a forecasted cash flow and the fair value (FV) of a forward contract designated as a hedge of the forecasted cash flow: Decrease in PV of expected cash flow of forecasted transaction $48,000 Increase in FV of forward contract $50,000 Increase in FV > Decrease in PV $ 2,000 Related Entry (at B/S date):

DR: Forward Contract $50,000 CR: Other Comprehensive Income $48,000 CR: Gain on Cash Flow Hedge 2,000

DR: Fx G/L (IS) 2,800 CR: AP (SFr) 2,800 140,000 x (.68 - .70) = 2,800 Spot Rate: $.70 Foward Rate: $.695

DR: Fx G/L (IS) 700 CR: AP (SFr) 700 140,000 x (.695 - .69) = 700 Spot Rate: $.69 Foward Rate: $.69 DR: AP ($) 93,800 CR: Cash 93,800 (Pay Broker) 140,000 x .67 = 96,600 DR: Invest in (SFr) 96,600 CR: AR (SFr) 96,600 Receive SFr (140,000 x .69) = 96,600

Which one of the following expenses would be remeasured using a historic exchange rate?

Depreciation expense. Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, most expenses (and revenues, gains, and losses) are converted using the current exchange rate. Expenses related to assets and liabilities converted at a historic rate are an exception ‐ they are converted using a historic exchange rate. Therefore, since depreciation expense does result from an asset (property, plant, and equipment) measured using a historic exchange rate, depreciation expense would be remeasured using a historic exchange rate.

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Dividends declared on 10/1/Y3

Dividends are valued at the rate of the date of declaration. 3rd quarter 10/1/Y3

HEDGE OF: Forecasted Transaction: to offset risk of exchange rate changes on planned (forecasted) transaction. Treat Gain/Loss:

Effective portion deferred in "Other Comprehensive Income;" Ineffective portion recognize in Current Income

A hedge to offset the risk of loss on a recognized asset or liability is which of the following types of hedge?

Either a cash flow hedge or a fair value hedge, at management's discretion. If the risk of loss on the recognized asset or liability being hedged is from changes in exchange rates, the hedge would be classified as a cash flow hedge.

What hedge form can a hedge of a recognized asset or liability be designated as?

Either a cash flow hedge or a fair value hedge.

HEDGE OF: Unrecognized Firm Commitment: to offset risk of exchange rate changes on a firm commitment: Comments:

Either derivative instruments or non-derivative financial instruments may be used.

HEDGE OF: Net Investment in Foreign Operation: to offset risk of exchange rate changes on conversion of financial statements. Comments:

Either derivative instruments or non-derivative financial instruments may be used. Adjustment offsets gain/loss on translation of foreign financial statements.

What current exchange rates are used when applying a conversion using translation for revenues, expenses, gains, and losses?

Either: 1. The exchange rate that existed when the items was earned or incurred; or 2. The average exchange rate for the period, if that is not materially different than the actual rates when earned or incurred.

The amount needed to balance the Balance Sheet ($383) is recognized as a Remeasurement Adjustment Gain in the Income from Continuing Operations section of the Income Statement, which increases Net Income which, in turn, increases

Ending Retained Earnings resulting in balancing the Balance Sheet.

The financial statements expressed in a foreign currency that need to be converted to a domestic currency could be the financial statements of a/an:

Equity Investee: Yes Subsidiary to be Consolidated: Yes The financial statements expressed in a foreign currency needing to be converted to a domestic currency could be those of either an equity investee or a subsidiary to be consolidated (or a branch, a joint venture, a partnership, or any other separate foreign operation).

Domestic Currency Strengthens, Accounts Payable Denominated in Foreign Currency

Exchange Gain

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Cost of goods sold

Expense accounts are valued at the average rate for the current year of business. Year average

HEDGE OF: Investment in Available-For-Sale Securities: to offset risk of exchange rate changes on investment. Type of Hedge:

Fair Value

Which of the following types of firm commitment denominated in a foreign currency can be hedged?

Firm Purchase Commitments: Yes Firm Sales Commitments: Yes Both firm purchase commitments and firm sales commitments can be hedged. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. The risk of an exchange rate change on the contract is the same as if the purchase or sale had been recognized, and such risk can be hedged.

Which one of the following hedges using a forward contract will require the recognition of a new asset or liability if a gain or loss occurs on the hedging instrument?

Firm commitment hedge. The hedge of a firm commitment is a fair value hedge, with changes in the fair value of the forward contract (hedging instrument) reported as an increase or decrease to the forward contract and a gain or loss recognized in current income. A change in the fair value of the firm commitment (hedged item) would be recognized as a loss or gain in current income, together with the recognition of a previously unrecognized firm commitment asset or liability for the amount of the change.

Which one of the following correctly reflects a set of events that may result in a sequence of related hedges?

Forecasted transaction ‐> firm commitment ‐> recognized liability. A forecasted transaction (a planned or expected transaction) would occur before a firm commitment, which would occur before a recognized liability. A forecasted transaction is a non‐firm but intended (perhaps even budgeted) transaction. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirement of GAAP. A recognized liability would be one that is already booked by the entity. Thus, the correct sequence would be forecasted transaction ‐> firm commitment ‐> recognized liability.

When used for speculative purposes, which of the following contracts is likely to result in a foreign currency loss to the contract holder who initiated the contract?

Foreign Currency Forward Exchange Contract: Yes Foreign Currency Option Contract: No While a foreign currency forward exchange contract entered into for speculative purposes is likely to result in a foreign currency loss (or gain) for the contract holder, a foreign currency option contract entered into for speculative purposes is not likely to result in a foreign currency loss for the contract holder.. Since the contract holder has the option of whether or not to exercise the contract option to exchange currencies, it is not likely that the option would be exercised if it would result in a loss.

The most important types of forward contracts are:

Foreign Currency Forward Exchange Contracts (FXFC). Foreign Currency Option Contracts (FCO).

For accounting purposes, which of the following are forward contracts?

Foreign Currency Forward Exchange Contracts: Yes Foreign Currency Option Contracts: Yes Both foreign currency forward exchange contracts, which establish an obligation to exchange currencies, and foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, are forward contracts for accounting purposes.

On November 1, year 2, Kir Co. signed a contract to purchase 10,000 British pounds on February 2, year 3. The relevant exchange rates are as follows: Spot rate Forward rate November 1, year 2 $1.98 $2.05 December 31, year 2 2.00 2.06 Kir accounts for the forward contract as a speculative transaction. What amount of gain, if any, should Kir report from this forward contract in its income statement for the year ended December 31, year 2?

Forward contracts are derivatives, and all derivatives are recorded at fair value with unrealized gains and losses recorded in earnings. (The only exception is for certain derivatives that qualify for hedge accounting.) The forward contract price is at $2.05 on November 1, and the forward price increased to $2.06 on December 31. Kir is in a gain position because the November forward contract to buy (Kir's strike price) is less than the December forward price. The 10,000 British pounds times $.01 is $100 gain.

Remeasurement Process - U.S. Dollar =

Functional Currency

Generally, the Functional Currency of the foreign entity will be determined according to the following guidelines:

Functional Currency = (Local, foreign) Recording Currency Functional Currency = U.S. Reporting Currency Functional Currency = Another Foreign Currency

HEDGE OF: Recognized Asset or Liability: to offset risk of exchange rate changes on booked assets or liabilities. Comments:

Gain/Loss on Hedged Item must be recognized in earnings.

Forward exchange contracts may be used to:

Hedge Risk: Yes Speculate: Yes Forward exchange contracts may be used both to hedge risk and to speculate. When used to hedge risk, the intent is to use the change in value of the forward exchange contract (hedging instrument) to offset, in part at least, an opposite change in value of whatever is being hedged (hedged item). When used to speculate, the forward exchange contract is entered into with the intent of making a profit on the change in its value.

Forecasted Transaction:

Hedge a forecasted transaction denominated in a foreign currency; to offset the risk of exchange rate changes on non-firm, but budgeted (planned) transactions to be denominated in a foreign currency.

Net Investment in Foreign Operation:

Hedge a net investment in a foreign operation (e.g., subsidiary); to offset the risk of exchange rate changes on an investment in a foreign operation (e.g., translated value of financial statements expressed in a foreign currency).

Available-for-Sale Investment:

Hedge an investment in available-for-sale securities; to offset the risk of exchange rate changes on this class of investments denominated in a foreign currency.

Unrecognized, Firm Commitment:

Hedge an unrecognized, but firm commitment denominated in a foreign currency; to offset the risk of exchange rate changes on firm commitments for a future purchase or sale to be denominated in a foreign currency.

Hedging Forecasted Transactions, Purpose Example:

Hedge dividends from a foreign subsidiary that are budgeted for the coming year.

Hedging Forecasted Transactions, Purpose Example:

Hedge import or export transactions (denominated in a foreign currency) which are included in a firm's annual budget (i.e., planned).

Recognized Assets or Liabilities:

Hedge recognized (exposed) assets (e.g., receivables) or liabilities (e.g., payables); to offset the risk of exchange rate changes on already booked assets and liabilities denominated in a foreign currency.

What does a forward contract hedge against?

Hedges against possible loss in dollar value of foreign currency received in the future by selling that foreign currency now at a specified rate for delivery received in future.

What purpose does hedging of recognized assets or liabilities serve?

Hedges exposed receivables or payables to offset the risk of exchange rate changes on already booked assets and liabilities denominated in a foreign currency.

List the two general purposes for entering into a forward contract.

Hedging and Speculation.

What exchange rate or rates should be used to remeasure (not translate) nonmonetary accounts from one currency to another currency?

Historic exchange rate.

For Non-Monetary Items -

Historical Exchange Rate (HR), i.e., exchange rate in existence when account item arose.

Which of the following statements concerning the determination of a functional currency is/are correct? I. The functional currency can be selected at management's discretion. II. The functional currency could be the recording currency of the foreign entity. III. The functional currency could be the reporting currency of a parent.

I I and III, only. The functional currency could be either the recording currency of the foreign entity (Statement II) or the reporting currency of a parent (Statement III) (or even another foreign currency). The functional currency will be the currency of the primary economic environment in which an entity operates and primarily generates and expends cash, not whatever currency management chooses (Statement I).

Which of the following statements concerning the use of a forward contract for speculative purposes is/are correct? I. The forward contract is not intended to offset an existing risk. II. Changes in the value of the forward contract are deferred until the contract matures.

I only. When used for speculative purposes, a forward contract is not entered into to offset, or hedge, an existing risk. Rather, the purpose of entering into a speculative forward contract is to make a profit. Statement II is not correct. Changes in the value of a forward contract used for speculative purposes, measured using the forward rate, are recognized in the period in which the forward rate changes and are not deferred until the contract matures.

Which of the following could be the functional currency of a foreign subsidiary? I. The recording currency of the foreign subsidiary. II. The reporting currency of the subsidiary's parent. III. A currency other than either the recording currency of the foreign subsidiary or the reporting currency of the subsidiary's parent.

I, II, and III. The functional currency of a foreign subsidiary could be the recording currency of the foreign subsidiary, the reporting currency of the subsidiary's parent, or a currency other than either the recording currency of the subsidiary or the reporting currency of its parent.

U.S. GAAP: Financial statements in hyperinflationary economies are remeasured as if the functional currency were the reporting currency (U.S. dollar).

IFRS: Financial statements in functional currencies in hyperinflationary economies are indexed using the general price index and then translated to the reporting currency. The indexing results in restatements in terms of the measuring unit at the balance sheet date with the resulting gain or loss in income.

US GAAP: Financial statements in hyperinflationary economies are remeasured as if the functional currency were the reporting currency (U.S. dollar).

U.S. GAAP: Functional currency is the currency of the primary economic activities.

IFRS: Functional currency is the currency of the primary economic activities. Determination based on primary and secondary indicators.

US GAAP: Functional currency is the currency of the primary economic activities.

IFRS: Functional currency is the currency of the primary economic activities. Determination based on primary and secondary indicators.

U.S. GAAP: Equity is translated at historical rates.

IFRS: No specific guidance on what rate to use. Once management has chosen to use either the historical rate or the closing rate, the policy should be applied consistently.

US GAAP: Equity is translated at historical rates.

IFRS: No specific guidance on what rate to use. Once management has chosen to use either the historical rate or the closing rate, the policy should be applied consistently.

Which one of the following sets identifies the correct relationship between a foreign currency hedged item and a hedging instrument? When the Hedged Item is Then the Hedging Instrument is I. Receivable Receivable II. Receivable Payable

II only. Because a hedging instrument is intended to offset changes in the hedged item, when the hedged item is a receivable, the hedging instrument would have to be a payable.

If $1.00 will buy 0.76 Euros, then how many dollars will one Euro buy (rounded)?

If $1.00 will buy 0.76 Euro, then 0.76E = $1.00, and E = $1.00/0.76, or E = $1.32. So, one Euro will buy $1.32.

Functional Currency = (Local, foreign) Recording Currency

If operations of the foreign entity are relatively self-contained and integrated within the country in which it is located. EXCEPTION: If the local economy is highly inflationary (i.e., cumulative inflation of 100% or more over a three-year period) the Functional Currency = Reporting Currency (the $ if a U.S. subsidiary).

What is the difference between a foreign currency forward exchange contract and a foreign currency option contract?

In a foreign currency forward contract an exchange of currencies (or comparable settlement) must occur as provided by the terms of the contract. In a foreign currency option contract an exchange of currencies may occur at the option of the option holder. If the option is exercised, an exchange of currencies will occur; if it is not exercised, no exchange of currencies will occur.

Remeasurement (Translation) Adjustment—

In income statement.

Translation (Translation) Adjustment—

In other comprehensive income for reporting purposes and, subsequently, in accumulated other comprehensive income in the shareholders' equity section of the balance sheet.

Report Exchange Loss or Gain in current-period income statement as component of

Income from Continuing Operations.

Which one of the following would be remeasured using a historic exchange rate?

Inventories carried at cost. Property, plant, and equipment. Common stock.

Which of the following investments denominated in a foreign currency and classified as available‐for‐sale, if any, can be hedged?

Investments in Equity Securities: Yes Investments in Debt Securities: Yes Both investments in equity securities and investments in debt securities denominated in a foreign currency and classified as available‐for‐sale can be hedged.

What is foreign currency translation?

It is the conversion (translation) of financial statements expressed in one currency into comparable financial statements expressed in another currency.

What is a reporting currency?

It is the currency in which final financial statements are expressed.

What is a functional currency?

It is the currency of the primary economic environment in which an entity operates and generates net cash flows. It can be the recording currency, an affiliate's reporting currency, or another currency.

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Dividends declared in (6) were paid 1/2/Y4

Liabilities (dividends payable) are valued at the current rate at year‐end. Year‐end 12/31/Y3

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Account payable for equipment purchased on 4/1/Y3

Liabilities are valued at the current rate at year‐end. Year‐end 12/31/Y3

lternatives for determining forward exchange option fair value: Exchange-traded options:

Market price quoted on exchange = fair value.

Remeasurement, based on the temporal method of conversion, converts foreign currency amounts to reporting currency amounts using different exchange rates for different accounts based on which of the following distinctions?

Monetary and non‐monetary. The distinction used for applying different exchange rates to different accounts when using remeasurement is based on whether the account is monetary or non‐monetary.

How do you determine the dollar amount to settle a transaction denominated in a foreign currency?

Multiply the number of foreign currency units specified by the terms of the transaction by the spot exchange rate at the current date.

On December 1 of the current year, Bann Co. entered into an option contract to purchase 2,000 shares of Norta Co. stock for $40 per share (the same as the current market price) by the end of the next two months. The time value of the option contract is $600. At the end of December, Norta's stock was selling for $43, and the time value of the option was now $400. If Bann does not exercise its option until January of the subsequent year, which of the following changes would reflect the proper accounting treatment for this transaction on Bann's December 31, year‐end financial statements?

Net income will increase by $5,800. An option is a financial derivative and must be reported as either an asset or liability at fair value, with any change in fair value recognized in income of the period that the fair value changes (unless the option is used as a hedge). At the date the option contract was initiated, it had no intrinsic value (the strike price was the same as the current price), but had a time value of $600 (given). At December 31, the time value had decreased to $400, a decline of $200, but the intrinsic value had increased by $6,000, computed as the change in the market price from $40 per share to $43 per share, an increase of $3 x 2,000 shares (the option quantity) = $6,000. Thus, the net change in fair value, and the amount of gain that would be recognized in December 31 financial statements, is + $6,000 ‐ $200 = $5,800.

In which of the following hedges using a forward contract will at least a portion of any currency exchange gain or loss on the hedging instrument be reported as a translation adjustment in other comprehensive income?

Net investment in foreign operations hedge. The hedge of a net investment in foreign operations is a fair value hedge, but changes in the fair value of the forward contract (hedging instrument) that are equal to or less than the change in the translated value of the financial statements of the foreign operation are reported as a translation adjustment in other comprehensive income. The change in the forward contract reported as a translation adjustment offsets the change in the value of the translated financial statements of the foreign operation, which also are reported as a translation adjustment.

HEDGE OF: SPECULATION: Entered into for profit; Not hedging an exposure to currency risk. Type of Hedge:

None

HEDGE OF: SPECULATION: Entered into for profit; Not hedging an exposure to currency risk. Comments:

Not offsetting any obligation or other translation.

Which of the following is not a characteristic associated with foreign currency transactions?

Occur only when initiated by a foreign entity. Foreign currency transactions do not occur only when initiated by a foreign entity. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non‐domestic (e.g., non‐dollar) currency, regardless of whether the transaction is initiated by the domestic entity or the foreign entity.

What purpose does hedging of net investment in foreign operations serve?

Offsets risk of exchange rate changes on an investment in a foreign operation.

What purpose does hedging of forecasted transactions serve?

Offsets risk of exchange rate changes on nonfirm but budgeted foreign currency transactions between the time the transaction is planned and when it becomes firm.

What purpose does hedging of an investment in foreign operations serve?

Offsets risk of exchange rate changes on translation of financial statements of foreign operation, from foreign currency to dollars.

What purpose does hedging of foreign currency commitments serve?

Offsets the risk of exchange rate changes on a firm commitment denominated in a foreign currency for a future purchase or sale.

What is the purpose of a hedge of a foreign-currency denominated investment classified as available-for-sale?

Offsets the risk of exchange rate changes on a foreigncurrency-denominated investment in securities classified as available-for-sale.

What purpose does hedging of a recognized asset/liability serve?

Offsets the risk of exchange rate changes on an existing asset or liability.

What purpose does hedging of unrecognized firm commitments serve?

Offsets the risk of exchange rate changes on firm commitments for a future purchase or sale to be denominated in a foreign currency.

What purpose does hedging of a forecasted transaction serve?

Offsets the risk of exchange rate changes on nonfirm but budgeted transactions denominated in a foreign currency.

What purpose does hedging of available-for-sale investments serve?

Offsets the risk of exchange rate changes on this class of investments denominated in a foreign currency.

HEDGE OF: Forecasted Transaction: to offset risk of exchange rate changes on planned (forecasted) transaction. Comments:

Only derivative instruments qualify. Deferred gain/loss recognized when forecasted transaction affects income.

HEDGE OF: Investment in Available-For-Sale Securities: to offset risk of exchange rate changes on investment. Comments:

Only derivative instruments qualify. Gain/Loss is not recognized in "Other Comprehensive Income."

Which of the following general types of transactions could be a foreign currency transaction?

Operating Transactions: Yes Forward Exchange Contract Transactions: Yes Either operating transactions (export, import, lending, borrowing, investing, etc.) or forward exchange contract transactions (contracts to exchange currencies) could be foreign currency transactions. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non‐domestic (e.g., non‐dollar) currency.

lternatives for determining forward exchange option fair value: Not traded in active market:

Option pricing model (e.g., modified Black-Scholes option price model) = fair value.

The Translation Adjustment is reported in the Shareholders' Equity Section of the Balance Sheet and as an item of

Other Comprehensive Income in reporting Comprehensive Income.

Basically, use historic exchange rate for nonmonetary items:

Past Price Valuation. Assets and liabilities valued at past prices (not for assets and liabilities measured at amounts promised).

Which of the following types of planned transactions to be denominated in a foreign currency can be hedged?

Planned Sale: Yes Planned Purchase: Yes Either a planned sale or a planned purchase would be a forecasted transaction and, if denominated in a foreign currency, could be hedged.

lternatives for determining forward exchange option fair value: Over-the-counter options:

Price quoted from option dealer = fair value.

HEDGE OF: Net Investment in Foreign Operation: to offset risk of exchange rate changes on conversion of financial statements. Treat Gain/Loss:

Recognize as adjustment to Translation Adjustment; Gain in excess of Translation Adjustment to Net Income of current period

HEDGE OF: Investment in Available-For-Sale Securities: to offset risk of exchange rate changes on investment. Treat Gain/Loss:

Recognize both forward contract and investment change in FV in current income; any difference will affect current net income

HEDGE OF: SPECULATION: Entered into for profit; Not hedging an exposure to currency risk. Treat Gain/Loss:

Recognize in current net income

The following currency concepts are relevant to Foreign Currency Translation:

Recording Currency Reporting Currency Functional Currency

For each of the fact situations described in Column A, below, determine whether the recording currency, reporting currency, or another currency is most likely the functional currency for each foreign entity and whether the financial statements of each foreign entity should be converted using translation, remeasurement, or both. A U.S. parent company has an 80% owned subsidiary in Germany. The subsidiary's operations are relatively self‐contained and integrated within Germany. The subsidiary maintains its records and prepares its financial statements in Euros. The EEU economy is not highly inflationary.

Recording currency; Translation. Since the German subsidiary's operations are relatively self‐contained and integrated within Germany, rather than being dependent on its U.S. parent, and since the EEU (European Economic Union) economy is not highly inflationary, the subsidiary's recording currency is its functional currency. When the recording currency is the functional currency, the conversion of financial statements to the reporting currency is done using translation, which requires the use of a prescribed set of exchange rates that is different from the rates used in remeasurement. The fact that the subsidiary is only 80% owned does not affect the determination of the functional currency.

A foreign currency other than the recording currency, both remeasurement and translation will be required.

Remeasure from recording currency to functional currency (which is another foreign currency), then translate from functional currency to U.S. $ reporting currency.

If the functional currency of a foreign subsidiary is a foreign currency other than the subsidiary's recording currency, which one of the following will be used to convert the subsidiary's financial statements to the final reporting currency?

Remeasurement and then translation. Remeasurement and then translation would be used to convert to the reporting currency when a foreign currency other than the foreign subsidiary's recording currency is the functional currency. Specifically, the financial statements would be remeasured from the recording currency to the other foreign functional currency, and the remeasured financial statements would then be translated to the reporting currency.

Eagle, Inc. is a manufacturer and distributor of consumer products in the U.S. It has a wholly owned foreign subsidiary, El Rio, which sells Eagle products in Mexico. El Rio receives all of its products from Eagle, sells those products, and remits the proceeds to Eagle. El Rio maintains its books and prepares its financial statements in the Mexican peso. Which one of the following methods will Eagle most likely use to convert El Rio's financial statements to dollar‐based statements?

Remeasurement. Because El Rio's operations are a direct extension of Eagle, the peso is not El Rio's functional currency; Eagle's currency, the U.S. dollar, is El Rio's functional currency. Therefore, El Rio's financial statements will be converted to U.S. dollars using remeasurement.

Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. Which one of the following processes should Papco use to convert Sapco's financial statements to dollar‐based statements for consolidation purposes?

Remeasurement. Because Sapco's operations are a direct extension of Papco, Sapco's local foreign currency is not its functional currency. Rather, Papco's currency, the U.S. dollar, is Sapco's functional currency. Therefore, its financial statements expressed in the foreign currency will be converted to U.S. dollars using remeasurement.

When is the remeasurement method of converting financial statements from one currency to another currency used?

Remeasurment is used when converting from a recording currency (that is not the functional currency) to the functional currency. This might occur, for example, when: 1. The recording currency is in a highly inflationary economy; 2. The operations of the foreign entity are a direct and integral component or extension of its parent; 3. The functional currency is not the local foreign currency, but another foreign currency (other than the reporting currency).

Which one of the following could be translated using the weighted average exchange rate for the fiscal year?

Rent expense. Sales. Wage expense.

For each of the fact situations described in Column A, below, determine whether the recording currency, reporting currency, or another currency is most likely the functional currency for each foreign entity and whether the financial statements of each foreign entity should be converted using translation, remeasurement, or both. 1. A U.S. parent company has a wholly owned subsidiary in Mexico. The subsidiary's operations are an extension of and dependent on its U.S. parent. The subsidiary maintains its records and prepares its financial statements in Pesos. Mexico's economy is not highly inflationary.

Reporting currency; Remeasurement. Since the Mexican subsidiary's operations are an extension of and dependent on its U.S. parent, rather than being relatively self‐contained and independent of the parent, the Peso cannot be the functional currency‐it is not the currency in which the subsidiary primarily generates and expends cash. Therefore, the reporting currency (U.S. dollar) is the functional currency, not the recording currency (Peso). Conversion of financial statements from the recording currency to the functional currency is done using remeasurement, which requires the use of a prescribed set of exchange rates that is different from the rates used in translation.

Reporting currency; Remeasurement. Even though the Israeli subsidiary is relatively self‐contained and integrated within Israel, rather than being dependent on its U.S. parent, because the Israeli economy is highly inflationary, the recording currency (the Shekel) cannot be the functional currency. Therefore, the reporting currency (U.S. dollar) is the functional currency and the conversion of financial statements from the recording currency to the reporting currency is done using remeasurement, which requires the use of a prescribed set of exchange rates that is different from the rates used in translation.

How is retained earnings converted from one currency to another when translation (not remeasurement) is used?

Retained earnings is not translated, but rather is calculated as of the balance sheet date. The calculation is: Beginning Retained Earnings ($) + Translated Net Income/Net Loss ($) Dividends declared translated at the spot rate at date of declaration = Ending Retained Earnings ($).

In converting financial statements from a foreign currency to a reporting currency, which one of the following accounts would not be translated using an exchange rate?

Retained earnings. When converting financial statements from a foreign currency to a reporting currency using translation (or remeasurement), retained earnings is not translated using an exchange rate. Rather, retained earnings is calculated using already converted values. Specifically, beginning retained earnings in dollars + converted net income ‐ converted dividends declared = ending retained earnings in dollars.

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Sales

Revenue accounts are valued at the average rate for the current year of business. Year average

Which of the following is a foreign currency export transaction for a U.S. entity?

Sale of goods to be collected in a foreign currency. The sale of goods to be collected in a foreign currency would be a foreign currency export transaction. A foreign currency transaction occurs when a U.S. entity enters into a transaction that is denominated (to be settled) in a foreign currency, not in dollars.

Hedging Firm Commitments, Risk of Exchange Rate Changes:

Since the contract is to pay a specified amount of foreign currency, the party is at risk of exchange rate changes between the date of the contract (purchase order) and the date the purchase and obligation to pay (accounts payable) are recorded.

RWB Co., a U.S. entity, purchased goods for resale from a Thai manufacturer. The purchase agreement provided that the U.S. entity would pay the Thai entity 500,000 baht, the Thai currency. The goods were delivered on July 1, 20X8, with payment due August 29, 20X8. The following exchange rates were determined for the number of baht to the dollar (i.e., B/$): Spot Rate 60‐day Forward Rate July 1, 20X8 35.0B/$ 36.5B/$ August 29, 20X8 37.0B/$ 38.0B/$ Which one of the following is the amount (rounded) of exchange gain or loss, if any, that RWB Co. would recognize on the purchase of goods from the Thai manufacturer?

Since the exchange rate changed between the date the obligation was incurred (July 1) and the date it was settled (August 29), the effects of the exchange rate change must be recognized as an exchange gain or loss. The correct answer would be the difference between the spot rate on July 1 and the spot rate on August 29, or (500,000B/35.0B per $ = $14,286) ‐ (500,000B/37.0B per $ = $13,514) = $772.

Panco, a U.S. entity, has a subsidiary, Sanco, located in a foreign country. Sanco's operations are concentrated in the country in which it is located and are essentially independent of Panco. The economy of the foreign country is not highly inflationary. Sanco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 20X8: Statement of Net Income and FCUs Comprehensive Income (20X8) (in 000) Sales 12,000 COGS (4,000) Depreciation Expense (1,000) Other Expenses (3,000) Net Income 4,000 Other Comprehensive Income 0 Comprehensive Income 4,000 Retained Earnings (20X8) Beginning Retained Earnings (end 20X7) 6,000 Add: Net Income (20X8) 4,000 Deduct: Dividends (20X8) (1,000) Ending Retained Earnings 9,000 Balance Sheet (12/31/20X8) Cash and Account Receivable 2,000 Inventory 6,000 Fixed Assets 10,000 Total Assets 18,000 Liabilities 2,000 Common Stock 7,000 Retained Earnings 9,000 Subtotal 18,000 Accumulated Other Comprehensive Income 0 Total Liabilities + Equity 18,000 The following exchange rates were available: Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200 Weighted average exchange rate for 20X8: 1 FCU = $1.300 Spot exchange rate at date dividend declared: 1 FCU = $1.290 Spot exchange rate at December 31, 20X8: 1 FCU = $1.310 Which one of the following is the amount (in 000) of Sanco's depreciation expense in U.S. dollars?

Since translation should be used to convert Sanco's financial statements expressed in FCUs to U.S. dollars, depreciation expense should be converted using the exchange rate in effect when depreciation was incurred during the year or the weighted average exchange rate for the period. In this case, the weighted average exchange rate for the period is given as 1 FCU = $1.300. Therefore, the correct dollar amount of Sanco's depreciation expense would be 1,000 FCUs x $1.300 = $1,300.

Since translation should be used to convert Sanco's financial statements expressed in FCUs to U.S. dollars, dividends declared should be translated at the exchange rate in effect when the dividends were declared (the same would be true for remeasurement). In this case, the exchange rate is given as 1 FCU = $1.290. Therefore, the correct dollar amount of Sanco's dividends declared would be 1,000 FCUs x $1.290 = $1,290.

For forward contracts entered into for speculative purposes, which of the following exchange rates, if any, will be used to measure the contracts prior to maturity?

Spot Rate: No Forward Rate: Yes The forward rate is used, and the spot rate is not. When a forward contract is entered into for speculative purposes, the contract is measured using the forward rates as of the dates the contract is initiated and at any subsequent measurement date(s) (e.g., balance sheet date). Changes in the forward rate create gains and losses on the forward contract, which are recognized in the period in which the forward rate changes.

Which of the following exchange rates may be used in accounting for a forward contract hedging instrument?

Spot Rate: Yes Forward Rate: Yes Both the spot rate and the forward rate will be used in accounting for a forward contract used for hedging. The forward rate is used as the basis for determining the change in value of a forward contract. As the forward rate changes, so also will the carrying value of the forward contract, resulting in exchange gains and losses. The spot rate is used to determine the premium or discount on the forward contract. Specifically, the difference between the spot rate and the forward rate at the date of the forward contract is the premium (or discount) on the forward contract, which enters into the determination of income over the life of the contract.

Which of the following statements concerning the hedging of an investment in a foreign operation is/are correct? I. The hedged item is the result of translating the foreign operation's financial statements. II. Only forward contracts can be used to hedge an investment in a foreign operation.

Statement I is correct; Statement II is not. In the hedging of an investment in a foreign operation, the hedged item is the result of translating the foreign operation's financial statements from a foreign currency to the functional currency (Statement I). The intent of the hedge is to offset changes in the translated results that are caused by changes in exchange rates. Statement II is not correct; either derivatives (e.g., forward contracts) or non‐derivatives can be used to hedge an investment in a foreign operation. For example, borrowing in the same foreign currency would hedge the investment, but the borrowing is not necessarily a derivative (e.g., forward contract).

Time value:

The "value" assigned to the probability that the relationship between the changing spot price and the strike price will increase the value of the option during its life.

The specific translation methodology to use to convert financial statements expressed in a foreign currency into domestic (dollar) equivalents depends on the Functional Currency of the foreign entity. The Functional Currency of the foreign entity can be:

The Recording Currency The Reporting Currency Another Foreign Currency

Hedging Foreign Currency Denominated Asset or Liability, Accounting Treatment:

The accounting for the hedge of a recognized asset or liability would depend on the designated purpose of the hedge - whether to hedge cash flow or to hedge fair value.

Orr Corporation had a realized foreign exchange loss of $13,000 for the year ended December 31, 20X8, and must also determine whether the following items will require year‐end adjustment. Orr had a $7,000 gain resulting from the translation of the accounts of its wholly owned foreign subsidiary for the year ended December 31, 20X8. Orr had an account payable to an unrelated foreign supplier payable in the supplier's local currency. The U.S. Dollar equivalent of the payable was $60,000 on October 31, 20X8 and $64,000 on December 31, 20X8. The invoice is payable on January 30, 20X9. In Orr's 20X8 consolidated income statement, what amount should be included as foreign exchange loss?

The correct amount of foreign exchange loss is $17,000. The $4,000 loss on the account payable ($64,000 ‐ $60,000 = $4,000) would be included in net income. Therefore, the correct amount of foreign exchange loss is $13,000 + $4,000 = $17,000. The translation loss (or gain) would not be included in net income for the year, but rather would be reported as an item of other comprehensive income (outside net income) for the year.

On October 1, 20X8, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB‐Destination on December 1, 20X8, with payment by Pronto on January 30, 20X9. The following dollar cost per Euro exchange rate information was available: Spot Rate Forward Rate for December 1 Forward Rate for December 31 Forward Rate for January 30 October 1 $1.30 $1.29 $1.28 $1.27 December 1 $1.29 ‐ $1.28 $1.27 December 31 $1.28 ‐ ‐ $1.27 January 30 $1.27 ‐ ‐ ‐ Which of the following is the amount (rounded) at which RWB Co. should recognize sales as a result of its sale to Pronto?

The correct answer is derived by multiplying the number of Euros to be received (300,000) by the dollar cost (value) per Euro at the date of the sale ($1.29), or 300,000E x $1.29 = $387,000. The amount of the sale would not be adjusted for subsequent changes in exchange rates.

On September 1, 2004, Brady Corp. entered into a foreign exchange contract for speculative purposes by purchasing 50,000 Euros for delivery in 60 days. The rates to exchange $1 for 1 Euro follow: 9/1/04 9/30/04 Spot rate .75 .70 30‐day forward rate .73 .72 60‐day forward rate .74 .73 In its September 30, 2004, income statement, what amount should Brady report as foreign exchange loss?

The correct answer is the difference between the 60‐day forward rate on September 1 of $0.74 and the 30‐day forward rate on September 30 of $0.72, or $0.02 x 50,000 Euros = $1,000, the correct amount of the loss.

What is a recording currency?

The currency in which an entity maintains its books of accounts. Normally, the recording currency is the local currency of the country in which an entity is located.

Reporting Currency:

The currency in which the final (e.g., consolidated) financial statements are expressed.

Recording Currency:

The currency in which the foreign entity's books of account are maintained.

The Reporting Currency

The currency of the final reporting entity (the dollar for a U.S. entity).

Functional Currency

The currency of the primary economic environment in which an entity operates and generates net cash flows.

Which one of the following would best describe the functional currency of a foreign subsidiary of a U.S. parent?

The currency of the primary economic environment in which the subsidiary operates and generates most of its net cash flow. The functional currency of a foreign subsidiary would be the currency of the primary economic environment in which the subsidiary operates and primarily generates and expends cash. That currency could be the recording currency, the reporting currency, or another foreign currency.

Intrinsic value:

The difference between the current spot rate for the currency and the strike price - the price at which exercise of the option would result in a gain.

Define "forward rate".

The exchange rate (existing now) for a specified future date.

How are financial statements converted when the functional currency is neither the recording currency nor the reporting currency but the currency of another (third) country?

The financial statements are first remeasured from the recording currency to the functional currency and then translated from the functional currency to the reporting currency.

The Recording Currency

The foreign entity's local foreign currency.

Define "indirect exchange rate".

The foreign price of one domestic unit of currency.

How are forward contracts entered into for speculative purposes accounted for?

The forward exchange contract is measured (valued) and recorded at the forward exchange rate (quoted now) for exchanges that will occur at the maturity date of the contract. Any change in value resulting from changing forward exchange rates will be recognized in current income.

The specific method to be used to convert financial statements of a subsidiary expressed in a foreign currency into the domestic currency of the parent depends primarily on:

The functional currency of the subsidiary. The method to be used to convert financial statements of a subsidiary from a foreign currency to the parent's currency depends primarily on the functional currency of the subsidiary. Whether the functional currency of the subsidiary is the local foreign currency, the parent's currency, or another foreign currency will determine the conversion method or methods to be used.

When does Functional Currency = Reporting Currency ($)?

The functional currency would be the reporting currency: 1. When the foreign entity is a direct and integral component or extension of a U.S. entity's operations; or 2. When the local economy of the foreign entity is highly inflationary.

On December 12, 20X8, Imp Co. entered into a forward exchange contract to hedge a purchase of inventory in November 2008, payable in March 20X9. The forward contract was to purchase 100,000 Euros in 90 days as a fair value hedge of the payable due in March. The relevant direct exchange rates were as follows: Spot Rate Forward Rate (for 3/12/X9) December 12, 20X8 $1.86 $1.80 December 31, 20X8 $1.96 $1.83 At December 31, 20X8, what amount of foreign currency transaction gain should Imp include in income from this forward contract only? (Ignore discount and present value considerations.)

The gain (or loss) recognized on the contract will be computed as the number of Euros to be purchased (100,000E) multiplied by the change in the forward exchange rate between the date the contract was executed ($1.80) and the end of the fiscal period, December 31, 20X8 (1.83). Therefore, the gain recognized will be 100,000E x ($1.83 ‐ $1.80 = $0.03) = $3,000. It is a gain because the forward contract increased in value as of December 31. The gain on the forward contract will partially offset the loss on the inventory for the period. A complete determination of the gain on the forward contract (only) would include amortization of the difference between the spot rate and forward rate at the initiation of the contract ($6,000) and discounting the nominal gain of $3,000 for the period December 31 to the March settlement date.

If the change in value of the forward contract is effective in offsetting a decrease or an increase in the expected cash flow of the forecasted transaction, how should the gain or the loss be deferred and reported?

The gain or the loss should be deferred and reported as a component of "other comprehensive income."

What kind of hedge is the hedge of a firm commitment?

The hedge of a firm commitment can be either a fair value hedge or a cash flow hedge.

What general kind of hedge, if any, is the hedge of a recognized asset or liability? I. Fair value. II. Cash flow.

The hedge of a recognized asset or liability may be either a fair value hedge or a cash flow hedge, depending on management's designation. However, the hedge of a recognized asset or liability denominated in a foreign currency generally will be a cash flow hedge.

What general kind of hedge, if any, is the hedge of an available‐for‐sale investment denominated in a foreign currency? I. Fair value. II. Cash flow.

The hedge of an available‐for‐sale investment denominated in a foreign currency is a fair value hedge. The risk hedged is the effect of exchange rate changes on the fair value in dollars of the investment.

Which one of the following is not a characteristic associated with hedging foreign currency firm commitments?

The hedged item is for an already booked asset or liability. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. Therefore, an asset or liability has not been booked (recognized) already.

What are characteristics associated with hedging foreign currency firm commitments?

The hedged item is for purchase or sale to be recorded in the future. The hedged item is evidenced by a contract or similar legal commitment. The risk being hedged exists prior to an asset or liability being recognized.

What exchange rate or rates should be used to translate (not remeasure) paidin capital accounts from one currency to another currency?

The historic exchange rate, that existed when the paidin capital items arose, but not earlier than when the investment in the entity was initially made.

Based on preliminary discussions with a foreign customer, Alcoco, a U.S. entity, budgeted a significant sale to the foreign entity denominated in its foreign currency expected in June 20X9. To hedge the risk of an adverse exchange rate change on the dollar value of the expected sale, on January 2, 20X9, Alcoco entered into a forward exchange contract to sell an amount of the foreign currency equal to the expected sale. On March 31, 20X9, the value of the expected sale amount in dollars had decreased by $3,800. The fair value of the forward contract at that date had increased by $4,000. Which one of the following is the amount that should be recognized in current income for the forward contract only (the hedging instrument) in Alcoco's quarterly financial statements as of March 31?

The ineffective portion of the (cash flow) hedge should be reported in current income. The effective portion of the hedge ($3,800) should be reported in other comprehensive income, and the ineffective portion ($200) should be reported in current income. The effective portion of the hedge is the amount of change in the forward contract (hedging instrument) equal to the change in the fair value of the expected sale amount (the hedged item) ($3,800); the ineffective portion is the difference ($200) and should be reported in current income.

If change in the value of the hedge is ineffective in offsetting the change in the expected cash flow of the forecasted transaction, how should that loss or gain be reported?

The loss or gain should be reported in current income.

The net effect of a change in value of a hedged item and its related hedging instrument may be: I. A gain. II. A loss. III. Neither a gain nor a loss.

The net effect of a change in value of a hedged item and its related hedging instrument may be a gain, a loss, or neither a gain nor a loss (a perfect hedge).

On December 12, 20X8, Averseco entered into a forward exchange contract to purchase 100,000 units of a foreign currency in 90 days. The contract was designated as and qualified as a fair value hedge of a purchase of inventory made that day and payable in March 20X9. The relevant direct exchange rates between the foreign currency and the dollar are as follows: Spot Rate Forward Rate (for March 12, 20X9) December 12, 20X8 $0.88 $0.90 December 31, 20X8 0.98 0.93 At December 31, 20X8, what amount of foreign currency transaction net gain or loss should Averseco recognize in income as a result of its foreign currency obligation and related hedge contract? (Ignore premium/discount and present value considerations.)

The net loss will be $7,000. The gain or loss on the payable will be measured as the number of foreign currency units multiplied by the change in the spot rate between the date the liability arose, December 12, and the end of the year, December 31. Thus, the loss on the payable will be 100,000 foreign currency units x ($0.98 ‐ $0.88 = $0.10) = $10,000. The gain or loss on the forward contract (disregarding any premium/discount at initiation of the contract and without using a present value factor) will be measured as the number of foreign currency units multiplied by the change in the forward rate between the date the contract was executed, December 12, and the end of the year, December 31. Thus, the gain on the forward contract will be 100,000 foreign currency units x ($0.93 ‐ $0.90 = .03) = $3,000. The net will be $10,000 ‐ $3,000 = $7,000.

Spot rate:

The number of units of a currency that would be exchanged for one unit of another currency on a given date.

Which one of the following best describes the currency in which the final consolidated financial statements are presented?

The reporting currency. The reporting currency is the currency in which the final consolidated financial statements are presented (reported).

For each item determine which date the exchange rate from Table A should be used for the translation. The subsidiary's functional currency is its local currency. Retained earnings

The retained earnings are carried over from 1/1/Y3 with the translated net income added and translated dividends subtracted. No translation rate used

What exchange rate or rates should be used to translate (not remeasure) asset and liability accounts from one currency to another currency?

The spot exchange rate (closing rate) as of the balance sheet date.

In which one of the following independent circumstances would the local foreign currency of a country least likely be the functional currency for a manufacturing subsidiary of a U.S. company located in that country?

The subsidiary makes all of its product for sale to and for use by its U.S. parent. If a subsidiary makes all of its product for sale to and for use by its parent, the subsidiary is likely to be a direct and integral extension of its parent and, therefore, the parent's currency is likely to be the functional currency, not the local foreign currency of the subsidiary. In the circumstances described, the subsidiary likely receives virtually all of its cash inflow from its parent, which it converts to the local currency for operating costs. Therefore, it generates most of its cash flows in the U.S. dollar, and that is its functional currency, not the local foreign currency.

What is the risk being hedged when using a forward contract for speculation?

There is no separate risk being hedged. The forward contract and the resulting loss or gain stand alone.

Direct quote:

This is a direct exchange rate and it measures how much domestic currency must be exchanged to receive one unit of a foreign currency. $1.25 = 1 €.

Indirect quote:

This is an indirect exchange rates and it measures how many units of foreign currency may be purchased with one unit of domestic currency. $1.00 = .80 €. The indirect quote is the reciprocal of the direct quote (1 ??? / $1.25 = .80 €).

Hedging Firm Commitments, Accounting Treatment (assuming a fair value hedge): The change in fair value of the firm commitment (the hedged item), measured as the change in the forward exchange rate, should be recognized as in increase or decrease in the carrying value of the firm commitment with a corresponding gain or loss recognized in net income. (Note:

This treatment requires recognizing an asset or liability for the firm commitment that otherwise would not be recognized under GAAP.)

What purpose does foreign currency speculation serve?

To make a gain as a result of exchange rate changes by buying foreign currency for future delivery at a price lower than its value when delivered, or by selling foreign currency for future delivery at a price higher than it can be bought at delivery date.

Speculation Purpose:

To make a gain as a result of exchange rate changes either by buying foreign currency for future delivery at a price lower than its value when delivered or by selling foreign currency for future delivery at a price higher than it can be bought at the delivery date. In this case, there is no existing obligation or other conversion being hedged, rather the forward contract is entered into to make a profit (i.e., for speculative purposes).

Hedging Firm Commitments, Purpose:

To offset the risk of exchange rate changes on a firm commitment for a future purchase or sale denominated in a foreign currency; a contract has been entered into, but the related transaction has not been recorded under GAAP. The risk of an exchange rate change on the contract is the same as if the purchase or sale were recorded.

Hedging Foreign Currency Denominated Available-for-Sale Security:

To offset the risk of exchange rate changes on an investment in securities (debt or equity) that are held available for sale.

Hedging Forecasted Transactions, Purpose:

To offset the risk of exchange rate changes on non-firm, but budgeted (planned) foreign currency transactions (e.g., purchase or sale) between the time the transaction is planned and when it becomes firm or is executed.

Hedging Foreign Investment in Foreign Operations:

To offset the risk of exchange rate changes on the translation (conversion) of the financial statements of a foreign operation, (branch, investee or subsidiary) from the foreign currency to dollars.

Which one of the following sets correctly identifies the characteristics of foreign currency transactions for a U.S. entity?

Transaction Denominated In: Non-Dollars Transaction Measured In: Dollars For a U.S. entity, a foreign currency transaction will be denominated (settled) in non‐dollars, but measured and recorded on the U.S. entity's books in dollars.

Which of the following kinds of transactions, all denominated in a foreign currency, would be a foreign currency transaction?

Transaction Types: Export: Yes Lending: Yes Investing: Yes Any transaction denominated (that is, to be settled) in a foreign currency is a foreign currency transaction, including import, export, borrowing, lending, and investing transactions.

A sale of goods, denominated in a currency other than the entity's functional currency, resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. Exchange rates between the functional currency and the currency in which the transaction was denominated changed. The resulting gain should be included as a:

Transaction gain reported as a component of income from continuing operations. The event described is a foreign currency (FC) transaction, not FC translation, and the gain (or loss) would be reported as a component of income from continuing operations for the current period.

Which one of the following sets shows the correct reporting of an adjustment (gain or loss) that results from translation and one that results from remeasurement of financial statements from a foreign currency to a reporting currency?

Translation Adjustment: Other comprehensive income Remeasurement Adjustment: Net Income An adjustment resulting from translation of financial statements would be reported in other comprehensive income, and an adjustment resulting from remeasurement would be reported in net income.

Why might an entity need to translate financial statements expressed in a foreign currency?

Translation may be needed to: 1. Apply the equity method of accounting to an investee; 2. Prepare combined financial statements; 3. Prepare consolidated financial statements.

he functional currency of the entity issuing financial statements to be converted to another currency will determine the method to be used to convert the financial statements. Two methods are possible:

Translation; Remeasurement.

SPECULATION: Entered into for profit; Not hedging an exposure to currency risk.

Type: (None) Basic Approach: Adjust carrying value of Forward Contract to Fair Value Treat Gain/Loss: Recognize in current net income Comments: Not offsetting any obligation or other translation.

Net Investment in Foreign Operation: to offset risk of exchange rate changes on conversion of financial statements

Type: ASC 81535 does not classify this hedge the accounting is similar to CF hedge because effective portion of gains/loss are reported in OCI Basic Approach: Adjust carrying value of Forward Contract to Fair Value Treat Gain/Loss: Recognize both forward contract and investment change in FV in current income; any difference will affect current net income Comments: Only derivative instruments qualify. Gain/Loss is not recognized in "Other Comprehensive Income."

Forecasted Transaction: to offset risk of exchange rate changes on planned (forecasted) transaction

Type: Cash Flow Basic Approach: Adjust Forward Contract to Fair Value Treat Gain/Loss: Effective portion deferred in "Other Comprehensive Income;" Ineffective portion recognize in Current Income Comments: Only derivative instruments qualify. Deferred gain/loss recognized when forecasted transaction affects income.

Unrecognized Firm Commitment: to offset risk of exchange rate changes on a firm commitment

Type: Cash Flow OR Fair Value Basic Approach: Adjust carrying value to Fair Value for both Forward Contract and Firm Commitment (recognize asset or liability) Treat Gain/Loss: Cash Flow: Effective Portion deferred in "Other Comprehensive Income," Ineffective portion in Current Income Fair Value: Recognize in current income for both forward contract and firm commitment; any difference will affect net income Comments: Either derivative instruments or nonderivative financial instruments may be used.

Recognized Asset or Liability: to offset risk of exchange rate changes on booked assets or liabilities

Type: Cash Flow OR Fair Value Basic Approach: Adjust carrying value to Fair Value for both Forward Contract and Recognized Asset or Liability Treat Gain/Loss: Cash Flow: Effective portion in "Other Comprehensive Income;" Ineffective portion in Current Income. Fair Value Recognize in current income for both forward contract and recognized asset or liability; any difference will affect net income. Comments: Gain/Loss on Hedged Item must be recognized in earnings.

Investment in Available-For-Sale Securities: to offset risk of exchange rate changes on investment

Type: Cash Flow OR Fair Value Basic Approach: Adjust carrying value to Fair Value for both Forward Contract and Recognized Asset or Liability Treat Gain/Loss: Recognize both forward contract and investment change in FV in current income; any difference will affect current net income Comments: Gain/Loss on Hedged Item must be recognized in earnings.

What are characteristics of hedging?

Typically involves offsetting transactions or positions. Is a strategy for managing risks. Can be used for obligations to be satisfied in a foreign currency.

Paid-In Capital:

Use Historic Rate in existence when Paid-In Capital arose (but not earlier than investment in foreign entity).

Assets and Liabilities:

Use Spot rate at Balance Sheet date (except paid-in-capital and retained earnings).

Revenues, Expenses, Gains, and Losses:

Use exchange rate at dates on which earned or incurred; however, a weighted average rate for the period can be used.

Hedging Firm Commitments, Criteria for Designation:

Use of a forward contract, either an exchange contract or an option contract, to hedge a firm commitment requires that: 1) The commitment being hedged must be firm, be identified, and present exposure to foreign currency prices changes. 2) The forward contract must be designated and effective as a hedge of a commitment and be in an amount that does not exceed the amount of the commitment. (To the extent the amount of the forward contract exceeds the amount of the commitment, the forward contract is treated as speculation, not a hedge.)

Hedging Forecasted Transactions, Criteria for Designation:

Use of a forward contract, either an exchange contract or an option contract, to hedge a forecasted transaction requires that (these requirements generally apply to all hedges): 1) The forecasted transaction must be identified, probable of occurring and present an exposure to foreign currency price changes. 2) Use of a forward contract to hedge must be consistent with company risk management policy, designated and documented in advance as intended as a hedge, and be highly effective as a hedge.

Hedging Foreign Currency Denominated Asset or Liability, Criteria for Designation:

Use of a forward contract, either an exchange contract or an option contract, to hedge a recognized asset or liability requires that: 1) The asset or liability is denominated in a foreign currency and has already been booked (recognized). 2) The gain or loss on the hedged asset or liability must be recognized in earnings.

Hedging Foreign Currency Denominated Available-for-Sale Security, Criteria for Designation:

Use of a forward contract, either an exchange contract or an option contract, to hedge an available-for-sale investment requires that: a) The securities being hedged must be identified and must not be traded in the investor's currency. b) The forward contract must be designated and highly effective as a hedge of the investment, and in an amount that does not exceed the amount of the investment being hedged. (To the extent the amount of the forward contract exceeds the investment, the forward contract is treated as speculation, not a hedge.)

Hedging Foreign Investment in Foreign Operations, Criteria for Designation:

Use of a hedge instrument (e.g., borrowing or derivative contract) to hedge a net investment in a foreign operation requires that the contract be designated as a hedge of the net investment and be highly effective. The FASB classified this type of hedge as a fair value hedge because the changes in the value of the foreign investment (foreign investment using the equity method or foreign subsidiary to be consolidated). It is not classified as a cash flow hedge because it is highly unlikely that the investor will be liquidating its foreign investment to create a cash flow risk.

List the criteria for designation of hedging investments in foreign operations.

Use of hedge instrument to hedge net investment in foreign operation requires the contract be designated as a hedge of net investment and be highly effective as an economic hedge.

A foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating:

Wages Expense: Yes Sales to Customers: Yes Since the functional currency is the local currency, the income statement of the subsidiary would be converted using translation, which requires the use of the exchange rate when a revenue/gain was earned or expense/loss was incurred, or the weighted average exchange rate for the year. Therefore, the weighted average exchange rate for the current year would be an appropriate rate for converting both wages expense and sales to customers.

A subsidiary's functional currency is the local currency which has not experienced significant inflation. The appropriate exchange rate for translating the depreciation on plant assets in the income statement of the foreign subsidiary is the:

Weighted average exchange rate for the current year. The weighted average exchange rate for the current year is the correct rate to use to convert depreciation expense. Since the functional currency is the local currency, the income statement of the subsidiary would be converted using translation, which requires the use of the exchange rate when a revenue/gain was earned or expense/loss was incurred, or the weighted average exchange rate for the year. Since depreciation expense is incurred throughout the year, the weighted average exchange rate normally is the appropriate basis for conversion.

Define "foreign currency transaction".

When a domestic entity engages in a transaction with a foreign entity and the transaction is denominated in (i.e., to be settled in) a foreign currency.

When does Functional Currency = Another Foreign Currency?

When a foreign entity generates most of its cash flows in currency of another foreign country or when it is required to use another currency by law or contact.

Speculation Criteria for, and Nature of, Designation

When a forward contract is used for speculation, there is no separate risk being hedged. The forward contract, and the resulting loss or gain stand alone. They are not intended to offset any existing exposure.

When does Functional Currency = (Local, foreign) Recording Currency?

When operations of the foreign entity are relatively selfcontained and integrated within the country in which it is located, and the economy of that country is not in hyperinflation.

The treatment of a hedge of a recognized asset or liability as either .

a cash flow hedge or a fair value hedge is determined by management

Gains and losses from foreign currency transactions are reported as

a component of income from continuing operations in the income statement.

Hedging the future receipt of a foreign currency would require

a contract to sell that foreign currency in the future.

If we have a payable denominated in the € and the dollar strengthens, since we have to pay a fixed amount of €s, and they are now worth fewer dollars, we have experienced

a gain on the liability. The gains or losses arising from transactions denominated in a foreign currency are foreign currency transaction gains or losses.

If an account payable denominated in a foreign currency is created and settled in the same fiscal period,

a gain or loss can result.

A foreign currency forward exchange contract establishes

a legal obligation to exchange currencies.

Hedge the risk of exchange rate changes reducing the dollar value of a receivable denominated (to be received) in a foreign currency, or the risk of exchange rate changes increasing the dollars required to settle a payable denominated (to be paid) in a foreign currency. For example,

a receivable denominated in a foreign currency will result in collection of a fixed number of foreign currency units, but the dollar value of those units will vary with changes in the exchange rate between that foreign currency and the dollar. A U.S. company could enter into a forward contract now to sell those foreign currency units when received in the future and thus hedge the receivable.

All inventory sold during the year and remaining on hand at year-end is assumed to have been

acquired from the parent evenly throughout the year.

The carrying value of an outstanding account balance denominated in a foreign currency (e.g. account payable) should be

adjusted at year-end using the spot rate at year-end.

If the financial statements of a foreign entity were prepared without being in conformity with U.S. GAAP, those statements must be

adjusted to U.S. GAAP before they are converted to dollars.

The carrying value of a forward contract which hedges a forecasted transaction should be

adjusted to fair value at the balance sheet date.

Forward exchange contracts are

agreements to exchange commodities in the future at an exchange rate set at the present.

Hedging does not eliminate

all possible losses.

The translated Balance Sheet does not balance (Assets = $12,750; liabilities + Equity = $12,070) until the translation adjustment is included. The amount of the translation adjustment is the

amount needed to make the Balance Sheet balance ($680). The $680 is "plugged."

Changes in the forward rate can result in

an increase in fair value (a gain) or a decrease in fair value (a loss).

When the translation process of converting financial statements is used, the amount of the translation adjustment is reported

as an item of "Other Comprehensive Income."

Since the remeasurement adjustment is recognized in net income, it is not shown

as an item of Other Comprehensive Income.

Hedging Foreign Currency Denominated Available-for-Sale Security: This treatment requires recognizing changes in the fair value of available-for-sale investments in net income, not in other comprehensive income

as otherwise would be required under GAAP.

Hedging Firm Commitments, Accounting Treatment (assuming a fair value hedge): To the extent the gain or loss on the forward contract does not exactly offset the loss or gain on the firm commitment (i.e., the de facto ineffectiveness of the hedge), there will

be a net gain or loss reported in current net income.

Hedging Foreign Investment in Foreign Operations, Accounting Treatment: The change in fair value (in dollars) of both the hedging instrument (e.g., a borrowing) and the change in the translated value of the balance sheet of the foreign entity (hedged item) should

be determined.

A forward exchange contract for speculative purposes that has not been settled at a balance sheet date should

be revalued as of the balance sheet date.

If a currency other than the recording currency or the reporting currency is the functional currency,

both the translation and the remeasurement processes will be used.

The financial statements denominated in the foreign currency could be those of a

branch, joint venture, partnership, equity investee or subsidiary of the domestic entity.

The functional currency of an entity is determined

by the primary economic environment of the entity.

When a forward contract hedges an available-for-sale investment, a net gain or loss

can be recognized for a period during which they both exist.

If the local foreign economy is highly inflationary, the local (recording) currency

cannot be the functional currency.

Hedging recognized assets or liabilities can be designated either as

cash flow hedges or as fair value hedges.

If the investor holds significant ownership (>20% for equity method) or control (>50%), the investor is not likely to frequently sell that foreign investment, therefore the risk is the changes in value - not the

cash flows from liquidating the investment. The unrealized gains and losses are classified in OCI to offset the translation adjustment associated with the conversion of the foreign investment.

Monetary items are those where value is fixed by contract Examples:

cash, accounts receivable, accounts payable, bonds and notes, etc.

A recognized asset or liability is at risk of loss from

changes in the currency exchange rate.

This payable or receivable presents a risk because of the

changes in the exchange rates before settlement.

The fair value of a forward exchange contract is determined by

changes in the forward (exchange) rate during the life of the contract, discounted to its present value.

As exchange gain or loss on a forward contract for speculative purposes would result from

changes in the forward rate.

Currencies are

commodities.

Hedging Forecasted Transactions, Accounting Treatment: To the extent the change in the value of the forward contract (the hedge) is effective in offsetting a decrease (loss) or an increase (gain) in the expected cash flow of the forecasted transaction, the gain or the loss should be deferred and reported as a

component of "other comprehensive income."

Any qualified hedge of a forecasted transaction is

considered a cash flow hedge for accounting purposes.

Hedging Firm Commitments, Accounting Treatment assuming a CASH FLOW HEDGE): The change in the fair value of the forward exchange contract, measured as the change in the forward exchange rate, should be recognized as an increase or decrease in the

contract carrying value with a corresponding loss or gain recognized.

The weighted average exchange rate is used to

convert revenues to the reporting currency when the functional currency is the local currency.

In converting financial statements using the translation process, dividends declared by the foreign entity would be

converted at the exchange rate in effect when the dividends were declared.

If the local foreign (recording) currency of a foreign entity is its functional currency, its financial statements should be

converted to U.S. dollars using the translation process.

In converting financial statements using the translation process, paid-in capital items (common stock, additional paid-in capital, etc.) should be

converted using the exchange rate in effect when the investor acquired the entity.

Hedging Foreign Currency Denominated Available-for-Sale Security, Accounting Treatment: The change in fair value of the forward contract (the hedge), measured as the change in the forward exchange rate, should be recognized as an increase or decrease in the carrying value of the forward contract with a

corresponding gain or loss in net income.

Hedging Foreign Currency Denominated Available-for-Sale Security, Accounting Treatment: The change in fair value of the investment (the hedged item), measured as the change in market value, should be recognized as an increase or decrease in the carrying value of the investment with a

corresponding gain or loss in net income.

A foreign currency transaction is when a transaction is denominated in a

currency other than the domestic currency.

A spot exchange rate is a

current exchange rate.

The translation process of converting financial statement applies

current exchange rates to most accounts on the balance sheet of the foreign entity.

Hedging Forecasted Transactions, Accounting Treatment: To the extent the change in the value of the forward contract (the hedge) is ineffective in offsetting the change in the expected cash flow of the forecasted transaction (i.e., to the extent the changes in the forward contract and the expected cash flow are different), that amount of loss or gain should be reported in

current income.

In summary, all gains and losses on derivative instruments held for speculative purposes or treated as for speculative purposes are recognized in

current income.

Convert Foreign Currency Units (FC units) to Functional Currency Units ($) using spot exchange rate at

date of transaction.

Common stock is remeasured at the exchange rate in effect the

day the stock was issued (since the parent created the Sub).

The effective portion of a hedge of a forecasted transaction should be

deferred and reported as an item of "Other Comprehensive Income."

Hedge the obligation incurred when a purchase order is placed with a foreign entity to manufacture and deliver equipment with payment to be made in a specified amount of foreign currency. The buying party has a contractual obligation to "take and pay" on delivery of the equipment, but under GAAP will not record the obligation until the equipment is

delivered.

Both foreign currency forward exchange contracts and foreign currency option contracts are

derivative instruments.

The dollar value of an outstanding account balance denominated in a foreign currency must be

determined at the settlement date.

The remeasurement process of converting financial statements applies

different currency exchange rates to monetary items (accounts) than to nonmonetary items.

The amount needed to make the Balance Sheet (expressed in Dollars) balance is the amount of the Translation Adjustment. .Under Translation (method of converting) the Translation Adjustment

does NOT enter into determination of Net Income, but is treated as "Other Comprehensive Income" for reporting purposes.

The benefit of a FCO (over a FXFC) is that if changes in the exchange rate do not warrant it, the contract

does not have to be exercised; therefore, only the option premium (cost) is incurred.

A U.S. entity acquires an option (right) to buy euros but

does not have to buy the euros.

Beginning Retained Earnings is the

dollar value at the end of the prior year.

After all items on the financial statements of the foreign entity have been remeasured appropriately to financial statements expressed in dollars, the

dollar-based balance sheet will not balance without the remeasurment adjustment.

Foreign currency conversion occurs when a domestic (U.S.) entity must convert financial statements denominated (expressed) in a foreign currency into their

domestic (dollar) equivalents.

Dividends are translated at the exchange rate in

effect on the date of declaration.

Accounting for both foreign currency forward exchange contracts and foreign currency option contracts is

essentially the same.

A subsidiary of a company in the United States is in England. The subsidiary functions in the euro. The local currency is the British pound, the functional currency is the

euro, and the reporting currency is the U.S. dollar. The financial statements would be remeasured from the British pound to the euro and then translated from the euro to the U.S. dollar.

All revenue (sales) and expense items were assumed to have occurred

evenly throughout the year.

Revenues (sales) are assumed to have occurred

evenly throughout the year.

A forward exchange contract requires the parties to the contract to

exchange currencies at the maturity of the contract (or to otherwise settle the contract).

If the option is exercised, there is an

exchange of currencies.

Dividends are remeasured at the

exchange rate in effect on the date of declaration.

Fixed assets and Depreciation expense are translated at the

exchange rate in effect when the fixed assets were acquired.

Forward contracts can be used for speculative purposes. In this case, there is no

existing obligation (to pay or receive a foreign currency) being hedged, rather the forward contract is entered into to make money.

All derivative instruments are adjusted to and reported at

fair value.

The risk on an investment in a foreign operation derives from using changing exchange rates to convert

financial statement accounts from the foreign currency to the domestic currency.

U.S. generally accepted accounting principles must be applied to

financial statements of a foreign entity which are to be translated into U.S. dollars.

Under an FXFC contract, the obligation to buy or sell is

firm; the exchange must occur.

When a forward contract hedges a firm foreign currency commitment, a net gain or loss can be recognized

for a period during which they both exist.

The domestic entity will ultimately pay or receive a

foreign currency.

At the inception of a forward contract, it typically has no value (there has been no change in the forward rate); changes in value (and gains or losses) occur as the

forward rate changes.

A foreign currency other than the recording currency =

functional currency.

Hedging Foreign Investment in Foreign Operations, Accounting Treatment: To the extent the change in fair value (in dollars) of the hedging instrument is greater than the change in the translated balance sheet, the excess (of change in the hedging instrument) is recognized as a

gain and reported in current net income.

Hedging Firm Commitments, Accounting Treatment (assuming a fair value hedge): The change in fair value of the forward contract (the hedging instrument), measured as the change in the forward exchange rate, should be recognized as an increase or decrease in the carrying value of the forward contract with a corresponding

gain or loss recognized in net income.

Changing fair value of derivatives result in

gains and losses.

A recognized asset or liability is one that

has been recorded on a firm's books.

Any derivative that does not meet the requirements to qualify as a hedging instrument would be treated as

held for speculative purposes.

The functional currency of a foreign entity determines

how its financial statements should be translated.

Hedge the risk of exchange rate changes on the (dollar) fair value of an investment in debt or equity securities held available for sale that will be settled

in (sold for) a foreign currency.

A hedge of a net investment in a foreign operation is classified as a fair value hedge, but the effective gains and losses are recorded

in OCI, similar to the accounting for a cash flow hedge.

A firm can hedge an investment

in a foreign subsidiary.

Gains and losses on forward contracts for speculative purposes are recognized

in the period(s) in which the forward exchange rate changes.

Hedging Forecasted Transactions, Accounting Treatment: The change in the fair value of the forward exchange contract, measured as the change in the forward exchange rate, should be recognized as an

increase or decrease in the contract carrying value with a corresponding loss or gain recognized.

Foreign currency translation is concerned with converting financial statements expressed in one currency

into comparable financial statements expressed in another currency.

A transaction denominated in a foreign currency should be converted to

its dollar equivalent using the spot exchange rate.

The reason for entering into a forward contract for speculative purposes is to

make a profit.

Hedging is a strategy for

managing risk.

The dollar value of a transaction to be settled in a foreign currency

may change over time.

At the date a foreign currency transaction is initiated, it should be

measured and recorded at the dollar value to settle the transaction at that date.

The risk of exchange rate changes on recognized assets or liabilities can be

mitigated through hedging.

In order for a forward contract to qualify as a hedge of a foreign currency commitment, the commitment

must be firm.

Hedging Foreign Currency Denominated Available-for-Sale Security, Accounting Treatment: To the extent the gain or loss on the forward contract does not exactly offset the loss or gain on the investment (i.e., the de facto ineffectiveness of the hedge), there will be a

net gain or loss reported in current net income.

If the change in fair value of an instrument which hedges a net investment in a foreign operation is equal to or less than the change in fair value of the net investment being hedged, the two changes will be

netted against each other to get the translation adjustment gain or loss for the period.

An investment in a foreign operation is

not at risk from exchange rate change.

In converting financial statements using the translation process, the retained earnings balance expressed in the foreign currency is

not converted using an exchange rate.

The preliminary translated Balance Sheet does not balance (assets = $12,478; Preliminary Liabilities + Equity = $12,095). The difference ($383) is

not reported as a Remeasurement Adjustment in Shareholders' Equity.

Speculation, Accounting Treatment: The forward exchange contract is measured (valued) and recorded at the forward exchange rate (quoted now) for exchanges that will

occur at the maturity date of the contract.

The U.S. dollar can be the functional currency

of a foreign entity.

When derivatives are used for hedging purposes, gains and losses on those derivatives serve to

offset losses or gains on the hedged item.

Hedging Foreign Investment in Foreign Operations, Accounting Treatment: To the extent the change in fair value (in dollars) of the hedging instrument is equal to, or less than, the change in the translated balance sheet, both changes enter into the cumulative translation adjustment (an item of other comprehensive income) as

offsets to each other.

A foreign currency transaction will be recorded

on the books of a U.S. entity in dollars.

You would "hedge a bet" by offsetting a possible loss from betting on one team (to win) by betting

on the other team to win.

Under an FCO contract, the party holding the option has the right (option) to buy or sell, but does not have to exercise that option. The exchange will occur at the

option of the option holder.

A gain or loss on a forward contract entered into as a cash flow hedge can be recognized

partly in current income and partly in other comprehensive income.

An unsettled foreign currency transaction creates a

payable or receivable in a foreign currency.

Amounts (losses and gains) deferred in "other comprehensive income" should be recognized in net income in the

period(s) in which the related forecasted transaction(s) affect net income.

A forecasted transaction is a

planned transaction.

A U.S. entity enters into a FXFC to pay a predetermined price in U.S. dollars for a

predetermined quantity of euros.

At the inception of a forward option contract, the buyer will pay a

premium (option premium) to the counter party for the right to buy from or sell to the counterparty according to the terms of the contract; the amount of the premium would be a function of the intrinsic value of the option and the "time value" factor.

If the U.S. dollar is the functional currency of a foreign entity, the financial statements of that entity are

prepared initially in the local foreign currency.

If a hedge of a recognized asset is designated as a fair value hedge, the full amount of any gain or loss on the hedge instrument will be

recognized in current net income.

A gain or loss that results from revaluing a forward exchange contract for speculative purposes should be

recognized in the income statement.

A gain or loss that results from revaluing a forward exchange contract which hedges an investment held available-for-sale should be

recognized in the income statement.

A gain or loss that results from revaluing a forward exchange contract which hedges the fair value of a firm foreign currency commitment should be

recognized in the income statement.

A gain or loss on a forward contract entered into as a hedge of a net investment in a foreign operation can be

recognized partly in other comprehensive income and partly in current income.

Speculation, Accounting Treatment: If a balance sheet date occurs between initiation of the contract and maturity (settlement) of the contract, the contract must be revalued (at the balance sheet date) by using the forward exchange rate quoted at that time for the maturity date of the contract. Any change between the balance sheet date value of the contract and the already

recorded value of the contract, will be recognized as a gain or loss in net income for the period.

A US entity may include in its annual budget the purchase of a major piece of equipment from a foreign entity to be paid in the foreign currency (a forecasted transaction); During the budget period, the US entity enters into a contract with a foreign entity to construct the equipment (an identifiable firm commitment); Upon receiving the equipment, the US entity

records the asset and the payable to the foreign entity (a recognized liability).

In order for the recording currency of a foreign entity to be its functional currency, the foreign entity must be

relatively self-contained and integrated within the country.

When the remeasurement process of converting financial statements is used, the amount of the translation adjustment is

reported in the income statement.

The effects of a change in exchange rates on a transaction denominated in a foreign currency can

result in a gain in one period and a loss in another period.

When an entity has an account payable denominated in a foreign currency, a change in the exchange rate can

result in either a gain or a loss.

A forward (exchange) contract which hedges a firm foreign currency commitment should be

revalued as of the balance sheet date.

A forward (exchange) contract which hedges an investment available-for-sale denominated in a foreign currency should be

revalued to fair value as of the balance sheet date.

A forward exchange option contract gives the holder of the contract the

right to buy (call option) or sell (put option) a foreign currency, but does not require the holder to do so.

You would hedge against a possible loss in the dollar value of a foreign currency to be received in the future by

selling that foreign currency now at a specified rate for delivery when you receive it in the future (a forward contract).

Transaction terms provide that the transaction will be

settled (by a domestic entity) in a foreign currency.

In order for a forward contract to qualify as a hedge of a forecasted transaction, the forecasted transaction must be

specifically identified and the forward contract designated to the forecasted transaction.

Common stock is translated at the exchange rate in effect the day the

stock was issued (since parent created the sub).

Even though a firm foreign currency commitment has not been booked, it is still

subject to the risk of exchange rate changes.

Speculation, Accounting Treatment: At the settlement date (maturity date of the contract), the contract must be revalued by using the spot (current) exchange rate for the maturity date of the contract. Any change between the settlement date value of the contract and

the already recorded value of the contract, will be recognized as a gain or loss in net income for the current period.

The amount needed to make a translated balance sheet balance is

the amount of the required translation adjustment.

The amount of a year-end adjustment to an outstanding account balance denominated in a foreign currency is measured as

the difference between the dollar value recorded on the books and the dollar value to settle the account at yearend.

The net gain or loss to be recognized on a foreign currency available-for-sale investment and a related hedge of the investment is

the difference in their changes in fair value for a period.

Example of Speculation: A U.S. entity enters into a forward contract to purchase euros in 180 days at a rate (forward rate) existing now in the belief that the existing forward rate is less than the spot rate will be in 180 days. To the extent the forward contract rate is less than the spot rate on the date the contract expires,

the entity would make a gain. (Of course, if the spot rate at expiration is less than the forward contract rate, the entity would incur a loss.)

If the change in fair value of an instrument which hedges a net investment in a foreign operation is greater than the change in fair value of the net investment being hedged,

the excess will be recognized as a gain in net income for the period.

In recording the purchase of a forward contract for speculative purposes,

the forward exchange rate should be used.

A currency other than the recording currency or the reporting currency can be

the functional currency for a foreign entity.

Hedging Firm Commitments, Accounting Treatment assuming a CASH FLOW HEDGE): To the extent the change in the value of the forward contract (the hedging instrument) is effective in offsetting a decrease (loss) or an increase (gain) in the expected cash flow of the firm commitment, the gain or

the loss should be deferred and reported as a component of "other comprehensive income."

The determination of the fair value of a forward exchange option contract depends on

the market in which the option is traded, if any.

FCO contracts are significantly more costly to execute than FXFC contracts because

the option must be purchased by paying an option premium to the counterparty for the right to buy or sell the currency.

The functional currency of an entity is determined by

the primary economic environment of the entity.

The current exchange rate as of the balance sheet date is

the spot exchange rate at that date.

When a forward contract is entered into for speculative purposes,

there is no separate risk being hedged.

Different hedging purposes may apply

to a sequence of accounting-related events.

Hedging Firm Commitments, Accounting Treatment assuming a CASH FLOW HEDGE): To the extent the change in the value of the forward contract (the hedging instrument) is ineffective in offsetting the change in the expected cash flow of the firm commitment (i.e.,

to the extent the changes in the forward contract and the expected cash flow are different), that amount of loss or gain should be reported in current income.

If an investor accounts for an investment in a foreign entity using the equity method (because it has significant influence), the investor likely will need

to translate the financial statements of the foreign entity.

This contract is an "exchange" because the contract provides for

trading (exchanging) one currency for another currency.

"Accumulated Other Comprehensive Income" (including the Accumulated Translation Adjustment) is reported as an item in Shareholders' Equity in the

translated ($) Balance Sheet.

Hedging generally involves

two transactions for which a loss on one would be offset at least in part by a gain on the other.

A firm can mitigate the risk of exchange rate changes on recognized accounts receivable and accounts payable denominated in a foreign currency without

using hedge accounting.

A foreign currency transaction is a transaction that

will be settled in a foreign currency.

A U.S company buys goods from a Japanese company and agrees to pay for the goods with yen, rather than dollars. In this case, the transaction is denominated in yen, but the amount recorded on the books of the U.S. entity is measured in U.S. dollars; therefore, the transaction amount must be converted from

yen to dollars.

In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, the foreign subsidiary's functional currency is the currency:

Of the environment in which the subsidiary primarily generates and expends cash. By definition (SFAS #52), an entity's functional currency is the currency of the primary economic environment in which the entity operates. Normally, that is the currency of the environment in which the entity primarily generates and expends cash.

Which one of the following is most likely a foreign currency import transaction by a U.S. company?

Purchase of goods to be paid in a foreign currency. The purchase of goods by a U.S. entity would most likely reflect an import transaction and, since it is to be settled in a foreign currency, would be a foreign currency import transaction.

Which of the following is not associated with the general principles of accounting for foreign currency operating transactions?

Gains and losses are deferred until transactions are settled. Gains and losses on foreign currency operating transactions that result from changes in currency exchange rates are not deferred. Such gains and losses must be recognized in current income of the period in which the currency exchange rate changes.

Soco plans to buy 100,000 Euros with U.S. dollars. The exchange rate is $1.00 = 0.75 Euro. Assuming no transaction cost, how much will Soco have to pay in dollars (rounded) for 100,000 Euros?

If $1.00 will buy 0.75 Euro, then 0.75E = $1.00, and E = $1.00/0.75, or E = $1.33. So, one Euro will cost $1.33; therefore, 100,000 E x $1.33 = $133,333.

A strengthening or weakening dollar means that the dollar buys

more or less of the foreign currency. It also means we receive less or more of the foreign currency owed to us.

The effects of a change in currency exchange rates on an outstanding account balance (e.g. account payable) should be

recognized as a gain or loss for the period.

Define "exchange rate".

The price of one unit of a country's currency expressed in units of another country's currency.

Determine (New) Dollar amount to Settle currently by: Dollar amount at balance sheet date

#FC Units × by Balance Sheet Date Spot Exchange Rate

Determine (New) Dollar amount to Settle currently by: Dollar amount to settle.

#FC Units × by Settlement Date Spot Exchange Rate

On November 15, 20X5, Celt Inc., a U.S. company, ordered merchandise FOB shipping point from an East German company for 200,000 marks. The merchandise was shipped and invoiced to Celt on December 10, 20X5. Celt paid the invoice on January 10, 20X6. The spot rates for marks on the respective dates are as follows: November 15, 20X5 $.4955 December 10, 20X5 .4875 December 31, 20X5 .4675 January 10, 20X6 .4475 In Celt's December 31, 20X5, income statement, the foreign exchange gain is:

$4,000 Cash or amounts owed by or to a company that are denominated in a foreign currency be translated at the current rate with a gain or loss being recognized. Recognition is based on the change in the spot rate between the recording of the transaction and the date of the financial statements. The other critical date is the date at which the transaction became an amount owed by or to the company. This occurs at the transfer of title date of December 10, 20X5. Any change before that date is an adjustment in the cost of the merchandise. This correctly picks up the gain as the change between when the debt was established and the balance sheet date.

(500,000 x .75 = 375,000). DR: Inventory $375,000 CR: Accounts Payable (FC) $375,000

At Balance Sheet Date, If Before Settlement Date Record Difference As:

-- Adjustment to Recorded Account Balance (Receivable/Payable), and -- Loss or Gain for the Period. Report Loss or Gain in Current-Period Income Statement as Component of Income from Continuing Operations.

On November 15 a U.S. Co. purchases equipment from Foreign Co. for 500,000 units of Foreign currency (500,000 FC) with the full amount payable on January 31. The exchange rates are as follows: November 15 1 FC = $.75 (direct quotation) December 31 1 FC = $.74 January 31 1 FC = $.76 January 31: It will now take more dollars to settle the obligation in FC. Below are the following entries to: 1) record the change in the exchange rate from December 31 to January 31 (500,000 x (.74 - .76) = 10,000), 2) the purchase of the FC (500,000 x .76 = 380,000), and 3) settle the Accounts Payable in FC.

1) DR: Foreign currency transaction G/L (IS) $10,000 CR: Accounts Payable (FC) $10,000 2) DR: Investment in FC $380,000 CR: Cash $380,000 3) DR: Accounts Payable (FC) $380,000 CR: Investment in FC $380,000

Determine Difference between Recorded Dollar amount to Settle and New (current) Dollar amount to Settle at settlement date. Record Difference as

1) Adjustment to Recorded Receivable/Payable; 2) Exchange Loss or Gain.

IF THE DOLLAR STRENGTHENS: from to indirect $1.00 = 0.80 € $1.00 = 0.909 € direct $1.25 = 1 € $1.10 = 1 €

1) It will take fewer U.S. dollars to acquire one unit of foreign currency. 2) Imports become less expensive to the U.S. 3) U.S. exports become more expensive to the foreign country.

IF THE DOLLAR WEAKENS: from to indirect $1.00 = 0.80 € $1.00 = 0.625 € direct $1.25 = 1 € $1.60 = 1 €

1) It will take more U.S. dollars to acquire one unit of foreign currency (€ = foreign currency unit). 2) Imports become more expensive to the U.S. 3) U.S. exports become less expensive to the foreign country.

Recognize the effects of exchange rate changes:

1) On accounts denominated in a foreign currency (e.g., Receivables/Payables); 2) In the period in which the exchange rate changes; 3) As adjustment to account balance, and as exchange loss or gain.

On December 15 a U.S. Co. sells goods to a Foreign Co. for 500,000 units of Foreign Currency (500,000 FC) with the full amount payable on January 15. The exchange rates are as follows: December 15 1 FC = $.75 (direct quotation) December 31 1 FC = $.72 January 15 1 FC = $.74 January 31: When 1 FC is received it is worth more dollars. Below are the following entries to: 1) record the change in the exchange rate (500,000 x (.72 - .74) = 10,000), 2) the receipt of the FC to settle the account receivable (500,000 x .74 = 370,000), and 3) convert the FC to dollars.

1. DR: Accounts Receivable (FC) $10,000 CR: Foreign currency transaction G/L (IS) $10,000 2. DR: Investment in FC $370,000 CR: Accounts Receivable (FC) $370,000 3. DR: Cash $370,000 CR: Investment in FC $370,000

On October 1, 20X2 we agreed to sell goods with the receivable to be paid in euros on February 1, 20X3, for 1 FC worth of merchandise. The exchange rates are as follows: Transaction date: October 1 $2.00 = 1 FC Balance sheet date: December 31 $1.00 = 1 FC Settlement date: February 1 $3 = 1 FC February 1: The FC is now worth $3. Below are the following entries to: 1) record the change in the exchange rate, 2) the receipt of FCs, and 3) convert the FCs to dollars.

1. DR: Accounts Receivable (FC) $2 CR: Foreign currency transaction G/L (IS) $2 2. DR: Investment in FC $3 CR: Accounts receivable (FC) $3 3. DR: Cash $3 CR: Investment in FC $3

What is the general rule for handling a foreign currency denominated account that is outstanding as of a balance sheet date?

What are the general rules for treatment of a foreign currency operating transaction?

1. Measure and record the transaction on books in terms of the functional currency; 2. Convert foreign currency units to functional currency units using the spot exchange rate; 3. Recognize the effect of exchange rate changes as gains/losses in period of exchange rate change.

On October 1 of the current year, a U.S. company sold merchandise on account to a British company for 2,000 pounds (exchange rate, 1 pound = $1.43). At the company's December 31 fiscal year end, the exchange rate was 1 pound = $1.45. The exchange rate was $1.50 on collection in January of the subsequent year. What amount would the company recognize as a gain (loss) from foreign currency translation when the receivable is collected?

A foreign currency exchange gain will be recognized for the change in exchange rate between December 31 and the January collection date. That gain is computed as $1.45 ‐> $1.50 = $0.05 x 2,000 pounds = $100 gain.

On October 1, 2004, Velec Co., a U.S. company, contracted to purchase foreign goods requiring payment in francs one month after their receipt at Velec's factory. Title to the goods passed on December 15, 2004. The goods were still in transit on December 31, 2004. Exchange rates were one dollar to 22 francs, 20 francs, and 21 francs on October 1, December 15, and December 31, 2004, respectively. Velec should account for the exchange rate fluctuation in 2004 as:

A gain included in net income before extraordinary items. Foreign exchange gains and losses on monetary receivables and payables are recognized as part of ordinary operations, not as an extraordinary item. Exchange rate fluctuations cause these to be an everyday occurrence. The second part of this problem is when to start recording the gain or loss. Until the title passed, no payable existed on the books, and therefore no exchange rate gains or losses would have been recorded. Only when title passes does the liability exist on the books. Therefore, there is an exchange rate gain because the rate changed from 20 Fr./$1 to 21 Fr./$1. We can pay our franc debt with fewer dollars on December 31, 2004, than we could have on December 15, 2004. Thus, this is the correct response.

Which of the following is not associated with accounting for a foreign currency import transaction?

A settlement amount greater than the recorded amount results in an exchange gain. Because an import transaction normally results in a liability to the buyer (importer), a settlement amount (of the liability) greater than the current carrying amount of the liability will result in an exchange loss, not an exchange gain.

At Date Transaction Initiated: Translate Transaction into Dollars using Current Spot Exchange Rate

At Balance Sheet Date, If Before Settlement Date : Determine Dollar Amount to Settle Transaction at Balance Sheet Date (Settlement Amount) At Date Transaction Is Settled: Determine Dollar Amount to Settle Transaction (Settlement Amount).

A December 15, 20X8, purchase of goods was denominated in a currency other than the entity's functional currency. The transaction resulted in a payable that was fixed in terms of the amount of foreign currency and was paid on the settlement date, January 20, 20X9. The exchange rate of the currency in which the transaction was denominated changed at December 31, 20X8, resulting in a loss that should:

Be included as a component of income from continuing operations for 20X8. The foreign currency exchange loss that occurred as a result of the exchange rate change in 20X8 should be recognized in 20X8 as a component of income from continuing operations in the income statement. Gains and losses resulting from changes in exchange rates are recognized in current earnings in the period in which the exchange rate changes.

On October 1, 20X4, Mild Co., a U.S. company, purchased machinery from Grund, a German company, with payment due on April 1, 20X5. If Mild's 20X4 operating income included no foreign exchange transaction gain or loss, then the transaction could have:

Been denominated in U.S. dollars. If the transaction was denominated in U.S. dollars, there is no foreign exchange gain or loss for Mild. (There would be a gain or loss for Grund.)

Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one month after the goods were received at Fogg's warehouse. Between the receipt of goods and the time of payment, the exchange rates changed in Fogg's favor. The resulting gain should be included in Fogg's financial statements as a(an):

Component of income from continuing operations. The foreign currency exchange gain that occurred as a result of the exchange rate change should be recognized as a component of income from continuing operations in the income statement. Gains and losses resulting from changes in exchange rates are recognized in current earnings in the period in which the exchange rate changes.

On October 1, 20X2 we entered into a transaction to purchase goods payable in a Foreign Currency (FC) on January 31, 20X3. The purchase was for 1 FC worth of merchandise. The exchange rates are as follows: Transaction date: October 1 $2.00 = 1 FC (direct quotation) Balance sheet date: December 31 $1.00 = 1 FC Settlement date: January 31 $1.50 = 1 FC December 31: The FC is worth $1. The change in the exchange rate is recorded.

DR: Accounts Payable (FC) $1 CR: Foreign currency transaction G/L (IS) $1 Note: Foreign currency transaction gain/loss (G/L could be a debit (loss) or credit (gain) depending on the changes in the exchange rates. Also, this account is recognized in earnings on the Income Statement (IS).

On October 1, 20X2 we agreed to sell goods with the receivable to be paid in euros on February 1, 20X3, for 1 FC worth of merchandise. The exchange rates are as follows: Transaction date: October 1 $2.00 = 1 FC Balance sheet date: December 31 $1.00 = 1 FC Settlement date: February 1 $3 = 1 FC October 1: The entry to record the sale at the current exchange rate.

DR: Accounts Receivable (FC) $2 CR: Sales $2

DR: Inventory $2 CR: Accounts Payable (FC) $2

Domestic Currency Weakens, Accounts Receivable Denominated in Foreign Currency:

Exchange Gain

Domestic Currency Strengthens, Accounts Receivable Denominated in Foreign Currency

Exchange Loss

Domestic Currency Weakens, Accounts Payable Denominated in Foreign Currency

Exchange Loss

On December 31, 20X8, the end of its fiscal year, Domco had a foreign currency account payable with a settlement amount greater than its previously recorded carrying amount. Which one of the following would Domco recognize for 20X8?

Exchange loss Since the foreign currency account payable had a settlement amount greater than its previously recorded carrying amount, Domco would have to recognize the change in settlement amounts in the period in which the settlement amount changed—20X8. Specifically, since the amount to settle the account payable increased during 20X8, Domco would have to recognize an exchange loss ‐ it will take more dollars to acquire the foreign currency needed to settle the account.

Define "foreign currency translation".

Financial statements denominated in (expressed in terms of) a foreign currency but to be reported in the domestic currency (on financial statements).

Introduction and Definitions Results 10/2/2016 Question 1 AICPA.921110FAR-TH-FA During 2004, Peg Construction Co. recognized substantial gains from: An increase in value of a foreign customer's remittance caused by a major foreign currency revaluation. A court‐ordered increase in a completed long‐term construction contract's price due to design changes. Should these gains be included in continuing operations or reported as an extraordinary item in Peg's 2004 income statement?

Gain from major currency revaluation: Continuing operations Gain from increase in contract's price: Continuing operations Any company that deals with international customers and suppliers will, in the ordinary course of business, have gains and losses on changes in the relative values of the various currencies. These gains and losses must, therefore, be counted as ordinary income from continuing operations. The court ordered increase in the construction contract presents a little different problem. Changes in contract price due to design changes is a very ordinary factor in the construction business and definitely ordinary income. However, most of these are not court ordered but handled in the ordinary course of business. A court ordered settlement, if material, may need to be separated out from the normal operations. Still lawsuits are not unusual in today's business environment so it would still not qualify for extraordinary treatment (both unusual and infrequent). It may be considered as part of 'other revenue and expenses' but this is still part of income from continuing operations making this response correct.

Which one of the following sets correctly identifies the relationship between a recorded amount and a related settlement amount that will result in an exchange gain on an import transaction and an exchange loss on an export transaction?

Gain on Import Transaction: Recorded > Settlement Loss on Export Transaction: Recorded > Settlement A gain on an import transaction would occur when the recorded amount is greater than the settlement amount, and a loss on an export transaction would occur when the recorded amount is greater than the settlement amount. An import transaction will result in a payable. A gain on a foreign currency payable would occur when the settlement amount is less than the recorded amount. An export transaction will result in a receivable. A loss on a foreign currency receivable would occur when the recorded amount is greater than the settlement amount.

Can a gain or loss on a foreign currency import transaction be recognized if the transaction is initiated in one fiscal period and settled:

In the same fiscal period: Yes In a later fiscal period: Yes A gain or loss on a foreign currency import transaction can be recognized if the transaction is initiated in one fiscal period and settled in either the same fiscal period or a later fiscal period. The effect of exchange rate changes on accounts denominated in a foreign currency should be recognized in the period(s) in which the exchange rate changes. Therefore, if such an account (e.g., account payable) exists in more than one period, the effects of exchange rate changes in either or both periods would result in the recognition of a gain or loss in either or both periods.

It will now take fewer dollars to settle the obligation in FC. (500,000 x (.75 - .74)) = 5,000 DR: Accounts Payable (FC) $5,000 CR: Foreign currency transaction G/L (IS) $5,000

On October 1, 20X8, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB‐Destination on December 1, 20X8, with payment by Pronto on January 30, 20X9. The following dollar cost per Euro exchange rate information was available: Spot Rate Forward Rate for December 1 Forward Rate for December 31 Forward Rate for January 30 October 1 $1.30 $1.29 $1.28 $1.27 December 1 $1.29 ‐ $1.28 $1.27 December 31 $1.28 ‐ ‐ $1.27 January 30 $1.27 ‐ ‐ ‐ Which of the following is the amount (rounded) of the exchange gain or loss that RWB Co. should recognize in 20X8 as a result of its sale to and receivable from Pronto?

The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 1, the date of the sale, and December 31, the end of 20X8, and getting the difference. That calculation would be (300,000E × $1.29 = $387,000) - (300,000E × $1.28 = $384,000) = $3,000.

On October 1, 20X8, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB‐Destination on December 1, 20X8, with payment by Pronto on January 30, 20X9. The following dollar cost per Euro exchange rate information was available: Spot Rate Forward Rate for December 1 Forward Rate for December 31 Forward Rate for January 30 October 1 $1.30 $1.29 $1.28 $1.27 December 1 $1.29 ‐ $1.28 $1.27 December 31 $1.28 ‐ ‐ $1.27 January 30 $1.27 ‐ ‐ ‐ Which of the following is the amount (rounded) of the exchange gain or loss that RWB Co. should recognize in 20X9 as a result of its sale to and receivable from Pronto?

The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 31, the end of 20X8, and January 30, the settlement date, and getting the difference. That calculation would be (300,000E × $1.28 = $384,000) - (300,000E × $1.27 = $381,000) = $3,000.

Define "functional currency".

The currency of the primary economic environment in which an entity operates and generates cash flows.

Forward rate:

The number of units of one currency that would be exchanged for units of another currency at a specified future point in time.

A sale of goods was denominated in a currency other than the entity's functional currency. The sale resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. Exchange rates between the functional currency and the currency in which the transaction was denominated changed so that a loss was incurred. The loss should be included as a:

Transaction loss reported as a component of income from continuing operations. The event described is a foreign currency (FC) transaction, not FC translation, and the loss (or gain) would be reported as a component of income from continuing operations for the current period.

Define "foreign currency transactions".

Transactions of a domestic entity denominated in a foreign currency but to be recorded on the domestic entity's books in the domestic currency.

When 1 FC is received, it is worth fewer dollars. (500,000 x (.75 - .72)) = 15,000 DR: Foreign currency transaction G/L (IS) $15,000 CR: Accounts Receivable (FC) $15,000

On September 22, 20X5, Yumi Corp. purchased merchandise from an unaffiliated foreign company for 10,000 units of the foreign company's local currency. On that date, the spot rate was $.55. Yumi paid the bill in full on March 20, 20X6, when the spot rate was $.65. The spot rate was $.70 on December 31, 20X5. What amount should Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, 20X5?

When a monetary obligation in a foreign currency exists, all gains and losses reflective of changes in exchange rates are recognized in current income. The loss would be based on the rate at initiation and the rate at year end. (The recovery in the next period would be treated as a gain in that period.) The loss is $1,500 [($.55 - $.70)10,000].

If a fiscal period ends between the date a foreign currency transaction is initiated and when it is settled, the outstanding account balance (e.g. account receivable) must be

FAR - C8 - Foreign Currency Denominated Transactions

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