1. 5
Accounting for Foreign Currency Transactions and Hedging Foreign Exchange Risk

2. Foreign Currency Transactions
Many Country companies engage in international activities such as:
Exporting or importing goods,
Establishing a foreign branch, or
Holding an equity investment in a foreign company.

3. Foreign Currency Transactions
Recording and reporting problems with foreign currency transactions:
Transactions in a foreign currency must be translated before they can be aggregated with domestic transactions.
Receivables or payables denominated in foreign currencies are subject to gains and losses.
Companies use hedging strategies with derivatives to minimize the impact of exchange rate changes.

4. Exchange Rates—Means of Translation
Translation - process of expressing amounts stated in a foreign currency in the currency of the reporting entity by using an appropriate exchange rate.
Exchange rate - ratio between a unit of one currency and another currency for which that unit can be exchanged at a particular time.

5. Exchange Rates—Means of Translation
Direct Exchange Rate
Units of domestic currency that can be converted into one unit of foreign currency.
Direct rate = ($1.517 U.S. for 1 British pound)
Indirect Exchange Rate
Units of foreign currency that can be converted into one unit of domestic currency.
Indirect rate = 1.00/1.517 = ($1 U.S. for British pound)

6. Exchange Rates—Means of Translation
Spot Rate
Rate at which currencies can be exchanged today.
Forward or Future Rate
Rate at which currencies can be exchanged at some future date.
Forward Exchange Contract
Contract to exchange currencies of different countries on a stipulated future date, at a specified rate (the forward rate).

7. Exchange Rates—Means of Translation
Floating Rates
Relationship between major currencies is determined by supply and demand factors.
Increase risk to companies doing business with a foreign company.
Example – Payable to be settled in 100,000 yen

8. Measured Versus Denominated
Transactions are normally measured and recorded in terms of the currency where the company is located.
Reporting Currency - usually the currency where the company located.
Transaction between a U.S. firm and a foreign company:
Companies negotiate whether settlement is to be made in dollars or in the foreign currency.
If settled by foreign currency, U.S. firm measures the receivable or payable in dollars, but the transaction is denominated in the foreign currency.
LO 1 Measured versus denominated.

9. Foreign Currency Transactions
Foreign Currency Transaction - requires payment or receipt (settlement) in a foreign currency.
U.S. firm exposed to risk of unfavorable changes in the exchange rate.
Direct exchange rate increasing, or foreign currency unit strengthening.
More dollars needed to acquire the foreign currency units. =
Direct exchange rate decreasing, or foreign currency unit weakening.
Fewer dollars needed to acquire the foreign currency units. =
LO 2 Foreign Currency Transactions.

10. Foreign Currency Transactions
Importing or Exporting of Goods or Services
Translating Accounts Denominated in Foreign Currency
Balance sheet date
Settlement date
Transaction date
Units of foreign currency x Current direct exchange rate
Increase or decrease is generally reported as a foreign currency transaction gain or loss, sometimes referred to as an exchange gain or loss, in determining net income for the current period.
LO 3 Common transactions.
LO 4 Three stages of concern.

11. Importing and Exporting Transactions
Exercise 2 During December of the current year, Teletex Systems, Inc., a company based in Seattle, Washington, entered into the following transactions:
Dec. 10 Sold seven office computers to a company located in Colombia for 8,541,000 pesos. On this date, the spot rate was 365 pesos per U.S. dollar.
Inventory delivered
12/10/2015
U.S. firm (Teletex)
Columbia firm
8,541,000 pesos
received on 1/10/2016
LO 3 Common transactions.
LO 4 Three stages of concern.

12. Importing and Exporting Transactions
Exercise 2 Dec. 10, Sold seven office computers to a company located in Colombia for 8,541,000 pesos. On this date, the spot rate was 365 pesos per U.S. dollar. Prepare the journal entry on the books of Teletex Systems, Inc.
Accounts receivable 23,400
Sales 23,400
Sales price in pesos 8,541,000
Pesos per U.S. dollar /
Sales price in U.S. dollars $ 23,400
LO 3 Common transactions.
LO 4 Three stages of concern.

13. Importing and Exporting Transactions
Exercise 2 Prepare journal entry necessary to adjust the accounts as of December 31. Assume that on December 31 the direct exchange rates was Colombia peso $
Transaction loss
Accounts receivable 510
Receivable in pesos 8,541,000
Direct exchange rate to U.S. dollar $
Receivable in U.S. dollars $ 22,890
Balance in receivable 23,400
Transaction loss $
LO 3 Common transactions. LO 4 Three stages of concern.

14. Importing and Exporting Transactions
Exercise 2 Prepare journal entry to record settlement of the account on January 10. Assume that the direct exchange rate on the settlement date was Colombia peso $
Cash (8,541,000 x $.00320) 27,331
Accounts receivable ($23,400 - $510) 22,890
Transaction gain 4,441
LO 3 Common transactions. LO 4 Three stages of concern.

15. Importing and Exporting Transactions
Exercise 2 During December of the current year, Teletex Systems, Inc., a company based in Seattle, Washington, entered into the following transactions:
Dec. 12 Purchased computer chips from a Taiwan company. Contract was denominated in 500,000 Taiwan dollars. Direct exchange rate on this date was $.0391.
Inventory received
12/12/2015
U.S. firm (Teletex)
Taiwan firm
500,000 Taiwan dollars
paid on 1/10/2016
LO 3 Common transactions.
LO 4 Three stages of concern.

16. Importing and Exporting Transactions
Exercise 2 Dec. 12, Purchased computer chips from a company domiciled in Taiwan. The contract was denominated in 500,000 Taiwan dollars. The direct exchange spot rate on this date was $ Prepare the journal entry on the books of Teletex Systems, Inc.
Merchandising Inv./Raw Mat. 19,550
Accounts payable 19,550
Purchase price in Taiwan dollars 500,000
Direct exchange rate to U.S. dollar x $.0391
Purchase price in U.S. dollars $ 19,550
LO 3 Common transactions.
LO 4 Three stages of concern.

17. Importing and Exporting Transactions
Exercise 2 Prepare journal entry necessary to adjust the account as of December 31. Assume that on December 31 the direct exchange rates was Taiwan dollar $.0351.
Accounts payable 2,000
Transaction gain 2,000
Payable in pesos 500,000
Direct exchange rate to U.S. dollar $
Payable in U.S. dollars $ 17,550
Balance in payable 19,550
Transaction gain $ 2,000
LO 3 Common transactions. LO 4 Three stages of concern.

18. Importing and Exporting Transactions
Exercise 2 Prepare journal entry to record settlement of account on January 10. Assume that the direct exchange rate on the settlement date was Taiwan dollar $.0398.
Transaction loss 2,350
Accounts payable ($19,550 - $2,000) ,550
Cash (500,000 x $.0398) 19,900
LO 3 Common transactions. LO 4 Three stages of concern.

19. Importing and Exporting Transactions
Importing or Exporting of Goods or Services
Foreign currency transaction gains and losses are included in net income.
LO 3 Common transactions. LO 4 Three stages of concern.

20. Importing and Exporting Transactions
Hedging Foreign Exchange Rate Risk
Derivative Instrument - a financial instrument that provides the holder (or writer) with the right (or obligation) to participate in some or all of the price changes of another underlying value of measure, but does not require the holder to own or deliver the underlying value of measure.
Two broad categories:
Forward-based
Option-based
Derivatives are recognized in the balance sheet at their fair value, resulting in a payable position for one party and a receivable position for the other.

21. Importing and Exporting Transactions
Forward Exchange Contracts
A forward exchange contract (forward contract) is an agreement to exchange currencies of two different countries at a specified rate (the forward rate) on a stipulated
future date.
LO 5 Forward exchange contracts.

22. Importing and Exporting Transactions
Which Kind of Forward Contract to Choose?
Forward Contract used as a Hedge of a(n):
Foreign currency transaction.
Unrecognized firm commitment (a fair value hedge).
Foreign-currency-denominated “forecasted” transaction (a cash flow hedge).
Net investment in foreign operations.
Speculation
Forward contracts used to speculate changes in foreign currency.
LO 5 Forward exchange contracts.

23. Using Forward Contracts as a Hedge
Hedge of a Foreign Currency Exposed Liability
Problem 2 Crystal Exporting Co. is a U.S. wholesaler engaged in foreign trade. The following transaction is representative of its business dealings. The company uses a periodic inventory system and is on a calendar-year basis. All exchange rates are direct quotations.
Dec. 1 Crystal Exporting purchased merchandise from Chang’s Ltd., a Hong Kong manufacturer. The invoice was for 210,000 Hong Kong dollars, payable on April 1. On this same date, Crystal Exporting acquired a forward contract to buy 210,000 Hong Kong dollars on April 1 for $.1314.
LO 7 Forward contracts as a hedge.

24. Using Forward Contracts as a Hedge
Problem 2 (additional facts)
April 1 Crystal Exporting submitted full payment of 210,000 Hong Kong dollars to Chang’s, Ltd., after obtaining the 210,000 Hong Kong dollars on its forward contract.
Spot rates and the forward rates for the Hong Kong dollar were as follows:
Forward Rate for
Spot Rate ($) April 1 Delivery ($)
Dec
Dec
Dec
April
LO 7 Forward contracts as a hedge.

25. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on December 31.
Dec 1 Purchases 26,565
Accounts Payable 26,565
Hong Kong dollars 210,000
Dec. 1 Direct Spot Rate $ .1265
Payable in U.S. dollars $ 26,565
LO 7 Forward contracts as a hedge.

26. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on December 1.
Dec 1 FC Receivable from Exch. Dealer 27,594
Dollars Payable to Exch. Dealer 27,594
Hong Kong dollars 210,000
Dec. 1 Forward Rate $
Payable in U.S. dollars $ 27,594
LO 7 Forward contracts as a hedge.

27. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on December 31.
Dec 31 Accounts Payable
Transaction Gain 126
Hong Kong dollars 210,000
Dec. 31 Spot Rate $
Payable in U.S. dollars $ 26,439
Payable recorded on Dec ,565
Transaction gain $
LO 7 Forward contracts as a hedge.

28. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on December 31.
Dec 31 Transaction Loss
FC Receivable from Exchange Dealer
Hong Kong dollars 210,000
Dec. 31 Forward Rate $
Payable in U.S. dollars $ 27,468
Payable recorded on Dec ,594
Transaction loss $ (126)
LO 7 Forward contracts as a hedge.

29. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on Apr 1.
Apr 31 Transaction Loss 3,591
Accounts payable 3,591
Hong Kong dollars 210,000
Apr. 1 Spot Rate $
Payable in U.S. dollars $ 30,030
Payable established on Dec ,439
Transaction loss $ (3,591)
LO 7 Forward contracts as a hedge.

30. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on Apr 1.
Apr 1 FC Receivable from Exch. Dealer 2,562
Transaction Gain 2,562
Hong Kong dollars 210,000
Apr. 1 Spot Rate $
Payable in U.S. dollars $ 30,030
Payable established on Dec ,468
Transaction loss $ ,562
LO 7 Forward contracts as a hedge.

31. Using Forward Contracts as a Hedge
Problem 2 Prepare journal entries for the transactions including the necessary adjustments on Apr 1.
Apr 1 Investment in Foreign Currency 30,030
Dollars Payable to Exch. Dealer 27,594
Cash 27,594
FC Receivable from Exch. Dealer 30,030
(payment to dealer and receipt of 210,000 Hong Kong dollars)
Accounts Payable 30,030
Investment in Foreign Currency 30,030
(payment of liability upon transfer of 210,000 Hong Kong dollars)
LO 7 Forward contracts as a hedge.

32. Using Forward Contracts as a Hedge
Problem 2 Transaction Summary
Thus the net effect is a $1,029 loss when the forward contract is used.
LO 7 Forward contracts as a hedge.

33. Using Forward Contracts as a Hedge
Hedge of a Foreign Currency Exposed Asset
Accounting for a forward contract entered into as a hedge of an exposed receivable position is similar to an exposed liability position.
Because the U.S. firm will be receiving foreign currency in settlement of the exposed receivable balance, it will enter into a forward contract to sell foreign currency for U.S. dollars.
LO 7 Forward contracts as a hedge.

34. Using Forward Contracts as a Hedge
Fair Value Hedge—Hedging an Unrecognized Foreign Currency Commitment
A U.S. firm, at a date earlier than the transaction date, may make a commitment to a foreign company to buy or sell goods at a price established in foreign currency.
Changes in the exchange rate between the commitment date and transaction date would be reflected in the cost or sales price of the asset.
The U.S. firm may enter a forward contract to hedge its commitment.
LO 7 Forward contracts as a hedge.

35. Using Forward Contracts as a Hedge
Exercise 14 Consider the following information:
1. On December 1, 2008, a U.S. firm contracts to sell equipment (with an asking price of 10,000 pesos) in Mexico. The firm will take delivery and will pay for the equipment on March 1, 2009.
2. On December 1, 2008, the company enters into a forward contract to sell 10,000 pesos for $9.48 on March 1, 2009.
3. Spot rates and the forward rates for March 1, 2009, settlement were as follows (dollars per peso):
Spot Rate Forward Rate
December 1, $9.54 $9.48
Balance sheet date (12/31/08)
March 1,
4. On March 1, the equipment was sold for 10,000 pesos. The cost of the equipment was $40,000.
LO 7 Forward contracts as a hedge.

36. Using Forward Contracts as a Hedge
Exercise Prepare all journal entries needed on December 1, December 31, and March 1 to account for the forward contract, the firm commitment, and the transaction to sell the equipment.
Dec 1 Receivable from Exchange Dealer* 94,800
FC Payable to Exchange Dealer 94,800
Dec 31 FC Payable from Exchange Dealer** 400
Foreign Exchange Gain
Foreign Exchange Loss 400
Firm Commitment**
* (10,000 x $9.48 = $94,800)
** [(10,000 x ($ $9.44)] = $400
LO 7 Forward contracts as a hedge.

37. Using Forward Contracts as a Hedge
Exercise 14 Prepare all journal entries needed on December 1, December 31, and March 1 to account for the forward contract, the firm commitment, and the transaction to sell the equipment.
Mar 1 Foreign Exchange Loss 300
FC Payable from Exchange Dealer* 300
Firm Commitment* 300
Foreign Exchange Gain 300
Investment in FC 94,700
Firm Commitment 100
Sales (10,000 x 9.48) 94,800
* [(10,000 ´ ($ $9.47)] =$300
LO 7 Forward contracts as a hedge.

38. Using Forward Contracts as a Hedge
Exercise Prepare all journal entries needed on December 1, December 31, and March 1 to account for the forward contract, the firm commitment, and the transaction to sell the equipment.
Mar 1 Cash 94,800
FC Payable to Exchange Dealer 94,700
Investment in FC 94,700
Dollars Receivable from Exchange Dealer 94,800
Cost of Goods Sold 40,000
Inventory 40,000
LO 7 Forward contracts as a hedge.

39. Using Forward Contracts as a Hedge
Cash Flow Hedge-A Forecasted Transaction
Cash Flow Hedge - hedging cash flows for future transactions that have not yet occurred or for which there are no firm commitments.
Cash flow hedges may defer the Income statement recognition of gains and losses on forecasted transactions if certain criteria are met.
Amounts in accumulated other comprehensive income are reclassified into earnings in the same period which the hedged forecasted transaction affects earnings.
LO 7 Fair value hedge vs. cash flow hedge.

40. Using Forward Contracts as a Hedge
Exercise 13 Consider the following information:
1. On December 1, 2008, a U.S. firm plans to purchase a piece of equipment (with an asking price of 100,000 francs) in Switzerland during January of The transaction is probable, and the transaction is to be denominated in euros.
2. On December 1, 2008, the company enters into a forward contract to buy 100,000 francs for $1.01 on January 31, 2009.
3. Spot rates and the forward rates for January 31, 2009, settlement were as follows (dollars per francs):
Spot Rate Forward Rate
December 1, $0.99 $1.01
Balance sheet date (12/31/08)
Jan. 31 and Feb. 1,
4. On Feb. 1, the equipment was purchased for 100,000 francs.
LO 7 Fair value hedge vs. cash flow hedge.

41. Using Forward Contracts as a Hedge
Exercise Prepare all journal entries needed on Dec. 1, Dec. 31, Jan. 31, and Feb. 1 to account for the forecasted transaction, the forward contract, and the transaction to buy the equipment.
Dec.1 FC Receivable from Exchange Dealer 101,000
Dollars Payable to Exchange Dealer* 101,000
Dec.31 FC Receivable from Exchange Dealer** 1,000
Foreign Exchange Gain – OCI 1,000
* (100,000 x $1.01) = $101,000
** [(100,000 x ($1.01- $1.02)] = $1,000
LO 7 Fair value hedge vs. cash flow hedge.

42. Using Forward Contracts as a Hedge
Exercise Prepare all journal entries needed on Dec. 1, Dec. 31, Jan. 31, and Feb. 1 to account for the forecasted transaction, the forward contract, and the transaction to buy the equipment.
Jan.31 FC Receivable from Exchange Dealer 2,000
Foreign Exchange Gain – OCI 2,000
[(100,000 ´ ($1.02- $1.04)]
  Investment in FC 104,000
Dollars Payable to Exchange Dealer 101,000
Cash 101,000
FC Receivable from Exchange Dealer 104,000
 Feb. 1 Equipment 104,000
Investment in FC 104,000
LO 7 Fair value hedge vs. cash flow hedge.