1. Session VII & VIII Foreign Currency

2. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-2 Foreign Exchange Basics n Exchange rates n Conversion values n Exchange rate factors n Inflation n Interest rates n Balance of payments

3. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-3 FX Gains and Losses n Realized gains and losses n Result of FX transactions n Exchange of currency takes place n Unrealized gains and losses n Result of FX translations n Conversion for F/S purposes

4. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-4 FX Transactions n Two-transaction approach for US GAAP n Gain or loss recognized in the income statement

5. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-5 Forward Exchange Contracts n Agreement to exchange currency at a specified time at a specified rate n Forward rate n Spot rate

6. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-6 FX Translations n Current Rate Method (Modified Current Rate Method) n Temporal Method n Only approaches approved under US GAAP

7. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-7 Current Rate Method n Local currency is the functional currency n Method n Assets and liabilities translated at current rate n Capital accounts translated at historical rate n Dividends translated at current rate upon declaration n Revenue and expense translated at weighted average rate n Balancing amount recorded in OCI

8. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-8 Temporal Method n Home currency is functional currency n Method n Cash, A/R and A/P translated at current rate n Other assets and liabilities translated at historical rates n Capital accounts translated at historical rate n Revenue and expense other than items dependent on non-monetary items translated at weighted average rate n Balancing amount recorded in income statement

9. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-9 Translation and Remeasurement n When local currency is functional currency, it is TRANSLATED into the home currency n When the local currency is not the functional currency, it is REMEASURED into the functional currency, which is usually the home currency

10. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-10 FX Risk Management n Self-sustaining operations support the local currency as the functional currency n Integrated operations support the home currency as the functional currency n Fixed rate currency n Floating rate currency n Intervention n Arbitrage

11. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-11 Mundell-Fleming Model n Capital mobility offsets the ineffective nature of monetary and fiscal policy n Ineffective monetary policy with fixed rate currency n Ineffective fiscal policy with floating rate currency

12. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-12 FX Risk Exposure n CA > CL = positive exposure n CA < CL = negative exposure n Positive exposure & appreciation yields gain n Negative exposure & depreciation yields gain n FX risk includes both translations and transactions

13. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-13 Transaction Risk Exposure n Transaction denominated in FX n Settlement date is different from transaction date n Results from actual exchange of cash n Results from actual changes in exchange rates n Plan FX strategies and execute them See Exhibit 2.7

14. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-14 Hedging Strategies n FX forward contract: most common n Transaction denomination: US $ billing n Risk sharing: agreed rate and price n Price adjustment: price protection n Currency options contract n Cross-currency swap n Currency swap Contract based strategies

15. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-15 Forward Exchange Contract Accounting n A/R Sales revenue n Deferred FX expense Deferred credit n FX expense Deferred FX expense n Cash Deferred credit A/R

16. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-16 The Euro n Legal tender for most of EU members n Removal of exchange rate risk n Lowers transaction costs n Benefits consumer

17. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-17 Translation Risk Exposure n Accounting exposure only n Increase net assets under appreciation n Increase net liabilities under depreciation

18. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-18 Managing Economic Exposure n Consider location of operations n Use the portfolio approach n Use flexible planning n Use pricing and promotional strategies

19. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-19 FX Forecasting n Implement effective information systems n Consider all relevant factors on a collective basis n Political and social environment n Political risk n Economic growth n Inflation n Balance of payments n Interest rates

20. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-20 US GAAP versus International Actg. Stds. n SFAS 52-FX Translation n If functional currency is US $, remeasure F/S n If functional currency is local currency, translate F/S n Use two-transaction approach for FX transactions n SFAS 133-Derivatives and Hedging n Report derivatives at fair value n Hedging gains & losses are recognized immediately

21. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-21 US GAAP versus International Actg. Stds.-continued n IAS 21-Foreign Currency n Temporal method required for integrated ops. n Current method required for self-sustaining ops. n Recommends two-transaction approach for FX transactions n IAS 39-Hedging n Similar to SFAS 133 (note the convergence!!)

22. Session IX Changing Prices

23. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-23 General and Specific Price Increases n General price level increases (GPI) n Based on market basket of goods & services n Specific price level increases (SPI) n Relates to a particular item

24. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-24 Tight Money Policy n Monetary policy influence both inflation and economic growth n See Figure 3.1 on page 87

25. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-25 Constant Money Restatement (Current Purchase Power Accounting) n Balance sheet n I/D items as monetary or nonmonetary n Extend monetary items at their face amount n Adjust nonmonetary items for changes in purchasing power n Roll-forward prior year balances n Income statement n Adjust items based date of occurrence n Compute depreciation based on adjusted historical cost n Adjust other items based upon weighted average n Compute cost of goods sold based on adj. Inventory items n Calculate purchasing power gain or loss See comprehensive example on pages 90 - 97.

26. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-26 Current Value Accounting n See pages 97 - 102 n We will place limited focus on this topic due to its subjective nature and lack of universal application

27. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005 7-27 IASC and Inflation n IAS 15: Price level accounting disclosures n IAS 29: Hyperinflation report n Requirement for IAS countries n Hyperinflation exists when 3-year cumulative inflation exceeds 100 percent n Restatement for GPI changes in primary financial statements n Hotly debated issue without firm resolution