1. Foreign Currency Transactions and Hedging Foreign Exchange Risk
Chapter Nine
Foreign Currency Transactions and Hedging Foreign Exchange Risk
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2. Understand concepts related to foreign currency, exchange
Learning Objective 9-1
Understand concepts related
to foreign currency, exchange
rates, and foreign exchange risk.
Understand concepts related to foreign currency, exchange rates, and foreign exchange risk.

3. Exchange Rate Mechanisms
Between 1945 and 1973, countries fixed the par value of their currency in terms of the U.S. dollar.
The U.S. dollar was based on the Gold Standard until 1971.
Since 1973, exchange rates have been allowed to float in value.
Several currency arrangements exist.
Exchange rates have not always fluctuated. During the period 1945–1973, countries fixed
the par value of their currency in terms of the U.S. dollar, and the value of the U.S. dollar
was fixed in terms of gold. Countries agreed to maintain the value of their currency
within 1 percent of the par value. If the exchange rate for a particular currency began to
move outside this 1 percent range, the country’s central bank was required to intervene
by buying or selling its currency in the foreign exchange market. Because of the law of
supply and demand, a central bank’s purchase of currency would cause the price of the
currency to stop falling, and its sale of currency would cause the price to stop rising.
The integrity of the system hinged on the U.S. dollar maintaining its value in gold and
the ability of foreign countries to convert their U.S. dollar holdings into gold at the fixed
rate of $35 per ounce. As the United States began to incur balance of payment deficits
in the 1960s, a glut of U.S. dollars arose worldwide, and foreign countries began converting
their U.S. dollars into gold. This resulted in a decline in the U.S. government’s gold
reserve from a high of $24.6 billion in 1949 to a low of $10.2 billion in In that year,
the United States suspended the convertibility of the U.S. dollar into gold, signaling the
beginning of the end for the fixed exchange rate system. In March 1973, most currencies
were allowed to float in value. Today, several different currency arrangements exist.

4. Different Currency Mechanisms
Independent Float - the currency is allowed to fluctuate according to market forces
Pegged to another currency - the currency’s value is fixed in terms of a particular foreign currency, and the central bank will intervene to maintain the fixed value
European Monetary System - a common currency (the euro) is used in multiple countries. Its value floats against other world currencies.
Different Currency Mechanisms
Independent Float - the currency is allowed to fluctuate according to market forces
Pegged to another currency - the currency’s value is fixed in terms of a particular foreign currency, and the central bank will intervene to maintain the fixed value
European Monetary System - a common currency (the euro) is used in multiple countries. Its value floats against other world currencies.

5. Foreign Exchange Rates
An Exchange Rate is the cost of one currency in terms of another.
Rates published daily in the Wall Street Journal are as of 4:00pm Eastern time on the day prior to publication. Rates are also available on line at: and
The published rates are wholesale rates that banks use with each other – retail rates to consumers are higher.
The difference between the rates at which a bank is willing to buy and sell currency is known as the “spread.”
Rates change constantly!
Foreign Exchange Rates
An Exchange Rate is the cost of one currency in terms of another.
Rates published daily in the Wall Street Journal are as of 4:00pm Eastern time on the day prior to publication.
The published rates are wholesale rates that banks use with each other – retail rates to consumers are higher. Rates are also available on line at: and
The difference between the rates at which a bank is willing to buy and sell currency is known as the “spread.”
Rates change constantly!

6. Foreign Exchange Rates
Spot Rate
The exchange rate that is available today.
Forward Rate
The exchange rate that can be locked in today for an expected future exchange transaction.
The actual spot rate at the future date may differ from today’s forward rate.
A forward contract requires the purchase (or sale) of currency units at a future date at the contracted exchange rate.
Foreign currency trades can be executed on a spot or forward basis. The spot rate is the
price at which a foreign currency can be purchased or sold today. In contrast, the forward
rate is the price today at which foreign currency can be purchased or sold sometime in
the future. Because many international business transactions take some time to be completed,
the ability to lock in a price today at which foreign currency can be purchased or
sold at some future date has definite advantages. A forward contract requires the purchase
(or sale) of currency units at a future date at the contracted exchange rate.

7. Foreign Exchange – Option Contracts
An options contract gives the holder the option of buying (or selling) currency units at a future date at the contracted “strike” price.
A “put” option allows for the sale of foreign currency by the option holder.
A “call” option allows for the purchase of foreign currency by the option holder.
An option gives the holder “the right but not the obligation” to trade the foreign currency in the future.
An options contract gives the holder the option of buying (or selling) currency units at a future date at the contracted “strike” price.
A “put” option allows for the sale of foreign currency by the option holder.
A “call” option allows for the purchase of foreign currency by the option holder.
An option gives the holder “the right but not the obligation” to trade the foreign currency in the future.

8. Option values Value is derived from :
A function of the difference between current spot rate and strike price
The difference between foreign and domestic interest rates
The length of time to option expiration
The potential volatility of changes in the spot rate
An option premium is a function of Intrinsic Value and Time Value
Option values
Value is derived from:
a function of the difference between current spot rate and strike price
The difference between foreign and domestic interest rates
The length of time to option expiration
The potential volatility of changes in the spot rate
An option premium is a function of Intrinsic Value and Time Value

9. Account for foreign currency
Learning Objective 9-2
Account for foreign currency
transactions using the two transaction perspective, accrual approach.
Account for foreign currency transactions using the two transaction perspective, accrual approach.

10. Foreign Currency Transactions
A U.S. company buys or sells goods or services to a party in another country. This is often called foreign trade.
The transaction is often denominated in the currency of the foreign party.
How do we account for the changes in the value of the foreign currency?
A U.S. company buys or sells goods or services to a party in another country. This is often called foreign trade.
The transaction is often denominated in the currency of the foreign party.
How do we account for the changes in the value of the foreign currency?

11. Transaction Exposure
Export sale: Exposure exists when the exporter allows buyer to pay in a foreign currency sometime after the sale has been made. The exporter is exposed to the risk that the foreign currency might depreciate between the date of sale and the date payment is received, decreasing the U.S. dollars collected.
Export sale: A transaction exposure exists when the exporter allows the buyer to pay
in a foreign currency and allows the buyer to pay sometime after the sale has been
made. The exporter is exposed to the risk that the foreign currency might depreciate
(decrease in value) between the date of sale and the date payment is received, thereby
decreasing the U.S. dollars ultimately collected.

12. Transaction Exposure
Import purchase: Exposure exists when the importer is required to pay in foreign currency sometime after the purchase has been made. The importer is exposed to the risk that the foreign currency might appreciate between the date of purchase and the date of payment, increasing the U.S. dollars that have to be paid for the imported goods.
Import purchase: A transaction exposure exists when the importer is required to pay
in foreign currency and is allowed to pay sometime after the purchase has been made.
The importer is exposed to the risk that the foreign currency might appreciate (increase
in price) between the date of purchase and the date of payment, thereby increasing
the U.S. dollars that have to be paid for the imported goods.

13. Foreign Currency Transactions
There are two methods of accounting for changes in the value of a foreign currency transaction, the one-transaction perspective and the two-transaction perspective.
The one-transaction perspective assumes:
the export sale is not complete until the foreign currency receivable has been collected .
Changes in the U.S. dollar value of the foreign currency is accounted for as an adjustment to Accounts Receivable and Sales.
Conceptually, the two methods of accounting for changes in the value of a foreign currency
transaction are the one-transaction perspective and the two-transaction perspective. The one-transaction perspective assumes that an export sale is not complete until the foreign currency receivable has been collected and converted into U.S. dollars. Any change in the U.S. dollar value of the foreign currency is accounted for as an adjustment to Accounts Receivable and to Sales.

14. Foreign Currency Transactions
GAAP requires the two-transaction approach and treats the sale and collection of cash as two separate transactions.
Account for the original sale in US Dollars at date of sale. No subsequent adjustments are required.
Changes in the U.S. dollar value of the foreign currency are accounted for as gains/losses from exchange rate fluctuations reported separately from sales in the income statement.
GAAP requires a two-transaction perspective. Account for the original sale in US Dollars.
Account for gains/losses from exchange rate fluctuations.
Instead, U.S. GAAP requires companies to use a two-transaction perspective in accounting
for foreign currency transactions.4 This perspective treats the export sale and
the subsequent collection of cash as two separate transactions. Because management
has made two decisions—(1) to make the export sale and (2) to extend credit in foreign
currency to the customer—the company should report the income effect from each of
these decisions separately. The U.S. dollar value of the sale is recorded at the date
the sale occurs. At that point, the sale has been completed; there are no subsequent
adjustments to the Sales account. Any difference between the number of U.S. dollars
that could have been received at the date of sale and the number of U.S. dollars
actually received at the date of collection due to fluctuations in the exchange rate is a
result of the decision to extend foreign currency credit to the customer. This difference
is treated as a foreign exchange gain or loss that is reported separately from Sales in
the income statement.

15. Foreign Exchange Transaction - Example
Summary of the relationship between fluctuations in exchange rates and foreign exchange gains and losses:
Summary of the relationship between fluctuations in exchange rates and foreign exchange gains and losses
A foreign currency receivable arising from an export sale creates an asset exposure to
foreign exchange risk. If the foreign currency appreciates, the foreign currency asset increases
in U.S. dollar value and a foreign exchange gain arises; depreciation of the foreign
currency causes a foreign exchange loss. A foreign currency payable arising from an import
purchase creates a liability exposure to foreign exchange risk. If the foreign currency
appreciates, the foreign currency liability increases in U.S. dollar value and a foreign exchange
loss results; depreciation of the currency results in a foreign exchange gain.
Foreign currency receivables from an export sale creates an asset exposure to foreign exchange risk.
Foreign currency payables from an import purchase creates a liability exposure to foreign exchange risk.

16. Accounting for Unrealized Gains and Losses
Under the two-transaction perspective, a foreign exchange gain or loss arises at the balance sheet date that has not yet been realized in cash.
Two approaches exist to account for unrealized foreign exchange gains and losses:
Deferral approach:
Gains and losses are deferred on the balance sheet until cash is paid or received and a realized foreign exchange gain or loss is included in income when paid.
Under the two-transaction perspective, this means that a foreign exchange gain or loss arises at the balance sheet date. The next question then is what should be done with these foreign exchange gains and losses that have not yet been realized in cash. Should they be included in net income?
The two approaches to accounting for unrealized foreign exchange gains and losses
are the deferral approach and the accrual approach. Under the deferral approach, unrealized
foreign exchange gains and losses are deferred on the balance sheet until cash is
actually paid or received. When cash is paid or received, a realized foreign exchange gain
or loss is included in income. This approach is not acceptable under U.S. GAAP.

17. Accounting for Unrealized Gains and Losses
Accrual approach (required by U.S. GAAP):
Unrealized foreign exchange gains and losses are reported in net income in the period in which the exchange rate changes.
Change in the exchange rate from the balance sheet date to date of payment results in a second foreign exchange gain or loss that is reported in the second accounting period.
U.S. GAAP requires U.S. companies to use the accrual approach to account for unrealized
foreign exchange gains and losses. Under this approach, a firm reports unrealized
foreign exchange gains and losses in net income in the period in which the exchange rate
changes. This is consistent with accrual accounting as it results in reporting the effect of
a rate change that will have an impact on cash flow in the period when the event causing
the impact takes place. Thus, any change in the exchange rate from the date of sale to the
balance sheet date results in a foreign exchange gain or loss to be reported in income in
that period. Any change in the exchange rate from the balance sheet date to the date of
payment results in a second foreign exchange gain or loss that is reported in the second accounting
period.

18. Understand how foreign currency
Learning Objective 9-3
Understand how foreign currency
forward contracts and foreign currency options can be used to hedge foreign exchange risk.
Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

19. Hedging Foreign Exchange Risk
Companies will avoid uncertainty associated with the effect of unfavorable changes in the value of foreign currencies using foreign currency derivatives.
The two most common derivatives used to hedge foreign exchange risk are foreign currency forward contracts and foreign currency options.
Hedging Foreign Exchange Risk
To avoid uncertainty, companies often use foreign currency derivatives to hedge against the effect of unfavorable changes in the value of foreign currencies. The two most common derivatives used to hedge foreign exchange risk are foreign currency forward contracts and foreign currency options.

20. Hedging Foreign Exchange Risk
Two foreign currency derivatives often used :
Foreign currency forward contracts lock in the price for which the currency will sell at contract’s maturity.
Foreign currency options establish a price for which the currency can be sold, but is not required to be sold at maturity.
Hedging Foreign Exchange Risk
Two foreign currency derivatives that are often used to hedge foreign currency transactions:
Foreign currency forward contracts lock in the price for which the currency will sell at contract’s maturity.
Foreign currency options establish a price for which the currency can be sold, but is not required to be sold at maturity.

21. Accounting for Derivatives
ASC Topic 815 provides guidance for hedges of four types of foreign exchange risk.
Recognized foreign currency denominated assets & liabilities.
Unrecognized foreign currency firm commitments.
Forecasted foreign currency denominated transactions.
ASC Topic 815 provides guidance for hedges of four types of foreign exchange risk.
Recognized foreign currency denominated assets & liabilities.
Unrecognized foreign currency firm commitments.
Forecasted foreign currency denominated transactions.
Net investments in foreign operations
Net investments in foreign operations

22. Accounting for Derivatives
The fair value of the derivative is recorded at the same time as the transaction to be hedged, based on:
The forward rate when the forward contract was entered into.
The current forward rate for a contract that matures on the same date as the forward contract.
A discount rate (the company’s incremental borrowing rate).
The fair value of the derivative is recorded at the same time as the transaction to be hedged, based on:
The forward rate when the forward contract was entered into.
The current forward rate for a contract that matures on the same date as the forward contract.
A discount rate (the company’s incremental borrowing rate).

23. Accounting for Derivatives
In accordance with U.S. GAAP, gains and losses arising from changes in the fair value of derivatives are recognized initially either
on the income statement as a part of net income or
on the balance sheet in accumulated other comprehensive income.
Recognition treatment depends partly on whether the company uses derivatives for hedging purposes or for speculation.
In accordance with U.S. GAAP, gains and losses arising from changes in the fair value of derivatives are recognized initially either (1) on the income statement as a part of net income or (2) on the balance sheet in accumulated other comprehensive income.
Recognition treatment depends partly on whether the company uses derivatives for hedging purposes or for speculation.
For speculative derivatives, the company recognizes the change in the fair value of the derivative (the gain or loss) immediately in net income. The accounting for changes in the fair value of derivatives used for hedging depends on the nature of the foreign exchange risk being hedged and on whether the derivative qualifies
for hedge accounting.

24. Accounting for Derivatives
U.S. GAAP allows hedge accounting for foreign currency derivatives only if three conditions are satisfied:
1. The derivative is used to hedge either a cash flow exposure or fair-value exposure to
foreign exchange risk.
2. The derivative is highly effective in offsetting changes in the cash flows or fair value
related to the hedged item.
3. The derivative is properly documented as a hedge.
U.S. GAAP allows hedge accounting for foreign currency derivatives only if three conditions are satisfied:1. The derivative is used to hedge either a cash flow exposure or fair-value exposure to foreign exchange risk.
2. The derivative is highly effective in offsetting changes in the cash flows or fair value
related to the hedged item.
3. The derivative is properly documented as a hedge.

25. Account for forward contracts and options used as hedges of
Learning Objective 9-4
Account for forward contracts
and options used as hedges of
foreign currency denominated
assets and liabilities.
Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

26. Accounting for Hedges
Two ways to account for hedges of foreign currency denominated assets and liabilities:
Cash Flow Hedge
The hedging instrument must completely offset the variability in the cash flows associated with the foreign currency receivable or payable.
Gains/losses are recorded in Accumulated Other Comprehensive Income.
Hedges of foreign currency denominated assets and liabilities, such as accounts receivable and accounts payable, can qualify as either cash flow hedges or fair value hedges. To qualify as a cash flow hedge, the hedging instrument must completely offset the vari- ability in the cash flows associated with the foreign currency receivable or payable. If the hedging instrument does not qualify as a cash flow hedge or if the company elects not to designate the hedging instrument as a cash flow hedge, the hedge is designated as a fair value hedge. The following summarizes the basic accounting for the two types of hedges of foreign currency denominated assets and liabilities.
Fair Value Hedge.
Any other hedging instrument.
Gains/losses are recognized immediately in net income.

27. Accounting for Hedges Cash Flow Hedge At the balance sheet date:
The hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate, and a foreign exchange gain or loss is recognized in net income.
2. The derivative hedging instrument is adjusted to fair value (an asset or liability on the balance sheet) with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI).
1. The hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate, and a foreign exchange gain or loss is recognized in net income (Cash Flow Hedge Step B.1. in Exhibit 9.2).
2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet) with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI) (Cash Flow Hedge Step B.2. in Exhibit 9.2).

28. Cash Flow Hedge continued . . .
Accounting for Hedges
Cash Flow Hedge continued . . .
At the balance sheet date:
3. An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income to offset any gain or loss on the hedged asset or liability.
4. An additional amount is removed from AOCI and recognized in net income to reflect (a) the current period’s amortization of the original discount or premium on the forward contract (if it is the hedging instrument) or (b) the change in the time value of the option (if it is the hedging instrument).
3. An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability (Cash Flow Hedge Step B.3. in Exhibit 9.2).
4. An additional amount is removed from AOCI and recognized in net income to reflect (a) the current period’s amortization of the original discount or premium on the forward contract (if a forward contract is the hedging instrument) or (b) the change in the time value of the option (if an option is the hedging instrument) (Cash Flow
Hedge Step B.4. in Exhibit 9.2).

29. Accounting for Hedges Fair Value Hedge At the balance sheet date:
Adjust the hedged asset or liability to fair value based on changes in the spot exchange rate and recognize a foreign exchange gain or loss in net income.
Adjust the derivative hedging instrument to fair value (resulting in an asset or liability reported on the balance sheet) and recognize the counterpart as a gain or loss in net income.
1. Adjust the hedged asset or liability to fair value based on changes in the spot exchange
rate and recognize a foreign exchange gain or loss in net income (Fair Value Hedge
Step B.1. in Exhibit 9.2).
2. Adjust the derivative hedging instrument to fair value (resulting in an asset or liability
reported on the balance sheet) and recognize the counterpart as a gain or loss in net
income (Fair Value Hedge Step B.2. in Exhibit 9.2).

30. Foreign Currency Option as a Hedge
An option is a contract that allows you to exercise a predetermined exchange rate if it is to your advantage. As with forward contracts, options can be designated as cash flow hedges or fair value hedges. Option prices are determined using the Black- Scholes Option Pricing Model covered in most finance texts.
Using a Foreign Currency Option as a Hedge
An option is a contract that allows you to exercise a predetermined exchange rate if it is to your advantage.
As with forward contracts, options can be designed as cash flow hedges or fair value hedges.
Option prices are determined using the Black-Scholes Option Pricing Model covered in most finance texts.

31. Account for forward contracts and options used as hedges
Learning Objective 9-5
Account for forward contracts
and options used as hedges
of foreign currency firm
commitments.
Account for forward contracts and options used as hedges of foreign currency firm commitments.

32. Foreign Currency Firm Commitment Hedge
A firm commitment is an executory contract not normally recognized in financial statements; the company has not delivered goods nor has the customer paid for them.
When a firm commitment is hedged using a derivative financial instrument, hedge accounting requires explicit recognition on the balance sheet at fair value of both the derivative financial instrument and the firm commitment.
A firm commitment is an executory contract; the company has not delivered goods
nor has the customer paid for them. Normally, executory contracts are not recognized
in financial statements. However, when a firm commitment is hedged using a derivative
financial instrument, hedge accounting requires explicit recognition on the balance sheet
at fair value of both the derivative financial instrument (forward contract or option) and
the firm commitment. The change in fair value of the firm commitment results in a gain
or loss that offsets the loss or gain on the hedging instrument (forward contract or option),
thus achieving the goal of hedge accounting

33. Foreign Currency Firm Commitment Hedge
Changes in the spot exchange rate are used to determine the fair value of the firm commitment when a foreign currency option is the hedging instrument.
U.S. GAAP allows hedges of firm commitments to be designated either as cash flow or fair value hedges.
Changes in the spot exchange rate are used to determine the fair value of the firm commitment when a foreign currency option is the hedging instrument.
U.S. GAAP allows hedges of firm commitments to be designated either as cash flow or fair value hedges.

34. Foreign Currency Firm Commitment Hedge
Options are carried at fair value on the balance sheet of both the derivative financial instrument (forward contract or option) and the firm commitment.
The change in value of the firm commitment gain/loss offsets the gain or loss on the hedging instrument. Gain/loss is recognized currently in net income, as is the gain/loss on the firm commitment attributable to the hedged risk.
Options are carried at fair value on the balance sheet of both the derivative financial instrument (forward contract or option) and the firm commitment.
The change in value of the firm commitment gain/loss offsets the gain or loss on the hedging instrument. Gain/loss is recognized currently in net income, as is the gain/loss on the firm commitment attributable to the hedged risk.

35. Account for forward contracts and options used as hedges
Learning Objective 9-6
Account for forward contracts
and options used as hedges
of forecasted foreign currency
transactions.
Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

36. Hedge of a Forecasted Foreign Currency Denominated Transaction
Cash flow hedge accounting may be used for foreign currency derivatives associated with a forecasted foreign currency transaction. The forecasted transaction must be probable, highly effective, and the hedging relationship must be properly documented. There is no recognition of the forecasted transaction or gains and losses on the forecasted transaction.
Hedge of a Forecasted Foreign Currency Denominated Transaction
Cash flow hedge accounting may be used for foreign currency derivatives associated with a forecasted foreign currency transaction.
The forecasted transaction must be probable, highly effective, and the hedging relationship must be properly documented.
There is no recognition of the forecasted transaction or gains and losses on the forecasted transaction.

37. Hedge of a Forecasted Foreign Currency Denominated Transaction
The company reports the hedging instrument (forward contract or option) at fair value, but changes in the fair value of are not reported in net income. Gains and losses on the hedging instrument are recorded in Other Comprehensive Income until the date of the forecasted transaction then transferred to net income on the projected transaction date.
The company reports the hedging instrument (forward contract or option) at fair value,
but because no gain or loss occurs on the forecasted transaction to offset against, the
company does not report changes in the fair value of the hedging instrument as gains
and losses in net income. Instead, it reports them in other comprehensive income. On
the projected date of the forecasted transaction, the company transfers the cumulative
change in the fair value of the hedging instrument from accumulated other comprehensive
income (balance sheet) to net income (income statement).Gains and losses on the hedging instrument are recorded in Other Comprehensive Income until the date of the forecasted transaction.

38. Prepare journal entries to account for foreign currency borrowings.
Learning Objective 9-7
Prepare journal entries to
account for foreign currency
borrowings.
Prepare journal entries to account for foreign currency borrowings.

39. Foreign Currency Borrowings
Companies often must account for foreign currency borrowings, another type of foreign currency transaction. Companies borrow foreign currency from foreign lenders to finance foreign operations or to take advantage of more favorable interest rates. The facts that the principal and interest are denominated in foreign currency and create an exposure to foreign exchange risk complicate accounting for a foreign currency borrowing.
In addition to the receivables and payables that arise from import and export activities, companies
often must account for foreign currency borrowings, another type of foreign currency
transaction. Companies borrow foreign currency from foreign lenders either to finance foreign
operations or perhaps to take advantage of more favorable interest rates. The facts
that both the principal and interest are denominated in foreign currency and both create an
exposure to foreign exchange risk complicate accounting for a foreign currency borrowing.

40. Journal Entries

41. Foreign Currency Borrowings
Companies also lend foreign currency to related parties, creating the opposite situation from a foreign currency borrowing. The company must keep track of a note receivable and interest receivable, both of which are denominated in foreign currency. Fluctuations in the U.S. dollar value of the principal and interest generally give rise to foreign exchange gains and losses that would be included in income.
At times companies lend foreign currency to related parties, creating the opposite situation
from a foreign currency borrowing. The accounting involves keeping track of a note
receivable and interest receivable, both of which are denominated in foreign currency.
Fluctuations in the U.S. dollar value of the principal and interest generally give rise to
foreign exchange gains and losses that would be included in income. An exception arises
when the foreign currency loan is made on a long-term basis to a foreign branch, subsidiary,
or equity method affiliate. Foreign exchange gains and losses on “intra-entity foreign
currency transactions that are of a long-term investment nature (that is, settlement is
not planned or anticipated in the foreseeable future)” are deferred in accumulated other
comprehensive income until the loan is repaid.12 Only the foreign exchange gains and
losses related to the interest receivable are recorded currently in net income.

42. IFRS—Foreign Currency Transactions and Hedges
There are no substantive differences between U.S. GAAP and IFRS in accounting for foreign currency transactions. Similar to U.S. GAAP, IAS 21, “The Effects of Changes in Foreign Exchange Rates,” requires the use of a two-transaction perspective in accounting for foreign currency transactions with unrealized foreign exchange gains and losses accrued in net income in the period of exchange rate change.
Similar to U.S. GAAP, IAS 21, “The Effects of Changes in Foreign Exchange Rates,”
also requires the use of a two-transaction perspective in accounting for foreign currency
transactions with unrealized foreign exchange gains and losses accrued in net income in
the period of exchange rate change. There are no substantive differences between IFRS
and U.S. GAAP in the accounting for foreign currency transactions.

43. IFRS—Foreign Currency Transactions and Hedges
IAS 39, “Financial Instruments: Recognition and Measurement,” governs accounting for hedging instruments including those used to hedge foreign exchange risk. One difference between the two sets of standards relates to the type of financial instrument designated as a foreign currency cash flow hedge. U.S. GAAP allows only derivative financial instruments to be used as a cash flow hedge. IFRS allows nonderivative financial instruments.
IAS 39, “Financial Instruments: Recognition and Measurement,” governs the accounting
for hedging instruments including those used to hedge foreign exchange risk. Rules and procedures
in IAS 39 related to foreign currency hedge accounting generally are consistent with
U.S. GAAP. Similar to current U.S. standards, IAS 39 allows hedge accounting for
recognized assets and liabilities, firm commitments, and forecasted transactions when
documentation requirements and effectiveness tests are met, and requires hedges to be
designated as cash flow or fair value hedges. One difference between the two sets of standards
relates to the type of financial instrument that can be designated as a foreign currency
cash flow hedge. Under U.S. GAAP, only derivative financial instruments can be
used as a cash flow hedge, whereas IFRS also allows nonderivative financial instruments,
such as foreign currency loans, to be designated as hedging instruments in a foreign currency
cash flow hedge.

44. IFRS—Foreign Currency Transactions and Hedges
In 2010, the IASB proposed a new hedge accounting model that would result in significant differences between IFRS and U.S. GAAP. In 2012, the IASB issued a draft of a forthcoming statement that would move hedge accounting from IAS 39 to IFRS 9, “Financial Instruments,” to implement the new model which would go into effect in IFRS 9 is intended to more closely align accounting with a company’s risk management activities.
In 2010, the IASB proposed a new hedge accounting model that would result in
significant differences between IFRS and U.S. GAAP. In 2012, the IASB issued a draft of a
forthcoming statement that would move hedge accounting from IAS 39, “Financial Instruments:
Recognition and Measurement,” to IFRS 9, “Financial Instruments,” to implement the new
model. The new model would go into effect in The forthcoming new hedging model will
replace the rules-based hedge accounting requirements in IAS 39 and is intended to more closely
align accounting with a company’s risk management activities. To improve transparency, the
new hedging model will require several value changes to be included in AOCI rather than net
income. As examples, the change in fair value of both the hedged item and the hedging
instrument in a fair value hedge will be reflected in AOCI (similar to a cash flow) and the change
in time value of options will be reflected in AOCI rather than net income.