PB1MAT Pert.1-4

12
12
Accounting for Foreign Currency
Transactions and Hedging
Foreign Exchange Risk
Advanced Accounting, Fifth Edition
Learning
Learning Objectives
Objectives
1.
Distinguish between the terms measured and

denominated.
2.
Describe what is meant by a foreign currency transaction.
3.
Understand some of the more common foreign currency

transactions.
4.
Identify three stages of concern to accountants for

foreign currency transactions, and explain the steps used to
translate foreign currency transactions for each stage.
5.
Describe a forward exchange contract.
Learning
Learning Objectives
Objectives
6.
Explain the use of forward contracts as a hedge of an

unrecognized firm commitment.
7.
Identify some of the common situations in which a forward

exchange contract can be used as a hedge.
8.
Describe a derivative instrument and understand how it may

be used as a hedge.
9.
Explain how exchange gains and losses are reported for fair
value hedges and cash flow hedges.
Foreign
Foreign Currency
Currency Transactions
Transactions
Many U.S. companies engage in international activities
such as:
Exporting or importing goods,
Establishing a foreign branch, or
Holding an equity investment in a foreign company.
Foreign
Foreign Currency
Transactions
Recording and reporting problems with foreign currency
transactions:
Transactions in a foreign currency must be translated
(expressed in dollars) 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.
Exchange
Means of
Exchange Rates
RatesMeans
of Translation
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.
Exchange
Means of
Exchange Rates
RatesMeans
of Translation
Translation
Direct Exchange Rate
Units of domestic currency that can be converted into
one unit of foreign currency.
Direct rate = 1.517 ($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 = .6592
($1 U.S. for .6592 British pound)
Exchange
Means of
Exchange Rates
RatesMeans
of Translation
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).
Exchange
Means of
Exchange Rates
RatesMeans
of Translation
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
Yen
Direct rate
Payable
Transaction
Date
100,000
$ 0.00434
$ 434.00
Change
in Rate
Settlement
Date
100,000
$ 0.00625
$ 625.00
Measured
Measured Versus
Versus Denominated
Denominated
Transactions are normally measured and recorded in
terms of the currency in which the reporting entity
prepares its financial statements.
Reporting Currency - usually the currency where the
company is 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.
Foreign
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.
Direct exchange rate
decreasing, or foreign
currency unit weakening.
More dollars needed to

acquire the foreign
currency units.
Fewer dollars needed to

acquire the foreign
currency units.
Foreign
Foreign Currency
Transactions
Importing or Exporting of Goods or Services
Translating Accounts Denominated in Foreign Currency
Transaction
date
Balance
sheet date
Settlement
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.
Importing
Importing and
and Exporting
Exporting Transactions
Transactions
Exercise 12-2: 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.
U.S. firm
(Teletex)
Inventory delivered
12/10/Year 1
Columbia firm
8,541,000 pesos
received on 1/10/Year 2
LO 3 Common transactions.
LO 4 Three stages of concern.
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: 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. (periodic
method)
Accounts receivable
Sales
Sales price in pesos
Pesos per U.S. dollar
Sales price in U.S. dollars
23,400
23,400
8,541,000
/
365
$ 23,400
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: Prepare journal entry necessary to adjust
the accounts as of December 31. Assume that on December
31 the direct exchange rates was Colombia peso $.00268.
Transaction loss
510
Accounts receivable
510
Receivable in pesos
Direct exchange rate to U.S. dollar
Receivable in U.S. dollars
Balance in receivable
Transaction loss
8,541,000
$ .00268
$ 22,890
23,400
$
510
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: 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 $.00320.
Cash (8,541,000 x $.00320)
27,331
Accounts receivable ($23,400 - $510)

Transaction gain
22,890
4,441
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: 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.
U.S. firm
(Teletex)
Inventory received
12/12/Year 1
Taiwan firm
500,000 Taiwan dollars
paid on 1/10/Year 2
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: 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 $.0391. Prepare the journal entry on the books
of Teletex Systems, Inc.
Purchases
19,550
Accounts payable
Purchase price in Taiwan dollars
Purchase price in U.S. dollars
19,550
500,000
x
$.0391
$ 19,550
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: 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
Payable in U.S. dollars
Balance in payable
Transaction gain
500,000
$
.0351
$ 17,550
19,550
$
2,000
Importing
Importing and
and Exporting
Transactions
Exercise 12-2: 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)

Cash (500,000 x $.0398)
17,550
19,900
Importing
Importing and
and Exporting
Transactions
Importing or Exporting of Goods or Services
Foreign currency transaction gains and losses are
included in net income.
Two-transaction approach:
The sale or purchase is viewed as a transaction separate
from the financing arrangement.

The dollar amount recorded (in Sales or in Purchases) is
determined by the exchange rate on the transaction date.
Adjustments to the foreign-currency-denominated
receivable or payable are recorded directly to the
transaction gain or loss and included in net income.
Importing
Importing and
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.
LO 8 Derivatives as a hedge.
Importing
Importing and
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.
Importing
Importing and
and Exporting
Transactions
Which Kind of Forward Contract to Choose?
1. Forward Contract used as a Hedge of a(n):
a. Foreign currency transaction.
b. Unrecognized firm commitment (a fair value hedge).
c. Foreign-currency-denominated forecasted
transaction (a cash flow hedge).
d. Net investment in foreign operations.
2. Speculation
Forward contracts used to speculate changes in foreign
currency.
LO 5 Forward exchange contracts.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Hedge of a Foreign Currency Exposed Liability
Problem 12-2: Christel 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 Christel Exporting purchased merchandise from
Changs Ltd., a Hong Kong manufacturer. The invoice was for
210,000 Hong Kong dollars, payable on April 1. On this same
date, Christel Exporting acquired a forward contract to buy
210,000 Hong Kong dollars on April 1 for $.1314.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Problem 12-2: (additional facts) April 1 Christel Exporting
submitted full payment of 210,000 Hong Kong dollars to
Changs, Ltd., after obtaining the 210,000 Hong Kong
dollars on its forward contract.
Spot rates and the forward rates for the Hong Kong dollar
were as follows:
Forward Rate for
Spot Rate ($) April 1 Delivery ($)
Dec. 1
.1265
.1314
Dec. 29
.1240
.1305
Dec. 31
.1259
.1308
April 1
.1430
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Problem 12-2: 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
26,565
LO 7 Forward contracts as a hedge.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
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
.1314
27,594
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Dec 31 Accounts Payable
126
Transaction Gain
126
Hong Kong dollars
210,000
Dec. 31 Spot Rate
.1259
26,439
Payable recorded on Dec. 1

Transaction gain
26,565
$
126
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Dec 31 Transaction Loss
126
FC Receivable from Exchange Dealer

Hong Kong dollars
126
210,000
Dec. 31 Forward Rate
.1308
27,468
Payable recorded on Dec. 1

Transaction loss
27,594
$
(126)
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Dec 31 Transaction Loss
3,591
Accounts payable
3,591
Hong Kong dollars
210,000
Apr. 1 Spot Rate
.1430
30,030
Payable established on Dec. 31

Transaction loss
26,439
$
(3,591)
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Dec 31 FC Receivable from Exch. Dealer
2,562
Transaction Gain
2,562
Hong Kong dollars
210,000
Apr. 1 Spot Rate
.1430
30,030
Payable established on Dec. 31

Transaction loss
27,468
$
2,562
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
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)

Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Problem 12-2: Transaction Summary
Transaction
Hedged Item
Balance
Gain/(Loss)
Accounts Payable
Dec. 1
Hedge
Balance
Gain/(Loss)
FC Receivable
$
26,565
Dec. 31
26,439
Apr. 1
30,030
Total gain/(loss)
Transaction
Dec. 1
$
126
(3,591)
(3,465)
$ 27,594
Dec. 31
27,468
Apr. 1
30,030
(126)
2,562
2,436
Thus the net effect is a $1,029 loss when the

forward contract is used.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
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.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Fair Value HedgeHedging 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.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Exercise 12-14: 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):
December 1, 2008
Balance sheet date (12/31/08)
March 1, 2009
Spot Rate
$9.54
9.49
9.47
Forward Rate
$9.48
9.44
4. On March 1, the equipment was sold for 10,000 pesos. The cost
of the equipment was $40,000.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Exercise 12-14: 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.
Dec 1
Receivable from Exchange Dealer*
94,800
FC Payable to Exchange Dealer

Dec 31 FC Payable from Exchange Dealer**
94,800
400
Foreign Exchange Gain

Foreign Exchange Loss
Firm Commitment**
400
400
400
* (10,000 x $9.48 = $94,800)

** [(10,000 x ($9.48 - $9.44)] = $400
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Mar 1
Foreign Exchange Loss
300
FC Payable from Exchange Dealer*

Firm Commitment*
300
300
Foreign Exchange Gain
300
Investment in FC
94,700
Firm Commitment
100
Sales (10,000 x 9.48)
94,800
* [(10,000 ($9.44 - $9.47)] =$300

Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
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

Inventory
40,000
40,000
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
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.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Exercise 12-13: 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 2009. 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):
December 1, 2008
Balance sheet date (12/31/08)
Jan. 31 and Feb. 1, 2009
Spot Rate
$0.99
1.01
1.04
Forward Rate
$1.01
1.02
4. On Feb. 1, the equipment was purchased for 100,000 francs.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Exercise 12-13: 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
101,000
Dollars Payable to Exchange Dealer*

Dec.31 FC Receivable from Exchange Dealer**
Foreign Exchange Gain OCI
101,000
1,000
1,000
* (100,000 x $1.01) = $101,000

** [(100,000 x ($1.01- $1.02)] = $1,000
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Exercise 12-13: 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
Foreign Exchange Gain OCI
[(100,000 ($1.02- $1.04)]
2,000
2,000
Investment in FC
104,000
Dollars Payable to Exchange Dealer
101,000
Cash
Feb. 1 Equipment
Investment in FC
101,000
104,000
104,000
104,000
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Economic Hedge of a Net Investment in a
Foreign Entity
A U.S. firm may enter into a foreign currency transaction
or a nonderivative financial instrument in an effort to
minimize or offset the effects of currency fluctuations
on an equity investment in a foreign company.
The gain or loss on the hedging instrument is reported in
the same manner as the translation adjustment, that is,
reported in the cumulative translation adjustment section
under comprehensive income. FASB ASC paragraph 81535-35-1
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Forward Contracts Acquired to Speculate in the
Movement of Foreign Currencies
A forward contract may be acquired for speculative purposes
in anticipation of realizing a gain.
Disclosure Requirements of the Various Hedges

FASB ASC Section 815-20-50 specifies certain minimal
disclosures for derivative instruments and nonderivative
instruments designated as qualifying hedging instruments.
Using
Using Forward
Forward Contracts
Contracts as
as aa Hedge
Hedge
Using Options to Hedge Foreign Currency Changes
Options, give the holder the advantage of right but not
the obligation to buy or sell the currency.
If the exchange rate changes in a negative manner, the
firm can simply let the option lapse without a loss.
LO 8 Derivatives used as a hedge.
Copyright
Copyright
Copyright 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
the express written permission of the copyright owner is
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to the Permissions Department, John Wiley & Sons, Inc. The
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and not for distribution or resale. The Publisher assumes no
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use of these programs or from the use of the information
contained herein.

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12

Advanced Accounting, Fifth Edition

Distinguish between the terms measured and

Describe what is meant by a foreign currency transaction.

Understand some of the more common foreign currency

Identify three stages of concern to accountants for

Describe a forward exchange contract.

Explain the use of forward contracts as a hedge of an

Identify some of the common situations in which a forward

Describe a derivative instrument and understand how it may

Indirect Exchange Rate

Forward or Future Rate

Forward Exchange Contract

Example Payable to be settled in 100,000 yen

Transaction between a U.S. firm and a foreign company:

More dollars needed to

Fewer dollars needed to

Units of foreign currency x Current direct exchange rate

LO 4 Three stages of concern.

Accounts receivable ($23,400 - $510)

LO 4 Three stages of concern.

LO 4 Three stages of concern.

Accounts payable ($19,550 - $2,000)

LO 4 Three stages of concern.

The sale or purchase is viewed as a transaction separate

from the financing arrangement.

LO 4 Three stages of concern.

Derivatives are recognized in the

LO 5 Forward exchange contracts.

Hong Kong dollars

Dec. 1 Direct Spot Rate

Payable in U.S. dollars

LO 7 Forward contracts as a hedge.

Dollars Payable to Exch. Dealer

Hong Kong dollars

Dec. 1 Forward Rate

Payable in U.S. dollars

LO 7 Forward contracts as a hedge.

Hong Kong dollars

Dec. 31 Spot Rate

Payable in U.S. dollars

Payable recorded on Dec. 1

LO 7 Forward contracts as a hedge.

FC Receivable from Exchange Dealer

Dec. 31 Forward Rate

Payable in U.S. dollars

Payable recorded on Dec. 1

LO 7 Forward contracts as a hedge.

Hong Kong dollars

Apr. 1 Spot Rate

Payable in U.S. dollars

Payable established on Dec. 31

LO 7 Forward contracts as a hedge.

Hong Kong dollars

Apr. 1 Spot Rate

Payable in U.S. dollars

Payable established on Dec. 31

LO 7 Forward contracts as a hedge.

Investment in Foreign Currency

Dollars Payable to Exch. Dealer

FC Receivable from Exch. Dealer

(payment to dealer and receipt of 210,000 Hong Kong dollars)

Investment in Foreign Currency