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Chapter 9

Translation Of
Foreign Currency Transactions

The Need For Translation


Foreign

Currency Transaction

Buying or selling goods or services


Borrowing or lending money
denominated in a foreign currency
Acquiring investments that must be paid
for in a foreign currency
Hedging transaction

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The Need For Translation


Foreign

Currency Financial
Statements
Significantly influenced companies
Subsidiaries
Integrated
Self-sustaining

Joint ventures

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Terminology

SPOT RATE: The term spot rate is used


to refer to the exchange rate at a
particular point in time.
In accounting literature, the most
relevant spot rate is the one that prevails
at the Balance Sheet date and, in this
context, it is generally referred to as the
current rate.

There are at least two spot rates at any


point in time
Bid rate
Ask rate

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Terminology

HISTORIC RATE:
This term is used to refer
to the exchange rate that
prevailed at the time a
particular Balance Sheet
item was:
- acquired (asset) or
- incurred (liability).

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Alternative Methods of
Translation
Current

/ Non-Current Method

Completely
Discredited

Monetary

/ Non-Monetary Method

Temporal

Method

Current

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Rate Method

The Temporal Method


The

Concept

Items valued at current


values are translated
using current exchange
rates.
Items valued at historic
values are translated
using historic exchange
rates.
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The Temporal Method


Example

Inventories carried at cost


would be translated at
historic rates
Inventories carried at net
realizable value would be
translated at current rates

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Temporal As Per
CICA Handbook

Paragraph 1651.03(c)(i) The temporal method is a


method of translation that translates assets, liabilities,
revenues and expenses in a manner that retains their bases
of measurement in terms of the Canadian dollar (i.e., it uses
the Canadian dollar as the unit of measure). In particular:
monetary items are translated at the exchange rate in effect at
the balance sheet date;
non-monetary items are translated at historical exchange
rates, unless such items are carried at market, in which case
they are translated at the exchange rate in effect at the
balance sheet date;
revenue and expense items are translated at the exchange
rate in effect on the dates they occur;
depreciation or amortization of assets translated at historical
exchange rates is translated at the same exchange rates as
the assets to which it relates.

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Temporal As Per
CICA Handbook
Monetary

Items Defined

Paragraph 1651.03(b) Monetary items are


money and claims to money the value of which,
in terms of the monetary unit, whether foreign
or domestic, is fixed by contract or otherwise.
Future Income tax liabilities and assets are
classified as monetary items.

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10

Temporal As Per
CICA Handbook

Items specified as non-monetary

Investments in equity instruments carried at cost


Inventories carried at cost
Prepaid items
Property, plant and equipment and accumulated amortization
Patents, trademarks, licenses and formulas
Goodwill
Other intangible assets (including deferred charges)
Deferred income
Share capital (see Paragraph 9-31)
Revenue and expenses related to non-monetary items,
including:
Cost of goods sold
Depreciation and amortization (including amortization of
deferred income)

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11

Temporal As Per
CICA Handbook

Other Guidance On Monetary Items


Paragraph 1651.47 Preference shares of a
foreign operation held by the reporting
enterprise are translated in the same manner
as common shares (i.e., at historical rates)
unless redemption is either required or
imminent, in which case the current rate is
used. ...
Paragraph 1651.52 Future income tax
liabilities and assets are monetary items and,
as such, are translated at the current rate.

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12

Conceptual Definition Vs. CICA

The two approaches


provide identical
results

References to
monetary confuse
temporal with
monetary vs. nonmonetary

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Temporal Method and


FC Transactions

Paragraph 1651.14 At the transaction


date, each asset, liability, revenue or
expense arising from a foreign currency
transaction of the reporting enterprise
should be translated into Canadian dollars
by the use of the exchange rate in effect at
that date. [October, 2006]

Use Of Averages If

Transactions occur uniformly over the period


Exchange rate changes uniformly over the period

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14

Temporal Method and


FC Transactions

Paragraph 1651.16 At each balance sheet date,


monetary items denominated in a foreign currency
should be adjusted to reflect the exchange rate in
effect at the balance sheet date. (July, 1983)

Paragraph 1651.18 At each balance sheet date,


for non-monetary assets of the reporting enterprise
that are carried at market, the Canadian dollar
equivalent should be determined by applying the
exchange rate in effect at the balance sheet date to
the foreign currency market price. (July, 1983)

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15

Exchange Gains And Losses

Source
Some items are
translated at
current rates
As the rate
changes, gains and
losses arise

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16

Exchange Gains And Losses


Balance
Sheet Item

Exchange
Rate
Movement

Effect on
Income

Asset

Increase

Gain

Asset

Decrease

Loss

Liability

Increase

Loss

Liability

Decrease

Gain

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Required Treatment of
Gains and Losses

Paragraph 1651.120 An exchange gain


or loss of the reporting enterprise that
arises on translation or settlement of a
foreign currency-denominated monetary
item or a non-monetary item carried at
market should be included in the
determination of net income for the
current period. (January, 2002)

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18

Required Treatment of
Gains and Losses
An

Exception

Changes in fair value on available-forsale investments to Other


Comprehensive Income
Exchange gains and losses receive
comparable treatment

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Required Treatment of
Gains and Losses
Foreign

Currency
Financial
Statements receive
different treatment
(see Chapter 10)

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Disclosure

Paragraph 1651.37 The amount of


exchange gain or loss included in net income
should be disclosed (see paragraphs
1651.20, 1651.24 and 1651.31). An entity
may exclude from this amount those
exchange gains or losses arising on financial
instruments classified as held for trading in
accordance with "Financial Instruments
Recognition And Measurement", Section
3855.
An entity may also exclude from this amount
exchange gains or losses on available-forsale financial assets and cash flow hedges
(see "Hedges", Section 3865) included in
any gains or losses removed from
accumulated other comprehensive income
and included in net income for the period.
(October, 2006)

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21

Disclosure
Paragraph

1520.03 contains
an identical
recommendation

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22

Foreign Currency
Purchases and Sales
Two

transaction approach
required
Transaction recorded at
current rate
Exchange gains and losses
into income as they arise

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Foreign Currency
Purchases and Sales
On December 12, 2007, a Canadian company
purchases Inventory in Switzerland for 100,000
Swiss Francs (SF, hereafter). At this time
SF1 = $0.94.
When the company closes its books on
December 31, 2007, the Inventory is still on hand
and the Accounts Payable has not been paid.
On this later date SF1 = $0.96.

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Foreign Currency
Purchases and Sales
December 12, 2007
Inventory [(SF)($100,000)($0.94)]

$94,000

Accounts Payable

$94,000

December 31, 2007


Exchange Loss
[(SF100,000)($0.96 - $0.94)]
Accounts Payable

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$2,000
$2,000

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Foreign Currency
Capital Transaction
Example
On December 31, 2008, a Canadian Company
with a December 31 year end borrows
1,000,000. At this time 1 = $1.40.
On December 31, 2009, the rate for the Euro is
1 = $1.50 and on December 31, 2010, the rate
is 1 - $1.55. On this latter date the loan is
repaid.
Ignore interest payments.

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Foreign Currency
Capital Transaction
December 31, 2008
Cash [(1,000,000)($1.40)]

$1,400,00
0
$1,400,0
00

Liabilities
December 31, 2009
Exchange Loss
[( 1,000,000)($1.50 - $1.40)
Liabilities

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$100,000
$100,000

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Foreign Currency Capital


Transaction
December 31, 2010
Exchange Loss
[(1,000,000)($1.55 - $1.50)]

$50,000

Liabilities

$50,000
December 31, 2010

Liabilities [1,000,000)($1.55)]
Cash

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$1,550,00
0
$1,550,00
0

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Held-To-Maturity
Investments
Example
On January 1, 2008, Empire Inc. acquires
200,000 in long-term debt of a British company.
At this time 1 = $2.15.
On December 31, 2008, when Empire Inc. closes
its books, the exchange rate is 1 = $2.25.

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Held-To-Maturity
Investments
January 1, 2008
Bonds [(200,000)($2.15)]

$430,000

Cash

$430,000

December 31, 2008


Bonds [(200,000)($2.25 - $2.15)]
Exchange Gain

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$20,000
$20,000

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Available-For-Sale At Cost
Investments
Example
On January 1, 2008, Empire Inc. acquires
200,000 in equity securities of a British
company.
At this time 1 = $2.15. The investment is
classified as available for sale and the shares do
not have a quoted market price.
On December 31, 2008, when Empire Inc. closes
its books, the exchange rate is 1 = $2.25.

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Available-For-Sale At Cost
Investments
January 1, 2008
Shares [(200,000)($2.15)]

$430,000

Cash

$430,000

December 31, 2008


No Entry Is Required

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Held-For-Trading
Investments
Example
On January 1, 2008, Empire Inc. acquires
200,000 in equity securities of a British
company.
At this time 1 = $2.15. The investment is
classified as held for trading.
On December 31, 2008, when Empire Inc. closes
its books, the market value of the securities has
increased to 215,000 and the exchange rate is
1 = $2.25.

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Held-For-Trading
Investments
January 1, 2008
Shares [(200,000)($2.15)]

$430,000
$430,00
0

Cash
December 31, 2008
Shares [(215,000)($2.25) - $430,000]
Fair Value Gain Net Income
[(215,000 - 200,000)
($2.25)]
Exchange Gain Net Income
[(200,000)($2.25 - $2.15)]
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$53,750
$33,75
0
20,000
34

Available-For-Sale At Fair Value


Investments
Example
On January 1, 2008, Empire Inc. acquires
200,000 in equity securities of a British
company.
At this time 1 = $2.15. The investment is
classified as available for sale.
On December 31, 2008, when Empire Inc. closes
its books, the market value of the securities has
increased to 215,000 and the exchange rate is
1 = $2.25.

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Available-For-Sale At Fair Value


Investments
January 1, 2008
Shares [(200,000)($2.15)]

$430,000

Cash

$430,000
December 31, 2008

Shares [(215,000)($2.25) $430,000]


Fair Value Gain OCI
[(215,000 - 200,000)
($2.25)]
Exchange Gain - OCI
[(200,000)($2.25 - $2.15)]

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$53,750

$33,750
20,000
36

Available-For-Sale At Fair Value


Investments
Reclassification

If investments are sold, the


Other Comprehensive
Income amounts will be
reclassified into Net
Income

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37

Hedging
An

extremely complex
area

Our

coverage is limited
to simple applications
in the area of foreign
exchange risk

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38

Hedging

Paragraph 3865.02
Hedging is an activity
designed to modify an
entity's exposure to one
or more risks by creating
an offset between
changes in the fair value
of, or the cash flows
attributable to, the
hedged item and the
hedging item (or changes
resulting from a
particular risk exposure
relating to those items).

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Hedged Items In General

Paragraph 3865.07(c) A hedged item is all or a


specified portion of a recognized asset, a
recognized liability, an anticipated transaction, or
a net investment in a self-sustaining foreign
operation, or a group of similar recognized assets,
recognized liabilities or anticipated transactions,
having an identified risk exposure that an entity
has taken steps to modify.

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Hedged Items:
Foreign Currency Applications
Foreign

currency denominated
monetary assets or monetary
liabilities
Anticipated Transactions
Firm commitments
Forecasted transactions
Investments

operations

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in self-sustaining foreign
41

Hedging Items In General

Paragraph 3065.07(d) A hedging item is all or


a specified percentage of a derivative, or all or a
specified percentage of a group of derivatives
offsetting a risk exposure identified in the
hedged item. All or a specified percentage of:
(i) a non-derivative financial asset;
(ii) a non-derivative financial liability; or
(iii) a group of non-derivative financial assets or nonderivative financial liabilities, provided that all nonderivative items in a group are similar;

may be designated as a hedging item only for a


hedge of a foreign currency risk exposure.

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42

Hedging Items:
Foreign Currency Applications
Example
On July 1, 2008, a Canadian
company purchases merchandise in
France for 200,000.
At this time 1 = $1.40.
The merchandise must be paid for
on December 31, 2008.

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43

Hedging Items:
Foreign Currency Applications
Purchase

Euros on July 1, 2008

Effective but costly (no return on funds)


Purchase

financial asset
denominated in Euros
Some rate of return
Low rates on short term investments

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44

Hedging Items:
Foreign Currency Applications
Purchase

non-financial assets
denominated in Euros
Inconvenient
May or may not be effective

Forward

contract to take delivery of


Euros on December 31, 2008
Effective
Requires no investment of funds

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45

A Derivatives Primer

Paragraph 3855.19(e) A derivative is a financial


instrument or other contract within the scope of this Section
with all three of the following characteristics:
(i) its value changes in response to the change in a
specified interest rate, financial instrument price,
commodity price, foreign exchange rate, index of prices or
rates, a credit rating or credit index, or other variable
(sometimes called the "underlying"), provided in the case of
a non-financial variable that the variable is not specific to a
party to the contract;
(ii) it requires no initial net investment or an initial net
investment that is smaller than would be required for other
types of contracts that would be expected to have a similar
response to changes in market factors; and
(iii) it is settled at a future date.

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46

A Derivatives Primer

Types
Contracts

Forwards
Futures
Both parties must perform

Options
Only one party required to perform

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47

A Derivatives Primer

Accounting procedures

Initial recognition at fair value (often nil)


Subsequent measurement at fair value
Gains and losses to Net Income (in general)

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Forward Exchange Contracts


Example
(From Text Paragraph 9-99)
On January 1, 2007, Sandor Inc., a
Canadian public company, enters into a
forward exchange contract to take
delivery of 100,000 on December 31,
2007 at a rate of 1 = $2.30.
On January 1, 2007, the exchange rate is
1 = $2.26.

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Forward Exchange Contracts


Initial

Recognition

No consideration for contract


Fair value = nil
No recognition in the financial
statements

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Forward Exchange Contracts

Settlement on December 31, 2007 when


rate is 1 = $2.33.
December 31, 2007

Cash [(100,000)($2.33)]
Cash [(100,000)($2.30)]
Gain On Contract

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$233,000
$230,000
3,000

51

Forward Exchange Contracts


If Balance Sheet date occurred
prior to settlement of the
contract, the fair value of the
contract would have to be
recorded in the Balance Sheet.
This would result in a gain or
loss to be included in Net
Income.

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52

Hedge Accounting
Objective
Hedge accounting is a method for recognizing the gains,
losses, revenues and expenses associated with the items in
a hedging relationship such that those gains, losses,
revenues and expenses are recognized in net income in the
same period when they would otherwise be recognized in
different periods.

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53

Hedge Accounting

Its use is optional


Often not necessary
(e.g., contract hedging a
monetary asset)
Sometimes cannot qualify
Management may decide not
to use

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54

Hedge Accounting
Qualification

Designation
Documentation
Evaluation for effectiveness
(Beyond the scope of this text)

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55

Fair Value Hedges


Under

this approach, gains and


losses on the hedging item
must be included in Net
Income.
Gains and losses on the hedged
item that are attributable to the
hedged risk must also be
included in Net Income.

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Fair Value Hedges

Fair value hedge accounting can be used


when the hedge is a hedge of the
exposure to changes in the fair value of:
a recognized asset or liability;
an unrecognized firm commitment; or
an identified portion of such an asset,
liability, or firm commitment.

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Cash Flow Hedge


Accounting
Cash

Flow Hedge Accounting


Under this approach, gains and
losses on the hedging item are
treated as items of Other
Comprehensive Income, rather than
as items to be included in the
determination of Net Income.

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Cash Flow Hedge


Accounting
Cash

flow hedge accounting can be


used when the hedge is a hedge of
the exposure to variability in cash
flows associated with:
a recognized asset or liability;
a forecasted transaction; or
the foreign currency risk in an
unrecognized firm commitment.

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Hedge Of Exposed Monetary Balance


Example
On November 1, 2008, Torcan Ltd.
a Canadian company with a
December 31 year end, sells
merchandise in Switzerland for
1,000,000 Swiss Francs (SF,
hereafter). Assume that, at this
time, the exchange rate is SF1 =
$0.90.
On December 31, 2008, the
exchange rate is SF1 = $0.92.
The merchandise is paid for on
February 1, 2009 when the
exchange rate is SF1 = $0.95.

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60

Example No Hedge
Accounting
November 1, 2008
Receivable [(SF1,000,000)($0.90)]

$900,000

Sales

$900,000
December 31, 2008

Receivable [(SF1,000,000)($0.92 $0.90)]


Exchange Gain

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$20,000
$20,000

61

Example No Hedge
Accounting
February 1, 2009
Receivable [(SF1,000,000)($0.95 $0.92)]

$30,000

Exchange Gain
Cash

$30,000
$950,000

Receivable

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$950,000

62

Example
Hedge With Forward Contract
Example

Hedge

On November 1, 2008, Torcan Ltd. a


Canadian company with a December
31 year end, sells merchandise in
Switzerland for 1,000,000 Swiss
Francs (SF, hereafter). Assume that,
at this time, the exchange rate is SF1
= $0.90.
On December 31, 2008, the
exchange rate is SF1 = $0.92.
The merchandise is paid for on
February 1, 2009 when the exchange
rate is SF1 = $0.95.

On November 1, 2008, Torcan


enters a contract to deliver
SF1,000,000 on February 1,
2009 at a rate of SF1 = $0.92.

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On December 31, 2008 the


one month forward rate is SF1
= $0.93, resulting in a fair
value for the contract of
$9,950.

63

Example
Hedge With Forward Contract

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Example
Hedge With Forward Contract
November 1, 2008
Receivable [(SF1,000,000)($0.90)]

$900,00
0

Sales

$900,000
December 31, 2008

Receivable [(SF1,000,000)($0.92 $0.90)]

$20,000

Exchange Gain
Exchange Loss
Forward Contract (Liability)

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$20,000
$9,950
$9,950 65

Example
Hedge With Forward Contract
February 1, 2009
Receivable [(SF1,000,000)($0.95 $0.92)]

$30,000

Exchange Gain
Exchange Loss
[(SF1,000,000)($0.95 - $0.92) $9,950)]
Forward Contract

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$30,000

$20,050
$20,050

66

Example
Hedge With Forward Contract
February 1, 2009
Cash

$950,000
Receivable

Cash [(SF1,000,000)($0.92)]
Forward Contract ($9,950 + $20,050)
Cash [(SF1,000,000)($0.95)]

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$950,000
$920,000
30,000
$950,000

67

Hedge Of Exposed Monetary Balance


Example
On October 1, 2008, Ardin Ltd. commits to
purchasing merchandise in Germany at a cost of
500,000. At this time the spot rate for Euros is 1
= $1.57. The merchandise is to be delivered and
paid for on May 1, 2009.
On October 1, 2008, Ardin also acquires a term
deposit with a maturity value of 500,000 (ignore the
interest that would accrue on this asset).
On December 31, 2008, when Ardin closes its
books, the exchange rate has decreased to 1 =
$1.55. On May 1, 2009, the rate is 1 = $1.52.

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68

Example No Hedge
Accounting
October 1, 2008
Term Deposit [(500,000)($1.57)]

$785,000

Cash

$785,000
December 31, 2008

Exchange Loss [(500,000)($1.55 $1.57)]


Term Deposit

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$10,000
$10,000

69

Example No Hedge
Accounting
May 1, 2009
Exchange Loss [(500,000)($1.55 $1.52)]

$15,000

Term Deposit
Cash [(500,000)($1.52)]

$15,000
$760,000

Term Deposit
Merchandise [(500,000)($1.52)]
Cash
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$760,000
$760,000
$760,000
70

Example No Hedge
Accounting

The economic gain on the commitment


(i.e., the purchase will now cost less)
cannot be recognized.

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Hedge Of Exposed Monetary Balance


Example
On October 1, 2008, Ardin Ltd. commits to
purchasing merchandise in Germany at a cost of
500,000. At this time the spot rate for Euros is 1
= $1.57. The merchandise is to be delivered and
paid for on May 1, 2009.
On October 1, 2008, Ardin also acquires a term
deposit with a maturity value of 500,000 (ignore the
interest that would accrue on this asset).

Document the
hedging
relationship and
use Cash Flow
Hedge
Accounting.

On December 31, 2008, when Ardin closes its


books, the exchange rate has decreased to 1 =
$1.55. On May 1, 2009, the rate is 1 = $1.52.

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72

Example
Cash Flow Hedge Accounting
October 1, 2008
Term Deposit [(500,000)($1.57)]

$785,000
$785,00
0

Cash
December 31, 2008
OCI - Exchange Loss [(500,000)($1.55 $1.57)]
Term Deposit

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$10,000
$10,000

73

Example
Cash Flow Hedge Accounting
May 1, 2009
OCI - Exchange Loss [(500,000)($1.55 $1.52)]

$15,000

Term Deposit
Cash [(500,000)($1.52)]

$15,000
$760,00
0
$760,00
0

Term Deposit
Merchandise [(500,000)($1.52)]
Cash
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$760,00
0
$760,00
0
74

Example
Cash Flow Hedge Accounting
Alternative

1 Reclassify Immediately

May 1, 2009
Merchandise
OCI Reclassification Adjustment

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$25,000
$25,000

75

Example
Cash Flow Hedge Accounting

Alternative 2 Reclassify When Merchandise Sold

January 1, 2010
Cost Of Goods Sold

$760,00
0

Merchandise

Cost Of Goods Sold


OCI Reclassification Adjustment
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$760,00
0
$25,000
$25,000
76

Hedge Of Net Investment


In Self-Sustaining Operation

Paragraph 3865.58 A hedge of a net investment in a self-sustaining


foreign operation, including a hedge of a monetary item that is
accounted for as part of the net investment (see Foreign Currency
Translation, Section 1651), should be accounted for as follows:
(a) the portion of the gain or loss on the hedging item that is
determined to be an effective hedge (see paragraphs 3865.08
-.45) should be recognized in other comprehensive income (see
Comprehensive Income, Section 1530); and
(b) the ineffective portion of the gain or loss on the hedging item
should be recognized in net income.

The gain or loss on the hedging item relating to the effective portion
of the hedge that has been recognized in other comprehensive
income should be recognized in net income in the same period during
which corresponding exchange gains or losses arising from the
translation of the financial statements of the self-sustaining foreign
operation are recognized in net income. (October, 2006)

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Hedge Of Net Investment


In Self-Sustaining Operation

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Hedge Of Net Investment


In Self-Sustaining Operation
Reduction

In Net Investment

Paragraph 1651.31 An appropriate


portion of the exchange gains and losses
accumulated in the separate component
of accumulated other comprehensive
income should be included in the
determination of net income when there
is a reduction in the net investment.
(October, 2006)
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Discontinuance Of
Hedge Accounting

Discontinue If:

The hedging item ceases to exist


The hedged item ceases to exist
It becomes probable that an anticipated
transaction will not occur
The entity terminates the hedging designation
The hedging relationship ceases to be effective

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International Convergence

Hedging covered in IAS


No. 39, Financial
Instruments
No differences that impact
on the material covered in
this text

Other foreign currency


issues in Chapter 10

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