International Acc Chapter6

8/17/2019 International Acc Chapter6

1/37

CHAPTER 6

FOREIGN CURRENCY

TRANSACTIONS AND

HEDGING FOREIGNEXCHANGE RISK


2/37

FOREIGN CURRENCY TRANSACTIONS

Export sales and import purchases areinternational transactions. When two partiesfrom dierent countries enter into atransaction, they must decide which of the

two countries' currencies to use to settle thetransaction. For example, if a U.S. computermanufacturer sells to a customer in Japan, theparties must decide whether the transactionwill be denominated i.e., whether paymentwill be made! in U.S. dollars or Japanese yen."n some cases, a third country's currency

mi#ht be used to denominate the transaction.


3/37

FOREIGN CURRENCY TRANSACTIONS

$ssume that a U.S. exporter Eximco! sells

#oods to a Spanish customer with payment tobe made in euros. "n this situation, Eximcohas entered into a forei#n currencytransaction. "t must restate the euro amount

that actually will be recei%ed into U.S. dollarsto account for this transaction. &his is becauseEximco eeps its boos and prepares (nancialstatements in U.S. dollars. $lthou#h theSpanish importer has entered into aninternational transaction, it does not ha%e aforei#n currency transaction payment will bemade in its home currency! and norestatement is necessary.


4/37

• $ssume that as is customary in its industry,Eximco does not re)uire immediate paymentand allows its Spanish customer three months

to pay for its purchases. *y doin# this, Eximcoruns the ris that from the date of the sale ismade until the date of payment, the euromi#ht decrease in %alue depreciate! a#ainst

the US. dollar and the actual number of U.S.dollars #enerated from the sale will be lessthan expected. "n this situation Eximco is saidto ha%e an exposure to forei#n exchan#e ris.


5/37

Accounting Issue

• &he ma+or issue in accountin# for forei#n currencytransactions is how to deal with the chan#e in the

domestic currency %alue of the sales re%enue andaccount recei%able resultin# from the export whenthe forei#n currency chan#es in %alue. &he corollaryissue is how to deal with the chan#e in the domesticcurrency %alue of the forei#n currency accountpayable and #oods bein# ac)uired in an importpurchase.

• $ssume that Eximco sells #oods to a Spanishcustomer at a price of million euros -! when the

spot exchan#e rate is ./0 per euro. "f paymentwere recei%ed at the date of sale, Eximco could ha%econ%erted -,000,000 into ,/00,000 and thisamount clearly would be the amount at which the

sales re%enue would be reco#ni1ed. "nstead, Eximcoallows the S anish customer three months to a for


6/37

Accounting Alternti!es

7onceptually, the two methods of accountin# for

chan#es in the %alue of a forei#n currency transactionare the one8transaction method and the two8transaction method. &he one8transaction methodassumes that an export sale is not complete until theforei#n currency recei%able has been collected and

con%erted into U.S. dollars. $ny chan#e in the U.S.8dollar %alue of the forei#n currency will be accountedfor as an ad+ustment to $ccounts 9ecei%able and toSales. Under this method, Eximco would ultimately

report Sales at ,230,000 and an increase in the7ash account of the same amount. &his approach canbe critici1ed because it hides the fact that thecompany could ha%e recei%ed ,/00,000 if theSpanish customer had been re)uired to pay at thedate of sale. &he company incurs a 50,000 loss


7/37


8/37

Under the two8transaction method, Eximco recordsthe U.S. dollar %alue of the sale at the date the saleoccurs. $t that point the sale has been completed>there are no subse)uent ad+ustments to the Salesaccount. $ny dierence between the number of U.S.dollars that could ha%e been recei%ed at the date ofsale and the number of U.S. dollars actually recei%ed

at the date of payment due to ?uctuations in theexchan#e rate is a result of the decision to extendforei#n currency credit to the customer. &hisdierence is treated as a Forei#n Exchan#e :ain or

@oss that is reported separately from Sales in theincome statement. Usin# the two8transactionmethod to account for its export sale to Spain,Eximco would mae the followin# +ournal entriesA


9/37


10/37


11/37

5 $ccounts recei%able -!-,000,000B./! ./00.000

Forei#n Sales ./00.000

&o record the sale and euro recei%able at

the spot rate of ./0

5y

$ccounts recei%able -! -,000,000B0.0! 0.000

Forei#n exchan#e #ain 0.000

Forei#n exchan#e #ain 0.000

Income summary 0.000

Forei#n exchan#e loss 0.0007ash -,000,000B.23! .230.00

0

$ccounts recei%able -!-,000,000B./!

./0.000

12/31y2 Income summary 30000

Forei#n exchan#e loss 30000

&he net impact on income in Cear includes Sales of,/00,000 and a Forei#n Exchan#e :ain of 0,000> in

Cear 5, a Forei#n Exchan#e @oss of 0,000 is recorded.


12/37

Summary for unsettled transaction accordance with IAS 21

Journal entries for importer 's Journal entries for exporter's

G Forei#n purchases G $9spot rate!


13/37

Example Ho A


14/37

solution amount in millions!

Ho%.5y

Forei#n purchases ./

$ccounts payable (3 * 5.5=16.5) ./


15/37

Example HoA 5

a?e the aroriate o&rna entrie' on +in$-Star Coman!

record' &nti )ec. ,1/ 2014 in accordance with IAS ;21=. The

e7chan$e rate' between #6 and #&ro were a' "oow'8


16/37

solution amount in millions!

185 machine' Jun 0

185 9.25=185($; - 50*

74 €20*40%=€8*9.25=74(($; $u# 0

73.2 )cash- 3BM./LK.50.8 forei#n exchan#e #ain

111 €20*60%=€12*9.25=111(($;


17/37

Example HoA

-In Day /, 502 in#8star company from E#ypthas ordered new machineries from I&$

manufacturin# 7orporation from France for 0million Euro, the settlement will be throu#h twopayments the (rst 0N after two months fromtransaction date and the second after (%e months

from the date of the (rst payment. In June 0 theorder has been shipped.

Re(uire):

Dae the appropriate +ournal entries on Oin#8

Star 7ompany records until


18/37

Solution amount in millions!277.5 machines Jun 0

277.5 9.25=277.5($; - 0*

83.25 €30*30%=€9*9.25=83.25(($; $u#0

82.35 )cash- MBM./L35.3

0.9 forei#n exchan#e #ain

1.05 €21*)9.25-9.2(=1.05(($;


19/37

HEDGING FOREIGN EXCHANGE RISK "n the precedin# example, Eximco has an asset exposurein euros when it sells #oods to the Spanish customer and it

allows the customer three months to pay for its purchase. "fthe euro depreciates o%er the next three months, Eximcoincurs a forei#n exchan#e loss. For many companies, theuncertainty of not nowin# exactly how much domesticcurrency will be recei%ed on this export sale is of #reat

concern. &o a%oid this uncertainty, companies often useforei#n currency deri%ati%es to hed#e a#ainst the eect ofunfa%orable chan#es in the %alue of forei#n currencies. &hetwo most common deri%ati%es used to hed#e forei#n

exchan#e ris are forei#n currency forward contracts andforei#n currency options. &hrou#h a forward contract,Eximco can loc in the price at which it will sell the euros itrecei%es in three months. $n option establishes a price atwhich Eximco will be able, but is not re)uired, to sell the

euros it recei%es in three months. "f Eximco enters into a

FOR*ARD CONTRACT USED TO HEDGE A RECOGNI+ED FOREIGN ,


20/37

FOR*ARD CONTRACT USED TO HEDGE A RECOGNI+ED FOREIGN ,CURRENCY DENO-INATED

We now return to the Eximco example in which thecompany has a forei#n currency account recei%able todemonstrate the accountin# for a hed#e of a reco#ni1ed

forei#n8currency8denominated asset. "n the precedin#example, Eximco has an asset exposure in euros when itsells #oods to the Spanish customer and allows thecustomer three months to pay for its purchase. &o hed#e itsexposure to a decline in the U.S. dollar %alue of the euro,Eximco decides to enter into a forward contract.

$ssume that on the date of sales, the three8monthforward rate for euros is .23/ and Eximco si#ns a contractwith First Hational *an to deli%er -,000,000 in three

months in exchan#e for ,23/,000. Ho cash chan#es handson this date. :i%en that the spot rate on this date is ./0,the euro is sellin# at a discount in the three8month forwardmaret the forward rate is less than the spot rate!. *ecausethe euro is sellin# at a discount of 0.0/ per euro, Eximcorecei%es /,000 less than if payment had been recei%ed at

FOR*ARD CONTRACT USED TO HEDGE A RECOGNI+ED FOREIGN


21/37

FOR*ARD CONTRACT USED TO HEDGE A RECOGNI+ED FOREIGN ,CURRENCY DENO-INATED

7onceptually, this expense is similar to the transaction lossthat arises on the export sale. "t exists only because thetransaction is denominated in a forei#n currency. &he ma+or

dierence is that Eximco nows the exact amount of thediscount expense at the date of sale, whereas, if the recei%ableis left unhed#ed, Eximco does not now the si1e of thetransaction loss until three months pass. "n fact, it is possiblethat the unhed#ed recei%able could result in a transaction #ain

rather than a transaction loss. :i%en that the future spot rate turns out to be only .23,sellin# euros at a forward rate of .23/ is ob%iously betterthan lea%in# the euro recei%able unhed#edPEximco willrecei%e /,000 more as a result of the hed#e. &his can be%iewed as a #ain resultin# from the use of the forward contract.Unlie the discount expense, the exact si1e of this #ain is notnown until three months pass. "n fact, it is possible that useof the forward contract could result in an additional loss. &his

would occur if the spot rate on date of payment is hi#her thanthe forward rate of .23/.!

Journal entries in eximco


22/37

Journal entries in eximco

Date of sales A / R ( .1 1.5) 1.5

!ore"#n sa$es 1.5

!or%ar& con'rac' rece"a$e (-1× 1.485) 1.485 e+erre& $oss 0.015

!or%ar& con'rac' (-1× 1.5) 1.5

Date ofpayment

Cash (-1× 1.48) 1.48

!ore"#n ,chan#e $oss 0.02

/ (-1× 1.5) 1.5

!or%ar& con'rac'

!or%ar& con'rac' #a"n

cash (-1× 1.48)

1.5

0.02

1.48

Cash 1.485

Forward contract receia!le 1.485


23/37

"nd oft#e year

Forward contract "$p 0.015

e+erre& $oss 0.015

Forward contract %ain

&ncome s'mmary

Forward contract "$p

Forei%n "$c#an%e loss

0.02

0.015

0.015

0.02

Summary for forward contract


24/37


Journal entries for importer Journal entries for exporter

G Forei#n purchases G $9spot rate!


25/37


Journal entries for importer Journal entries for exporter

G !or%ar& con'rac' , G !or%ar& con'rac' , En

doftheyear

G e+erre& $oss G e+erre& $oss

G !or%ar& con'rac' #a"ns G !or%ar& con'rac' #a"ns

G Income summary G Income summary

G !or%ar& con'rac' , G !or%ar& con'rac' ,

G !ore"#n ,chan#e $oss G !ore"#n ,chan#e $oss

e+erre& #a"n e+erre& #a"n or

!or%ar& con'rac' e !or%ar& con'rac' e

G!or%ar& con'rac' #a"ns

G!or%ar& con'rac' #a"ns

G !or%ar& con'rac' e G !or%ar& con'rac' e

G Income summary G Income summary

G !ore"#n ,chan#e $oss G !ore"#n ,chan#e $oss

HI&E A 89ed colour means I9

Example 2 settled transaction!


26/37

Example 2 settled transaction!

US

Ho%. 0, 502 K. 1.5


27/37

the acco&ntin$ entrie' in BON ro&

'ly

1

A / R (* 20 1.4) 28

!ore"#n sa$es 28 !or%ar& con'rac' rece"a$e (20 × 1.3) 26

e+erre& $oss 2

!or%ar& con'rac' ( 20 × 1.4) 28

A'% 1 Cash (10 × 1.6) 16

/ ( 10 × 1.4) 14

!ore"#n ,chan#e #a"ns 2

!or%ar& con'rac'

!or%ar& con'rac' $oss

cash( 10 × 1.6)

14

2

1+

Cash( 10 × 1.3) 13

Forward contract receia!le 1


28/37

,ct. 1 -as# (*10 1.5) 15

/ ( 10 × 1.4) 14

!ore"#n ,chan#e #a"n 1 !or%ar& con'rac' 14

!or%ar& con'rac' $oss 1

Cash( 10 × 1.5) 15

Cash 13

!or%ar& con'rac' rece"a$e. 1

Dec 1 !or%ar& con'rac' , 2

e+erre& $oss 2

Forei%n "$c#an%e %ain

&ncome s'mmary


Forward contract loss

2

2


29/37

the acco&ntin$ entrie' in @TR# Co

'ly

1

Forei%n p'rc#ases 14+

/ (20×.3) 14+

!or%ar& con'rac' (20 × .3) 146

e+erre& $oss 4

!or%ar& con'rac' aya$e (20 × .5) 150

A'% 1 !or%ar& con'rac' aya$e 5 Cash 5

Cash (10 × .9) 9

!or%ar& con'rac'


+

/ (10×.3) 3

!ore"#n ,chan#e $oss 6

-as# (*10 .)


30/37

,ct 0 Forward contract paya!le 5

Cash 5

Cash (10 × .2) 2

!or%ar& con'. $oss 1

!or%ar& con'rac'

/ (10×.3)

!ore"#n ,chan#e #a"n

Cash(10×.2)

3

12

Dec. 1 !or%ar& con'. e 4

e+erre& $oss 4 !or%ar& con'rac' #a"ns 5

Income summary 4

!or%ar& con'rac' , 4

Forei%n "$c#an%e loss 5

Example / unsettled transaction!


31/37

Example / unsettled transaction!

US

Ho%. 0, 502 K. 1.5


32/37


'ly

1

A / R (* 20 1.4) 28

2014 !ore"#n sa$es 28 !or%ar& con'rac' rece"a$e (20 × 1.3) 26

e+erre& $oss 2

!or%ar& con'rac' ( 20 × 1.4) 28

A'% 1 Cash (10 × 1.6) 16

2014 / ( 10 × 1.4) 14


!or%ar& con'rac'

!or%ar& con'rac' $oss

cash( 10 × 1.6)

14

2

1+

Cash( 10 × 1.3) 13

Forward contract receia!le 1



33/37


Dec.1 Forei%n "$c#an%e loss 1

2014 / ( 10 × (1.4-1.3) 1

!or%ar& con'rac' 1 !or%ar& con'rac' #a"n 1

!or%ar& con'rac' e 1.25

e+erre& $oss(2*5/8) 1.25


&ncome s'mmary


Forward contract e$p

1

1..25

1

1.25


34/37

mar.1 -as# (*10 1.5) 15

2015 / ( 10 × 1.3) 1

!ore"#n ,chan#e #a"n 2 !or%ar& con'rac' 13

!or%ar& con'rac' $oss 2

Cash( 10 × 1.5) 15

Cash 13

!or%ar& con'rac' rece"a$e. 1

Dec 1 !or%ar& con'rac' , .5

2015 e+erre& $oss .5


&ncome s'mmary



2

.5

.5

2


35/37

the acco&ntin$ entrie' in @TR# Co

'ly

1

Forei%n p'rc#ases 14+

/ (20×.3) 14+

!or%ar& con'rac' (20 × .3) 146

e+erre& $oss 4

!or%ar& con'rac' aya$e (20 × .5) 150

A'% 1 !or%ar& con'rac' aya$e 5 Cash 5

Cash (10 × .9) 9

!or%ar& con'rac'


+

/ (10×.3) 3

!ore"#n ,chan#e $oss 6

-as# (*10 .)



36/37


Dec.1 Forei%n "$c#an%e loss 1

2014 / ( 10 × (.4-.3) 1

!or%ar& con'rac' 1 !or%ar& con'rac' #a"n 1

!or%ar& con'rac' e 2.5

e+erre& $oss(4*5/8) 2.5

Forward contract %ain

&ncome s'mmary

Forei%n "$c#an%e loss

Forward contract e$p

2.5

2.5


37/37

mar. 0 Forward contract paya!le 5

2015 Cash 5

Cash (10 × .2) 2

!or%ar& con'. $oss 2

!or%ar& con'rac' 4

/ (10×.4)

!ore"#n ,chan#e #a"n Cash(10×.2)

4

2

2

Dec. 1 !or%ar& con'. e 1.5

2015 e+erre& $oss 1.5


Income summary 1.5

!or%ar& con'rac' , 1.5

F. -ont. loss 2

International Acc Chapter6

Documents

Transcript of International Acc Chapter6