i. introduction a.overview transactions can occur in a variety of ways as follows: us transaction$$...

I. Introduction

A.Overview

Transactions can occur in a variety of ways as follows:

US Transaction $$ (US <---> US)

Foreign Transaction $$ (US <---> Foreign)

Foreign Operation $$ US <---- (Foreign <---> Foreign)

of U.S. Company

Foreign FinancialFC (Foreign <---> Foreign)

Statement

I. Introduction (cont.)

B. Accounting for transactions denominated in a foreign currency

C. Accounting foreign operations

D. Overview of International Accounting Standards Committee Pronouncements

E. Overview of Accounting Standards in Foreign Countries

F. The Future of International Accounting Standards

II. Accounting for Transactions Denominated in a Foreign

CurrencyA. Exposed Foreign Asset or Liability

The collection of a receivable or payment of a liability is a separate event from the related sale or purchase. At the transaction date, all elements of the transaction are translated into dollars and recorded using the current exchange rate. At subsequent balance sheet dates, and at settlement date, any unsettled receivables or payables are adjusted to reflect the current rate. The resulting gain or loss is an element of current income.

EXAMPLE 1

On October 15, 20X1, U.S. Company purchases 10,000 wrenches from a Foreign Company at a price of 8 FCs each. Payments is denominated in FCs and is to be made on March 15, 20X2. Exchange rates are as follows:

October 15, 20X1 $1 = 5 FCS 1 FC = $.20

December 31, 20X1$1 = 3 FCS 1 FC = $.333

March 15, 20X2 $1 = 4 FCS 1 FC = $.25

EXAMPLE 1

SOLUTION - October 15, 20X2

Inventory 8 FC X 10,000 X $.20 = $16,000

Accounts Payable $16,000

SOLUTION - December 31, 20X2

Accounts Payable 8 FC X 10,000 X $.333 = $26,667Exchange Loss $26,667 - $16,000 = $10,667

SOLUTION - March 15, 20X2

Amount Paid 8 FC X 10,000 X $.25 = $20,000

Exchange Gain $26,667 - $20,000 = $ 6,667


Currency (cont.)B. Hedged Foreign Asset or Liability

When an existing net asset position (where

receivables denominated in a foreign currency exceed the payables) or net liability position (where payables exceed receivables) is hedged, offsetting receivables and payables are created. The resulting gains and losses that are incurred cancel out.

EXAMPLE 2

U.S. Company buys inventory with a cost of 2,500 FCs from Foreign Company on December 1, 20X2 payable on April 1, 20X3. Also on December 1, 20X2 U.S. Company bought a forward exchange contract to buy 2,500 FCs at $2.02. Spot exchange rates are as follows:

December 1, 20X2 1 FC = $2.00 $1 = .50

FC

December 31, 20X2 1 FC = $2.04 $1 = .49 FC

April 1, 20X3 1 FC = $2.10 $1 = .486 FC

EXAMPLE 2


Inventory 2,500 FC X $2.00 = $5,000

Accounts Payable $5,000

FC Receivable 2,500 FC X $2.00 = $5,000

Deferred Premium 2,500 FC X .02 = $ 50

Due to Exchange Broker $5,050


Exchange Loss 2,500 X (2.04 - 2.00) = $ 100

Accounts Payable 2,500 FC X $2.04 = $5,100

Exchange Gain 2,500 X (2.04 - 2.00) = $ 100

Accounts Receivable 2,500 FC X $2.04 = $5,100

Forward Contract Expense $50 X 1/4 = $ 12.50

EXAMPLE 2

SOLUTION - April 1, 20X2Exchange Loss 2,500 X (2.10 - 2.04) = $ 150

Amount Paid 2,500 FC X $2.10 = $5,250

Exchange Gain 2,500 X (2.10 - 2.04) = $ 150

Amount Received 2,500 FC X $2.10 = $5,250

Forward Contract Expense $50 X 3/4 = $ 37.50


Currency (cont.)C.Exposed Foreign Currency Commitment

There is no transaction or accounting event until the product is delivered.

When the product is delivered, the spot rate in effect at that date is used as the recorded cost of the asset.

D.Hedged commitment

Since a foreign currency commitment is not recorded until the product is delivered, the gain or loss on the forward exchange contract is deferred and closed to the cost of the product purchased.

EXAMPLE - 3

On October 10, 20X3, U.S. Company agrees to buy equipment from Foreign Company for 160,000 FCs. The equipment is scheduled for delivery on February 15, 20X4 and payment is due on that date. On October 10, 20X3, U.S. Company enters into a forward exchange contract to purchase 160,000 FCs at $1.02 for delivery on February

15, 20X4. Spot exchange rates are as follows:

October 10, 20X3 1 FC = $1.00 $1 = 1.00 FC

December 31, 20X3 1 FC = $1.06 $1 = .94 FC

February 15, 20X4 1 FC = $1.10 $1 = .91 FC

EXAMPLE - 3

SOLUTION - October 10, 20X3


Deferred Premium 160,000 FC X .02 = $ 3,200



Def Exchange Gain 160,000 X (1.06 - 1.00) = $ 9,600

FC Receivable 160,000 FC X $1.06 = $169,600Deferred Premium 160,000 FC X .02 = $ 3,200


EXAMPLE - 3

SOLUTION - February 15, 20X3

Def Exchange Gain 160,000 X (1.10 - 1.06) = $ 6,400


FC Received = $176,000

FC Paid 160,000FC X $1.10 = $176,000

Equipment 160,000 + 3,200 = $163,200

III. Accounting for Foreign Operations

A. Financial Statements of Foreign

Operation must conform to U.S. Generally Accepted Accounting Principles

1. Equity method investments

2. Consolidated financial statements

III. Accounting for Foreign Operations (cont.)

B.Determining the "Functional Currency" of the Foreign Operation

The functional currency of an investee company is the

currency in which it primarily generates and expends cash. If an entity's operations are self-contained and integrated within a particular country, the functional currency will be the currency of that country. If the entity is an integral component of the parent company, the functional currency would be that of the parent. If the foreign functional currency's cumulative three-year exchange rate is 100% or more, the currency is considered too unstable and its functional currency would be that of the parent.


C. Translation versus Remeasurement

The approach to converting financial statement amounts denominated in foreign currencies depends upon the defined functional currency.


1. Translation

If the functional currency is the local currency, the financial statement amounts are "translated." Translation produces a balance sheet that is the foreign balance sheet amounts converted to the parent's currency using the spot rate in effect at the balance sheet date. It produces an income statement that is the foreign income statement amounts converted to the parent's currency using the spot rate in effect at the transaction date. This is consistent with the idea that the foreign operation is a separate operation operating in the foreign country.

1. Translation

Assets and Liabilities Current Rate

Revenues and Expenses Average Current Rate

Paid-in-Capital Historical Rate

Gains and Losses - Separate Section of Owners' Equity


2.Remeasurement

If the functional currency is not the local currency, the financial statement amounts are "remeasured." Remeasurement produces results similar to the translation of foreign transactions discussed previously. This is consistent with the idea that the foreign operation is merely an arm of the parent company conducting parent company

transactions in the foreign country.

2. Remeasurement

Monetary Assets and Liabilities Current Rate

Non-Monetary Assets and LiabilitiesHistorical Rate

Most Revenues and Expenses Average Current Rate

Cost of Goods Sold and Depreciation Historical Rate

Paid-in-Capital Historical Rate

Gains and Losses Income Statement

i. introduction a.overview transactions can occur in a variety of ways as follows: us transaction$$...

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