Chapter 9: Foreign Currency Transactions

Question 1

Direct quotes

Answer 1

number of U.S dollars to purchase on foreign currency unit

Question 2

indirect quotes

Answer 2

the number of foreign currency units that can be obtained with one U.S dollar

Question 3

spot rate

Answer 3

the price at which a foreign currency can be purchased or sold today

Question 4

forward rate

Answer 4

the price today at which foreign currency can be purchased or sold sometime in the future

Question 5

forward exchange contracts

Answer 5

provide companies with the ability to lock in a price today for purchase or selling currency at a specific future date

Question 6

foreign currency options

Answer 6

provides the right but not the obligation to buy or sell foreign currency in the future, and therefore are more flexible than forward contracts

Question 7

Export sale

Answer 7

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

Question 8

import purchase

Answer 8

a transaction exposure exists when the importer is required to pay in foreign currency and allows the buyer to pay sometime after the sale has been made

Question 9

Two-transaction treatment

Answer 9

1. the initial transaction is recorded at the US dollar value at the spot exchange rate at the date of the transaction
2. subsequent changes in the exchange rate until collection of the receivable are reflected through a restatement of the foreign currency account receivable with an offsetting foreign exchange gain or loss reported in income

Question 10

foreign exchange risk

Answer 10

this is the risk that changes in the exchange rate over time will result in a foreign exchange loss

Question 11

If the balance sheet date falls between the transaction date and payment date…

Answer 11

the foreign currency receivable/payable is revalued based on exchange rates at the balance sheet date

Question 12

What value are derivatives carried at on the balance sheet?

Answer 12

fair value

Question 13

How does the fair value of derivatives on the balance sheet change how they are classified?

Answer 13

derivatives are reported on the balance sheet as assets when they have a positive fair value and as liabilities when they have a negative fair value

Question 14

What three conditions allow for hedge accounting?

Answer 14

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 hedge item
3. the derivative is properly documented as a hedge

Question 15

Cash flow hedges

Answer 15

foreign currency dominated assets and liabilities, foreign currency firm commitments, and forecasted foreign currency transactions

Question 16

fair value hedges

Answer 16

foreign currency dominated assets and liabilities, foreign currency firm commitments

Question 17

For cash flow hedges of foreign currency denominated assets and liabilities, at each balance sheet date:

Answer 17

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.
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).
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.
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).

Question 18

Accounting for a hedge of a forecasted transaction differs from the accounting for a hedge of a foreign currency firm commitment in two ways

Answer 18

1. Unlike the accounting for a firm commitment, there is no recognition of the forecasted transaction or gains and losses on the forecasted transaction.
2. The hedging instrument (forward contract or option) is reported at fair value, but because there is no gain or loss on the forecasted transaction to offset against, changes in the fair value of the hedging instrument are not reported as gains and losses in net income. Instead they are reported in other comprehensive income. On the projected date of the forecasted transaction, the cumulative change in the fair value of the hedging instrument is transferred from other comprehensive income (balance sheet) to net income (income statement).

Question 19

For fair value hedges of foreign currency denominated assets and liabilities, at each balance sheet date:

Answer 19

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.
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 gain or loss in net income.

Question 20

 Under fair value hedge accounting for hedges of foreign currency firm commitments:

Answer 20

• the gain or loss on the hedging instrument is recognized currently in net income, and
• the change in fair value of the firm commitment is also recognized currently in net income.

Question 21

Which of the following does U.S GAAP not consider to be an objective of segment reporting?

Answer 21

it helps users make comparisons between a segment of one enterprise and a similar segment of another enterprise.

Question 22

Which of the following operating segment disclosures is not required under current U.S accounting guidelines?
a. liabilities
b. interest expense
c. intersegment sales
d. unusual items

Answer 22

A

Question 23

In determining whether a particular operating segment is of significant size to warrant disclosure, which of the following is true?

Answer 23

three tests are applied, and only one must be met