Derivatives and Foreign Exchange Flashcards
How are gains and losses on financial instruments that hedge trading securities reported?
Reported in earnings with reporting unrealized gains and losses on trading securities
Define derivative instrument
A derivative instrument is a financial instrument or other contract that derives its value from the value of some other instrument and has all three of the following characteristics:
1. one or more underlyings and one or more notional amounts or payment provisions (or both)
2. requires no intiial net investment
3/ its terms require or permit a net settlement
Define underlying and notional amount
Underlying: Specified price, rate, or other variable (e.g., interet rate, security price, foreign exchnage rate, index or preices or rates, etc.)
Notional amount: A specified unit of measure (currency nuits, shares, bushels)
Name the four common derivative instruments
- options
- futures
- forward
- swaps
Identify the three types of hedge designations
Fair value hedge
Cash flow hedge
foreign currency hedge
describe the accounting for changes in fair value associated with each type of hedge designation
Fair value hedge: Included in current earnings with gain or loss from change in value of offsetting asset/liability
cash flow hedge: Effective portion- included in OCI until cash flows from hedge item are realized
Ineffective portion- included in current earnings
Foreign currency hedge-
Fair value hedge- included in current earnings with gain or loss from change in value of offsetting asset/liability
Cash flow hedge- included in OCI (effective portion)
net investment hedge- included in oci as cumulative translation adjustment
What are monetary items
assets and liabilities that are fixed in amount by contract or in terms of number of dollars
- examples include: cash, accounts and notes rec, and accounts and notes payable
- these items are already stated in constant dollars
What are nonmonetary items
- assets and liabilities that fluctuate in value with inflation/deflation
- i.e., inventories, property, plan and equipment, and capital stock. These items need to be restated to constant dollar
Identify the two foreign currency activities
- foreign currency translations
- Transactions
What is an entity’s functional currency under GAAP?
The functional currency is the currency of the primary economic environment in which the entity operates. All of the following conditions must be met:
- The foreign operations are relatively self-contained and integrated within the country
- the day to day operations do not depend on the parents of investor’s functional currency
- The local economy of the foreign entity is not highly inflationary
When is the translation method used?
Translation is used to restate financial statements denominated in the functional currency to the reporting currency
When is the remeasurement method used?
Remeasurement is used to restate financial statements from the foreign currency to the entity’s functional currency when:
- The reporting currency is the functional currency
- The financial statements must be restated in the entity’s functional currency prior to translating from the functional currency to the reporting currency
Identify the exchange rate to be used when remeasuring different components of the balance sheet and income statement
Balance sheet:
- monetary- current exchange rate
- non-monetary- historical rate
Income statement-
- balance sheet related- historical rate
- non-balance sheet related- weighted average
Identify the exchange rate to be used when translating different components of the balance sheet and income statement
Assets and liabilities:
current exchange rate
common stock and APIC:
historical rate
Revenue and expenses:
weighted average exchange rate for the period
Where are remeasurement gains/losses reported in the financial statements
Remeasurement gains and losses are recognized on the income statement
Where are translation adjustments reported in the financials?
Translations gains and losses are reported in OCI. They are treated as unrealized gains and losses
State two types of foreign currency transactions
- operating transactions, such as importing, exporting, borrowing, lending, and investing
- Forward exchange contracts- which are agreements to exchange two different currencies at a specified future date and at a specific rate
Where are foreign currency transaction gains and losses reported in the financial statements
foreign currency transaction gains or losses are included in determining net income for the period
For operating transactions in foreign currency, detail the recording process
- record original transaction exchange or spot rate on date of transaction
- At balance sheet date, compute gain/loss on the transaction by recalculating using the current exchange or spot rate
- On payment date, compute gains/loss on the transaction by using the exchange rate on payment date
