Exam #2 Flashcards
What is a DIRECT exchange rate?
The number of local currency units (LCU) needed to acquire one foreign currency unit (FCU). Also known as “American Terms”.
What is the equation for the direct rate?
$/1 FCU
What is an INDIRECT exchange rate?
The number of foreign currency units (FCU) needed to acquire one local currency unit (LCU). Also known as “European Terms”.
What is the equation for the indirect rate?
FCU/$1
What happens when the value of USD weakens?
- Direct exchange rate increases (b/c it takes more to acquire an FCU).
- Indirect exchange rate decreases (b/c $1 acquires fewer FCU).
What happens when the value of the USD strengthens?
- Direct exchange rate decreases (b/c it takes less to acquire an FCU).
- Indirect exchange rate increases (b/c $1 acquires more FCU).
Foreign Currency Exchange Rates are Calculated as follows:
_____ currency
_______________
_____ currency
Terms Currency
_________________
Base Currency
What is the spot rate?
The exchange rate for immediate delivery of currencies.
“At this moment”.
What is the current rate?
The spot rate on the entity’s balance sheet date.
“At year end”.
What is the forward rate?
The expected fair value of a currency.
“In the future”.
The “spread” refers to the difference between what rates?
Difference between the forward rate and the spot rate on any given date. This gives information about the perceived strengths or weaknesses of currencies.
What is functional currency?
Normally. the currency in which the foreign entity performs most of its cash functions (exception: highly inflationary economies).
What is reporting currency?
The currency used on financial statements of business entity (assumed to be USD for US-based entities).
What is local currency?
Currency used in the country where the company is located (even if the company doesn’t use this currency in business)
What are Foreign Currency Transactions related to?
Economic activities in a currency other than the entity’s reporting currency.
What happens at the transaction date?
Record the purchase/sale transaction at USD-equivalent value using the spot direct exchange rate.
What happens at the balance sheet date?
Adjust the payable/receivable to the USD-equivalent value using the current direct exchange rate.
What happens at the settlement date?
Adjust the foreign currency payable or receivable for any changes in exchange rate using the spot direct exchange rate.
1. Recognize any exchange gain/loss for the change in rates.
2. Record the settlement of the foreign currency payable/receivable.
What is recording currency?
The currency used to record the economic activities in the ledger of the entity. Typically, the LCU but could be another.
What is the goal of translation and remeasurement?
To convert financial reports into a version that can be consolidated w/ the US parent company.
Translation (to USD/reporting currency) is necessary when?
Recording currency equals functional currency.
Remeasurement (to functional currency) is necessary when?
Recording currency does not equal functional currency.
When are both translation and remeasurement required?
If the recording currency doesn’t equal functional currency & functional currency does not equal USD.
What is the first step of conversion?
Remeasurement first, then translation.
1) Is the recording currency equal to the functional currency?
YES: Translate to USD.
NO: Remeasure to functional currency.
2) Is functional currency equal to USD?
YES: No further work is needed.
NO: Translate to USD.
What is translation?
Converting the foreign entity’s functional currency into USD.
What is remeasurement?
Converting the foreign entity’s statements into its functional currency.
What is the recording currency when translating?
Same as functional.
What is the functional currency when translating?
No equal to USD.
What is the reporting currency when translating?
USD.
What is the method name for translation?
Current Rate Method.
What rate is used for assets & liabilities when translating?
Current Rate.
What rate is used for retained earnings when translating?
Mixed Rate (rolled forward from PY).
What rate is used for other stockholders’ equity when translating?
Historic Rate (dividends under this category)
- Use the latter of the event date (ex: date dividends are declared) or the subsidiary acquisition date.
What rate is used for revenues & expenses when translating?
Average Rate.
What exchange rate adjustment when translating?
Shows up as Other Comprehensive Income (OCI).
What is the recording currency when remeasuring?
Not the same as functional.
What is the functional currency when remeasuring?
Often USD (but can be other).
What is the reporting currency when remeasuring?
USD.
What is the method name for remeasurement?
Temporal Method.
What rate is used for assets & liabilities when remeasuring?
Monetary: Current Rate.
Nonmonetary: Historical Rates.
What rate is used for retained earnings when remeasuring?
Mixed (rolled forward).
What rate is used for other stockholders’ equity when remeasuring?
Historic (dividends).
What rate is used for revenues & expenses when remeasuring?
Mostly Average Rate
OR
Historic if related to nonmonetary items (ex: COGS & Depr. Expense).
What exchange rate adjustment when remeasuring?
Net Income on the Income Statement.
What are monetary accounts?
Accounts related to money with amounts that are “fixed” in terms of the units of currency.
What are examples of monetary items?
- Cash & cash equivalents.
- Receivables, and payables.
What are examples of nonmonetary accounts on the balance sheet?
- Marketable Securites.
- Inventories.
- Prepaid Expenses.
- PP&E.
- Accumulated Depreciation.
- Goodwill.
- Deferred Income.
- Common Stock.
What are examples of nonmonetary accounts on the income statement?
- COGS.
- Depreciation Expense.
- Amortization of Intangibles.
True or False: Translation adjustments do not affect net income and will not be part of retained earnings.
TRUE!
How does importing and exporting settlements in dollars effect exchange rates?
There is no effect to the direct or indirect exchange rates.
How does importing settlements in LCU’s effect exchange rates?
Direct increases = loss
Direct decreases = gain
Indirect increases = gain
Indirect decreases = loss
How does exporting settlements in dollars effect exchange rates?
Direct increases = gain
Direct decreases = loss
Indirect increases = loss
Indirect decreases = gain
