FAR-F6-M4-Foreign Currency Accounting

Question 1

What are foreign currency transactions?

Answer 1

These are transactions that are done in another currency but reported in the U.S. dollar. The issue is how to convert these transactions to USD and the related gains and losses.

These are transactions with a foreign entity denominated in a foreign currency.

Question 2

What is the definition of a direct rate?

Answer 2

The DOMESTIC PRICE of one unit of a foreign currency. For Example 1 peso = $0.32

Question 3

What is the definition of an indirect rate?

Answer 3

This is the FOREIGN PRICE of one unit of domestic currency. For example $1 = 3.2 pesos

Question 4

What is the definition of the spot rate?

Answer 4

The spot rate is the exchange rate at the current date.

Question 5

What is the definition of a forward rate?

Answer 5

The exchange rate now, for a date in the future.

Question 6

What is a functional currency?

Answer 6

The functional currency is the currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency.

Question 7

Is the following statement true or false. The foreign subsidiary’s functional currency is the currency of the environment in which the subsidiary primarily generates and expends cash.

Answer 7

True. The foreign subsidiary’s functional currency is the currency of the environment in which the subsidiary primarily generates and expends cash.

Question 8

Can the functional currency be a local currency if the foreign entity operates in a highly inflationary environment? Approximately 100% over 3 years?

Answer 8

NO. The functional currency cannot be the local currency if the foreign entity operates in a highly inflationary environment (i.e. 100% over 3 years)

Question 9

What are foreign currency translations?

Answer 9

Foreign currency translations are CONVERSIONS of financial statements of a foreign entity INTO financial statements expressed in the domestic currency (the U.S. dollar)

A second definition is: Foreign currency translation is the RESTATEMENT of financial statements denominated in the functional currency to the reporting currency using the appropriate rates of exchange.

Question 10

What are foreign currency translations?

Answer 10

Foreign currency translations are CONVERSIONS of financial statements of a foreign entity INTO financial statements expressed in the domestic currency (the U.S. dollar)

A second definition is: Foreign currency translation is the RESTATEMENT of financial statements denominated in the functional currency to the reporting currency using the appropriate rates of exchange.

Question 11

What is foreign currency remeasurement?

Answer 11

Foreign currency remeasurement is the RESTATEMENT of foreign financial statements from the foreign currency to the entity’s functional currency in the following situations:
1. the reporting currency is the functional currency
2. the financial statements must be restated in the entity’s functional currency prior to translating the financial statements from the functional currency to the reporting currency.

Question 12

Is the following statement true or false? Before a parent company can consolidate the financial statements of a foreign subsidiary, the subsidiary’s foreign currency financial statements must be restated in the parent company’s reporting currency. The method used to restate the foreign subsidiary’s financial statements is determined by the functional currency of the foreign subsidiary.

Answer 12

True. Before a parent company can consolidate the financial statements of a foreign subsidiary, the subsidiary’s foreign currency financial statements must be restated in the parent company’s reporting currency. The method used to restate the foreign subsidiary’s financial statements is determined by the functional currency of the foreign subsidiary.

Question 13

What are the steps to determine whether the translation method or the remeasurement method should be used to translate the foreign subsidiary’s financial statements to the parent company’s reporting currency?

Answer 13

Step 1: Determine whether the foreign subsidiary is using their functional currency.
IF YES, then use the translation method.
IF NO, then use the remeasurement method.

Question 14

What are the steps undertaken if the remeasurement method must be used?

Answer 14

If the foreign financial statements of the foreign subsidiary are NOT in subsidiary’s functional currency, then the financial statement are REMEASURED to functional currency starting with the BALANCE SHEET.

1. The balance sheet (1st converted to $)
   monetary items use the current / year end rate.
   nonmonetary items use the historical rate
2. The income statement
   nonbalance sheet related items use the weighted average rate.
   Balance sheet related items use the historical rate
   Examples of balance sheet related items are depreciation and PPE / COGS and Inventory / Amortization and Bonds and Intangibles.
3. Record any gain or loss in the income statement.
   Any gains or losses from remeasuring should be included in income from continuing operations of the parent company.

Question 15

Regarding the remeasurement method, where is the PLUG included in, the balance sheet or the income statement?

Answer 15

With the remeasurement method, you’re converting the balance sheet first, to figure out what retained earnings will have to be. Then convert the income statement and if net income is not exactly the same as retained earnings (which it won’t be), we’ll need to PLUG the income statement so that ultimately the right amount goes to retained earnings to make the balance sheet balance.

Question 16

What are the steps undertaken if the translation method is used?

Answer 16

If the financial statements of the foreign subsidiary are in the subsidiary’s functional currency, the financial statements are translated to the reporting currency starting with the income statement.

1. Income Statement (first step to convert to $1)
   All income statement items use the weighted average rate.
   Transfer net income to retained earnings
2. Balance sheet
   Assets and liabilities use the current / year end rate
   Common stock and APIC use the historical rate

Translated retained earnings is equal to beginning retained earnings plus translated net income for the current period (PLUG), less translated dividends declared for the current period.

3. Any gain or loss is recorded in AOCI in consolidated equity until realized. Plug CURRENCY TRANSLATION ADJUSTMENT to OCI

If gain:
Dr. CTA XXX
Cr. OCI (XXX)

If Loss:
Dr. OCI XXX
Cr. CTA (XXX)

Question 17

Will there be a foreign exchange gain or loss recognized if there is a change in exchange rates between the time a purchase or sale in a foreign currency is contracted and the time actual payment is made?

Answer 17

Yes, a foreign exchange transaction gain or loss will result if the exchange rate changes between the time a purchase or sale in a foreign currency is contracted and the time actual payment is made.

Question 18

Is the following statement true or false? A foreign exchange transaction gain or loss that is recognized in net income MUST BE COMPUTED each balance sheet date on all reported transactions denominated in foreign currencies that have not been settled. The difference between the exchange rate used in recording the transaction in dollars and the exchange rate at the balance sheet date is an UNREALIZED GAIN OR LOSS on the foreign currency transaction.

Answer 18

TRUE. A foreign exchange transaction gain or loss that is recognized in net income MUST BE COMPUTED each balance sheet date on all reported transactions denominated in foreign currencies that have not been settled. The difference between the exchange rate used in recording the transaction in dollars and the exchange rate at the balance sheet date is an UNREALIZED GAIN OR LOSS on the foreign currency transaction.