FAR - Specific Transactions, Events, & Disclosures - Foreign Currency Denomination Flashcards
Foreign Currency Denomination transaction
transaction in foreign currency but reported in USD (AKA translation)
Impacts foreign currency transactions/translations
exchange rate
price of 1 unit of currency expressed in foreign currency units
2 types of exchange rates
direct: domestic price of 1 unit of FC
EX: 1 euro = $1.24
indirect: foreign price of 1 unit of domestic currency
EX: 1 USD = .806
*they are reciprocals
EX: 1/1.24 = .806
spot rate
exchange rate at current date
forward rate
exchange rate now for delivery at future date
functional currency
currency of primary economic environment in which entity operates/makes CF
transaction measured/reported in?
Conversion?
Measured/reported in USD
FC units converted to USA using spot date @ date of transaction
Effects of exchange rate changes are recognized?
1) on accts denominated in FC
2) in period exchange % changes
3) as adj. to acct balance/ exchange gain (loss)
3 dates where measurement of FC effects financials?
1) transaction date
2) balance sheet
3) settlement date
Transaction date
FC units X Spot Rate = USD
1) determine FC units to settle transaction
2) convert FC to USD
*record transaction @ converted dollar &; no gain/loss recorded - RECOGNIZE
DR: Purchases
CR: A/P (fluctuates due to exchange rate changes)
Balance Sheet Date
1) determine new $ amount to settle transaction
FC units X Spot Rate = NEW USD
2) Determine difference between new dollar value and already recorded dollar value
New Value - Recorded USD = Difference
3) Record difference as adj. to recorded FC Receivable or Payable & recognize exchange gain/loss
Settlement Date
Determine new USD amount to settle
FC units X spot rate = NEW usd
2) determine difference between new USD & recorded value
new usd - recorded = diffference
3) record difference as adj to recorded FC receivable or payable & recognize exchange gain/loss
foreign currency transactions
Transactions of a domestic entity denominated in a foreign currency but to be recorded on the domestic entity’s books in the domestic currency.
foreign currency translation
Financial statements denominated in (expressed in terms of) a foreign currency but to be reported in the domestic currency (on financial statements).
foreign currency operating transaction
transaction that is denominated in a foreign currency
true/false
Foreign currency exchange gains (losses) on A/R are reported in current income as an item of income from continuing operations.
true
true/false
When there is a gain on a receivable that is denominated in a foreign currency, it means that the same number of foreign currency units translates into more dollars. Thus, the number of units (yen) per dollar declined.
When there is a loss on a payable, it means that they had to pay more dollars to settle the loan for the fixed amount of francs. Using an indirect quote, this means that the number of francs per dollar declined (it takes more dollars to get the same amount of francs).
true
true/false
If the transaction was denominated in U.S. dollars, there is no foreign exchange gain or loss
true
true/false
purchase of goods by a U.S. entity would most likely reflect an import transaction and, since it is to be settled in a foreign currency, would be a foreign currency import transaction
true
true/false
Because an import transaction normally results in a liability to the buyer (importer), a settlement amount (of the liability) greater than the current carrying amount of the liability will result in an exchange loss, not an exchange gain.
true
true/false
Gain on an import transaction would occur when the recorded amount is greater than the settlement amount, and a loss on an export transaction would occur when the recorded amount is greater than the settlement amount. An import transaction will result in a payable. A gain on a foreign currency payable would occur when the settlement amount is less than the recorded amount. An export transaction will result in a receivable. A loss on a foreign currency receivable would occur when the recorded amount is greater than the settlement amount
true
true/false
FC translation is concerned with converting financial statements expressed in a foreign currency into financial statements expressed in a domestic currency, not with the treatment of individual transactions
true
foreign currency contracts
FX contracts to buysell FC in future @ price (rate) set at the time contract initiated
1) FX forward exchange rate
2) FX option contract
FX Forward Exchange contract
establish obligation/agreement to buy/sell FC contract which requires paying USD for euros at a future rate
2 purposes -> 1) hedging 2) speculation
- no control over losses -> therefore, must hedge losses
FX option contract
establish right to buy/sell FC, but not obligation to do so
- US entity w/right to buy euros, but not required to buy
- if option exercised, exchange of currencies occurs
- control to result in losses due to exercise of options
General Acct requirements
Forward/Options contracts
1) measure @ FV
2) FV changes = gains/losses
3) gain/loss treatment depends on acct purpose of forward contract
- speculation (not hedging), gains/losses recognized in current income
- qualified hedge, treatment of G/L depends of hedge nature: 1) CF Hedge, 2) FV Hedge
Forward Exchange FV
FV based on forward exchange rate
- @ inception -> FV = 0 (no cash transferred)
- over time, forward rates changes increase/decrease contract FV
- FV increases/decreases = G/L
- G/L treatment depends on contract purpose
FV of Option Contracts
Depends on market in which traded:
1) exchange-traded: mkt price = FV
2) over-the-counter-traded: dealer price quote = FV
3) not traded in market: use option pricing model (Modified Black Scholes)
4) Option premium reflects FV
true/false
forward contract may be virtually any asset or liability (e.g., agricultural commodities); they are not limited to the exchange of currencies only.
true
true/false
Foreign currency transactions do not occur only when initiated by a foreign entity. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non-domestic (e.g., non-dollar) currency, regardless of whether the transaction is initiated by the domestic entity or the foreign entity
true
true/false
Forward contracts establish the price at the time the contract is executed, not at the time the contract is fulfilled.
true
true/false
For a U.S. entity, a foreign currency transaction will be denominated (settled) in non-dollars, but measured and recorded on the U.S. entity’s books in dollars.
true
Hedging
Risk Mgmt Strategy:
1) mitigate risk of loss
2) use derivative contracts/other arrangements to offset loss/uncertainty on transaction/balance
Hedge Acct
“special” acct for hedged item/hedging contract
What does a forward contract hedge against?
Hedges against possible loss in dollar value of foreign currency received in the future by selling that foreign currency now at a specified rate for delivery received in future.
cost to an entity that uses forward contracts for hedging purposes?
1) fees imposed by counterparty to forward contract
2) difference between spot rate and forward rate when forward exchange contracted executed
true/false
Because a hedging instrument is intended to offset changes in the hedged item, when the hedged item is a receivable, the hedging instrument would have to be a payable.
true
hedged item -
hedging instrument -
Forward Contract
agreement to buy/sell commodity in future at price (rate) determined at time this contract is executed
true/false
Both the spot rate and the forward rate will be used in accounting for a forward contract used for hedging. The forward rate is used as the basis for determining the change in value of a forward contract. As the forward rate changes, so also will the carrying value of the forward contract, resulting in exchange gains and losses. The spot rate is used to determine the premium or discount on the forward contract. Specifically, the difference between the spot rate and the forward rate at the date of the forward contract is the premium (or discount) on the forward contract, which enters into the determination of income over the life of the contract.
true
true/false
hedging does not assure that no gain or loss will be incurred on the hedged item. Only in a perfect hedge does no gain or loss occur. In order to be a perfect hedge, the hedging instrument would need to have a 100% inverse correlation to the hedged item. Such an outcome is rare.
true
Hedge acct treatment - forecasted transaction
CF hedge
1) Adj. forward contract to FV @ B/S Date
2) Determine change in PV of forecasted CF
3) Recognize “OCI” - Effective portion
4) Recognize Current Income - Ineffective Portion
forecasted transaction
planned transaction, budgeted or expected to occur
- Either a planned sale or a planned purchase would be a forecasted transaction
CF Hedge
hedging forecasted transaction
offset risk of exchange rate changes on forecasted transaction between when planned/executed
CF Hedge
EX: import/export
Firm Commitment
Contract for future purchase/sale not yet recorded under GAAP
*use forward rate
Hedging Firm Commitment
Offset risk of exchange rate changes on contract between when signed & when purchase/sale recorded
firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. Therefore, an asset or liability has not been booked (recognized) already
Firm Commitment denominated in F/C = 2 risks
1) FV Risk - FV Hedge
2) CF Risk - CF Hedge
1) Change inf FV of Firm Commitment Contract
- FV Hedge
2) Changes in CF related to changes in exchange rate to execute Firm Commitment Contract
- CF Hedge
FV Hedge Acct - Firm Commitment
Adj. FORWARD CONTRACT to FV based on forward rate @ appropriate date
- recognize related gain/loss in current income
CF Hedge Acct - Firm Commitment
Adj. FORWARD CONTRACT to FV based on forward rate @ appropriate date
- recognize in OCI - related gain/loss equal to expected change in PV of firm commitment CF - Effective*
- recognize in current income portion of related gain/loss different from expected change in PV of firm commitment CF - Ineffective
criteria for designation of hedging forecasted transactions.
1) must be identified, probable of occurring, and present an exposure to foreign currency price changes
2) Use of a forward contract to hedge must be consistent with company risk management policy.
* does not require that the forecasted transaction be expected to be initiated by the entity hedging the forecasted transaction
criteria for designation of hedging foreign currency commitments.
1) must be firm, be identified, and present exposure to foreign currency price changes
2) forward contract must be designated and effective as a hedge of a commitment and must be in an amount that does not exceed the amount of the commitment.
true/false
forecasted transaction (a planned or expected transaction) would occur before a firm commitment, which would occur before a recognized liability. A forecasted transaction is a non-firm but intended (perhaps even budgeted) transaction. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirement of GAAP. A recognized liability would be one that is already booked by the entity. Thus, the correct sequence would be forecasted transaction -> firm commitment -> recognized liability.
true
forecasted transaction -> firm commitment -> recognized liability
true/false
item being hedged does not have to be recorded on the entity’s books in order to be hedged. For example, forecasted transactions and unrecognized firm commitments may be hedged because they are subject to the same risk of foreign currency exchange rate changes as are already booked (recognized) assets and liabilities.
True
Hedging F/C Denominated Asset/Liab ?
Hedging recognized asset/liab to offset risk of exchange rate changes on asset/liab denominated in F/C
EX: hedge receivable denominated in F/C between when receivable is recognized and when it’s collected
Mgt designation:
1) FV Hedge 2) CF Hedge
Acct Treatment - Hedging F/C Asset/Liab
1) FV Hedge - gains/losses to net income
2) CF Hedge - gains/losses to OCI for effective portion
F/C Denominated Investment Avail-for-Sale
Foreign Investment Risks:
1) Market Value Risk
2) Currency Exchange Risk
Hedging objective = offset currency exchange risk (risk of exchange rate changes on investment)
Hedge Acct - Investment Avail-for-sale
FV Hedge
- Changes in FV of investment avail-for-sale (hedged item) recognized in Net Income
- Change in FV of forward contract (hedging instrument) and change in FV of investment (hedged item) both go in net income
Net Investment in Foreign Operations
Investment in a foreign operation (sub/JV)
- foreign op prepares financials in foreign currency
Hedging to offset risk of exchange rate changes on translation of F/C statements to USD statements
- CF Hedge
Hedge Acct - Net Investment in Foreign Ops
- Adj. forward contract to FV @ B/S date
- Recognize in OCI as translation adj. amount of adj equal to change in translated b/s
- Recognize as current income any amount of adj. that is different than change in translated b/s
criteria for designation of hedging recognized assets/liabilities.
1) asset/liability denominated in a foreign currency and has already been booked;
2) gain/loss on the hedged asset/liability must be recognized in earnings.
criteria for designation of hedging investments available for sale.
1) securities being hedged must be identified and must not be traded in the investor’s currency
2) forward contract must be designated and highly effective as a hedge of the investment, and in an amount that does not exceed the amount of the investment being hedged.
criteria for designation of hedging investments in foreign operations
Use of hedge instrument to hedge net investment in foreign operation requires the contract be designated as a hedge of net investment and be highly effective as an economic hedge
true/false
Borrowing from another foreign entity with the same foreign currency as the operation being hedged would hedge the (equity) investment in the foreign operation. Since the equity investment in a foreign operation is an asset and the borrowing would be a liability, both in the same foreign currency, a change in the exchange rate would have offsetting effects
true
true/false
time between when an asset is recognized and when the asset is fully satisfied would be intended to offset the risk of changes in the exchange rate on a recognized asset (or liability)
true
true/false
Both investments in equity securities and investments in debt securities denominated in a foreign currency and classified as available-for-sale can be hedged
true
true/false
An investment in a foreign operation can be hedged if it is either an equity method investee or a subsidiary to be consolidated (or a foreign branch or other separate foreign operation)
true
Speculation (risk-seeking)
forward contract entered into for profit
- buy contract for future receipt @ lower than its value when rec’d
- sell contract for future deliver @ price higher than it can be bought @ delivery date
EX: entity enters into forward contract to purchase euros in 180 days @ today’s exchange rate b/c they believe the rate well decline in 180 days
Speculation Acct
1) measure/record contract based on forward rate
2) At b/s date, remeasure contract using future existing forward rate.
* change in value is adj. to:
- adj. contract CV
- recognize gain/loss in period of change
3) At maturity date, remeasure contract using spot rate
- adj. contract to maturity value
- recognize gain/loss in period
purpose does foreign currency speculation serve?
make a gain as a result of exchange rate changes by buying foreign currency for future delivery at a price lower than its value when delivered, or by selling foreign currency for future delivery at a price higher than it can be bought at delivery date.
