FAR - Specific Transactions, Events, & Disclosures - Foreign Currency Denomination

Question 1

Foreign Currency Denomination transaction

Answer 1

transaction in foreign currency but reported in USD (AKA translation)

Impacts foreign currency transactions/translations

Question 2

exchange rate

Answer 2

price of 1 unit of currency expressed in foreign currency units

Question 3

2 types of exchange rates

Answer 3

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

Question 4

spot rate

Answer 4

exchange rate at current date

Question 5

forward rate

Answer 5

exchange rate now for delivery at future date

Question 6

functional currency

Answer 6

currency of primary economic environment in which entity operates/makes CF

Question 7

transaction measured/reported in?

Conversion?

Answer 7

Measured/reported in USD

FC units converted to USA using spot date @ date of transaction

Question 8

Effects of exchange rate changes are recognized?

Answer 8

1) on accts denominated in FC
2) in period exchange % changes
3) as adj. to acct balance/ exchange gain (loss)

Question 9

3 dates where measurement of FC effects financials?

Answer 9

1) transaction date
2) balance sheet
3) settlement date

Question 10

Transaction date

Answer 10

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)

Question 11

Balance Sheet Date

Answer 11

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

Question 12

Settlement Date

Answer 12

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

Question 13

foreign currency transactions

Answer 13

Transactions of a domestic entity denominated in a foreign currency but to be recorded on the domestic entity’s books in the domestic currency.

Question 14

foreign currency translation

Answer 14

Financial statements denominated in (expressed in terms of) a foreign currency but to be reported in the domestic currency (on financial statements).

Question 15

foreign currency operating transaction

Answer 15

transaction that is denominated in a foreign currency

Question 16

true/false

Foreign currency exchange gains (losses) on A/R are reported in current income as an item of income from continuing operations.

Answer 16

true

Question 17

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).

Answer 17

true

Question 18

true/false

If the transaction was denominated in U.S. dollars, there is no foreign exchange gain or loss

Answer 18

true

Question 19

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

Answer 19

true

Question 20

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.

Answer 20

true

Question 21

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

Answer 21

true

Question 22

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

Answer 22

true

Question 23

foreign currency contracts

Answer 23

FX contracts to buysell FC in future @ price (rate) set at the time contract initiated

1) FX forward exchange rate
2) FX option contract

Question 24

FX Forward Exchange contract

Answer 24

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

Question 25

FX option contract

Answer 25

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

Question 26

General Acct requirements

Forward/Options contracts

Answer 26

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

Question 27

Forward Exchange FV

Answer 27

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

Question 28

FV of Option Contracts

Answer 28

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

Question 29

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.

Answer 29

true

Question 30

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

Answer 30

true

Question 31

true/false

Forward contracts establish the price at the time the contract is executed, not at the time the contract is fulfilled.

Answer 31

true

Question 32

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.

Answer 32

true

Question 33

Hedging

Answer 33

Risk Mgmt Strategy:

1) mitigate risk of loss
2) use derivative contracts/other arrangements to offset loss/uncertainty on transaction/balance

Question 34

Hedge Acct

Answer 34

“special” acct for hedged item/hedging contract

Question 35

What does a forward contract hedge against?

Answer 35

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.

Question 36

cost to an entity that uses forward contracts for hedging purposes?

Answer 36

1) fees imposed by counterparty to forward contract

2) difference between spot rate and forward rate when forward exchange contracted executed

Question 37

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.

Answer 37

true

hedged item -

hedging instrument -

Question 38

Forward Contract

Answer 38

agreement to buy/sell commodity in future at price (rate) determined at time this contract is executed

Question 39

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.

Answer 39

true

Question 40

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.

Answer 40

true

Question 41

Hedge acct treatment - forecasted transaction

Answer 41

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

Question 42

forecasted transaction

Answer 42

planned transaction, budgeted or expected to occur

• Either a planned sale or a planned purchase would be a forecasted transaction

CF Hedge

Question 43

hedging forecasted transaction

Answer 43

offset risk of exchange rate changes on forecasted transaction between when planned/executed

CF Hedge

EX: import/export

Question 44

Firm Commitment

Answer 44

Contract for future purchase/sale not yet recorded under GAAP

*use forward rate

Question 45

Hedging Firm Commitment

Answer 45

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

Question 46

Firm Commitment denominated in F/C = 2 risks

1) FV Risk - FV Hedge
2) CF Risk - CF Hedge

Answer 46

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

Question 47

FV Hedge Acct - Firm Commitment

Answer 47

Adj. FORWARD CONTRACT to FV based on forward rate @ appropriate date

• recognize related gain/loss in current income

Question 48

CF Hedge Acct - Firm Commitment

Answer 48

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

Question 49

criteria for designation of hedging forecasted transactions.

Answer 49

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

Question 50

criteria for designation of hedging foreign currency commitments.

Answer 50

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.

Question 51

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.

Answer 51

true

forecasted transaction -> firm commitment -> recognized liability

Question 52

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.

Answer 52

True

Question 53

Hedging F/C Denominated Asset/Liab ?

Answer 53

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

Question 54

Acct Treatment - Hedging F/C Asset/Liab

Answer 54

1) FV Hedge - gains/losses to net income

2) CF Hedge - gains/losses to OCI for effective portion

Question 55

F/C Denominated Investment Avail-for-Sale

Answer 55

Foreign Investment Risks:

1) Market Value Risk
2) Currency Exchange Risk

Hedging objective = offset currency exchange risk (risk of exchange rate changes on investment)

Question 56

Hedge Acct - Investment Avail-for-sale

FV Hedge

Answer 56

• 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

Question 57

Net Investment in Foreign Operations

Answer 57

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

Question 58

Hedge Acct - Net Investment in Foreign Ops

Answer 58

• 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

Question 59

criteria for designation of hedging recognized assets/liabilities.

Answer 59

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.

Question 60

criteria for designation of hedging investments available for sale.

Answer 60

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.

Question 61

criteria for designation of hedging investments in foreign operations

Answer 61

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

Question 62

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

Answer 62

true

Question 63

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)

Answer 63

true

Question 64

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

Answer 64

true

Question 65

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)

Answer 65

true

Question 66

Speculation (risk-seeking)

Answer 66

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

Question 67

Speculation Acct

Answer 67

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

Question 68

purpose does foreign currency speculation serve?

Answer 68

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.