Foreign Currency Transactions

Question 1

Exchange Rate

Answer 1

The price of one unit of one currency in terms of another currency.

Question 2

Direct Rate

Answer 2

The domestic price of one unit of a foreign currency

Question 3

Indirect rate

Answer 3

This is the foreign price of 1 unit of domestic currency. $1 = .87 Euro or $1 = 3.2 Pesos

Question 4

Spot rate

Answer 4

The exchange rate at the current date.

Question 5

Forward rate

Answer 5

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

Question 6

Functional currency

Answer 6

The currency of the primary economic environment that the business operates in: A Chilean company’s functional currency would be the Chilean peso.

Question 7

When domestic currency weakens compared to a foreign currency

Answer 7

Accounts receivable creates an exchange gain because when you get paid, you’re getting more than you were initially owed, and therefore accounts payable create an exchange loss because you’re paying back more money than you originally owed.

Question 8

Transactions

Answer 8

On day of transaction, multiply foreign currency by spot rate to get the dollar value

At balance sheet date, do the same thing to get a new dollar value.

The difference is an exchange gain or loss and adjust the value of the receivable or payable.

At settlement date of transaction, determine the new dollar amount to settle transaction (F/C units * spot rate = new dollar value)

The difference between the new dollar value and what’s on the books is an exchange gain or loss.

Question 9

FX exchange contract

Answer 9

This is an obligation to buy or sell a foreign currency.

Question 10

FX option contract

Answer 10

This gives the right to buy or sell a foreign currency, but not an obligation to do so

If used for speculation then any gains or losses are recognized in current income.

If the instrument is a fair value or cash flow hedge, then the gains or losses apply to the related rules.

Question 11

Recording currency

Answer 11

The currency that the foreign books and financial statements are in.

Question 12

Reporting currency

Answer 12

The currency that the final financial statements will be in

Question 13

Functional currency

Answer 13

The currency of the primary economic environment that the entity operates in. Except when:

If the local economy is in hyperinflation, which means inflation of 100% or more for 3 straight years, the reporting currency is the functional currency

If the foreign operations could not operate without the US entity’s operations, then the reporting currency is also the functional currency.

Question 14

When the sub’s local recording currency is the functional currency

Answer 14

You translate the sub’s financials to US dollars using translation

Question 15

When the sub uses the US dollar as the functional currency but records in the local foreign currency

Answer 15

Financials are “remeasured” to US dollars.

Question 16

When the sub’s functional currency is something other than the functional currency

Answer 16

Then the sub’s financials are remeasured from recording currency to functional currency, and then translated from functional currency to US dollars.

Question 17

Translation

Answer 17

Assets and liabilities are translated using the spot rate (current rate) at balance sheet date.

Income statement accounts are translated using:

The exchange rate at the date the item was earned or incurred

The weighted avg exchange for the period

Retained earnings is computed - the converted trial balance will not balance.

A translation adjustment is made to balance. It is an item of other comprehensive income.

Question 18

Remeasurement

Answer 18

Use current spot rate for all monetary assets and liabilities (AP, AR)

Use historic rates for non monetary items like fixed assets, prepaid assets, COGS, depreciation.

Use weighted avg for revenues and expenses that occurred evenly throughout the year

Question 19

Remeasurement adjustment

Answer 19

Is needed to make a remeasured trial balance balance

Recognized as a gain or loss in income from continuing operations and flows through to retained earnings.

Question 20

Two conversion adjustments

Answer 20

First, a remeasurement adjustment which goes through the income statement

Second, a translation adjustment which goes through the statement of other comprehensive income.