Foreign Currency Transactions Flashcards
Exchange Rate
The price of one unit of one currency in terms of another currency.
Direct Rate
The domestic price of one unit of a foreign currency
Indirect rate
This is the foreign price of 1 unit of domestic currency. $1 = .87 Euro or $1 = 3.2 Pesos
Spot rate
The exchange rate at the current date.
Forward rate
The exchange rate now, for a date in the future.
Functional currency
The currency of the primary economic environment that the business operates in: A Chilean company’s functional currency would be the Chilean peso.
When domestic currency weakens compared to a foreign currency
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.
Transactions
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.
FX exchange contract
This is an obligation to buy or sell a foreign currency.
FX option contract
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.
Recording currency
The currency that the foreign books and financial statements are in.
Reporting currency
The currency that the final financial statements will be in
Functional currency
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.
When the sub’s local recording currency is the functional currency
You translate the sub’s financials to US dollars using translation
When the sub uses the US dollar as the functional currency but records in the local foreign currency
Financials are “remeasured” to US dollars.
When the sub’s functional currency is something other than the functional currency
Then the sub’s financials are remeasured from recording currency to functional currency, and then translated from functional currency to US dollars.
Translation
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.
Remeasurement
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
Remeasurement adjustment
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.
Two conversion adjustments
First, a remeasurement adjustment which goes through the income statement
Second, a translation adjustment which goes through the statement of other comprehensive income.
