1. Translation Of Foreign Currency Transactions
Chapter 9
Translation Of Foreign Currency Transactions

2. The Need For Translation
Foreign Currency Transaction
Buying or selling goods or services
Borrowing or lending money denominated in a foreign currency
Acquiring investments that must be paid for in a foreign currency
Hedging transaction
© 2008 Clarence Byrd Inc.

3. The Need For Translation
Foreign Currency Financial Statements
Significantly influenced companies
Subsidiaries
Integrated
Self-sustaining
Joint ventures
© 2008 Clarence Byrd Inc.

4. Terminology
SPOT RATE: The term spot rate is used to refer to the exchange rate at a particular point in time. In accounting literature, the most relevant spot rate is the one that prevails at the Balance Sheet date and, in this context, it is generally referred to as the current rate.
There are at least two “spot” rates at any point in time
Bid rate
Ask rate
© 2008 Clarence Byrd Inc.

5. Terminology
HISTORIC RATE: This term is used to refer to the exchange rate that prevailed at the time a particular Balance Sheet item was: - acquired (asset) or - incurred (liability).
© 2008 Clarence Byrd Inc.

6. Alternative Methods of Translation
Current / Non-Current Method
Monetary / Non-Monetary Method
Temporal Method
Current Rate Method
Completely
Discredited
© 2008 Clarence Byrd Inc.

7. The Temporal Method The Concept
Items valued at current values are translated using current exchange rates.
Items valued at historic values are translated using historic exchange rates.
© 2008 Clarence Byrd Inc.

8. The Temporal Method Example
Inventories carried at cost would be translated at historic rates
Inventories carried at net realizable value would be translated at current rates
© 2008 Clarence Byrd Inc.

9. Temporal As Per CICA Handbook
Paragraph (c)(i) The temporal method is a method of translation that translates assets, liabilities, revenues and expenses in a manner that retains their bases of measurement in terms of the Canadian dollar (i.e., it uses the Canadian dollar as the unit of measure). In particular:
monetary items are translated at the exchange rate in effect at the balance sheet date;
non-monetary items are translated at historical exchange rates, unless such items are carried at market, in which case they are translated at the exchange rate in effect at the balance sheet date;
revenue and expense items are translated at the exchange rate in effect on the dates they occur;
depreciation or amortization of assets translated at historical exchange rates is translated at the same exchange rates as the assets to which it relates.
© 2008 Clarence Byrd Inc.

10. Temporal As Per CICA Handbook
Monetary Items Defined
Paragraph (b) Monetary items are money and claims to money the value of which, in terms of the monetary unit, whether foreign or domestic, is fixed by contract or otherwise. Future Income tax liabilities and assets are classified as monetary items.
© 2008 Clarence Byrd Inc.

11. Temporal As Per CICA Handbook
Items specified as non-monetary
Investments in equity instruments carried at cost
Inventories carried at cost
Prepaid items
Property, plant and equipment and accumulated amortization
Patents, trademarks, licenses and formulas
Goodwill
Other intangible assets (including deferred charges)
Deferred income
Share capital (see Paragraph 9-31)
Revenue and expenses related to non-monetary items, including:
Cost of goods sold
Depreciation and amortization (including amortization of deferred income)
© 2008 Clarence Byrd Inc.

12. Temporal As Per CICA Handbook
Other Guidance On Monetary Items
Paragraph Preference shares of a foreign operation held by the reporting enterprise are translated in the same manner as common shares (i.e., at historical rates) unless redemption is either required or imminent, in which case the current rate is used. ...
Paragraph Future income tax liabilities and assets are monetary items and, as such, are translated at the current rate.
© 2008 Clarence Byrd Inc.

13. Conceptual Definition Vs. CICA
The two approaches provide identical results
References to monetary confuse temporal with monetary vs. non-monetary
© 2008 Clarence Byrd Inc.

14. Temporal Method and FC Transactions
Paragraph At the transaction date, each asset, liability, revenue or expense arising from a foreign currency transaction of the reporting enterprise should be translated into Canadian dollars by the use of the exchange rate in effect at that date. [October, 2006]
Use Of Averages If
Transactions occur uniformly over the period
Exchange rate changes uniformly over the period
© 2008 Clarence Byrd Inc.

15. Temporal Method and FC Transactions
Paragraph At each balance sheet date, monetary items denominated in a foreign currency should be adjusted to reflect the exchange rate in effect at the balance sheet date. (July, 1983)
Paragraph At each balance sheet date, for non-monetary assets of the reporting enterprise that are carried at market, the Canadian dollar equivalent should be determined by applying the exchange rate in effect at the balance sheet date to the foreign currency market price. (July, 1983)
© 2008 Clarence Byrd Inc.

16. Exchange Gains And Losses
Source
Some items are translated at current rates
As the rate changes, gains and losses arise
© 2008 Clarence Byrd Inc.

17. Exchange Gains And Losses
Balance Sheet Item
Exchange Rate Movement
Effect on Income
Asset
Increase
Gain
Decrease
Loss
Liability
© 2008 Clarence Byrd Inc.

18. Required Treatment of Gains and Losses
Paragraph An exchange gain or loss of the reporting enterprise that arises on translation or settlement of a foreign currency-denominated monetary item or a non-monetary item carried at market should be included in the determination of net income for the current period. (January, 2002)
© 2008 Clarence Byrd Inc.

19. Required Treatment of Gains and Losses
An Exception
Changes in fair value on available-for-sale investments to Other Comprehensive Income
Exchange gains and losses receive comparable treatment
© 2008 Clarence Byrd Inc.

20. Required Treatment of Gains and Losses
Foreign Currency Financial Statements receive different treatment (see Chapter 10)
© 2008 Clarence Byrd Inc.

21. Disclosure
Paragraph The amount of exchange gain or loss included in net income should be disclosed (see paragraphs , and ). An entity may exclude from this amount those exchange gains or losses arising on financial instruments classified as held for trading in accordance with "Financial Instruments — Recognition And Measurement", Section An entity may also exclude from this amount exchange gains or losses on available-for-sale financial assets and cash flow hedges (see "Hedges", Section 3865) included in any gains or losses removed from accumulated other comprehensive income and included in net income for the period. (October, 2006)
© 2008 Clarence Byrd Inc.

22. Disclosure Paragraph 1520.03 contains an identical recommendation
© 2008 Clarence Byrd Inc.

23. Foreign Currency Purchases and Sales
Two transaction approach required
Transaction recorded at current rate
Exchange gains and losses into income as they arise
© 2008 Clarence Byrd Inc.

24. Foreign Currency Purchases and Sales
On December 12, 2007, a Canadian company purchases Inventory in Switzerland for 100,000 Swiss Francs (SF, hereafter). At this time SF1 = $0.94.
When the company closes its books on December 31, 2007, the Inventory is still on hand and the Accounts Payable has not been paid. On this later date SF1 = $0.96.
© 2008 Clarence Byrd Inc.

25. Foreign Currency Purchases and Sales
December 12, 2007
Inventory [(SF)($100,000)($0.94)]
$94,000
Accounts Payable
December 31, 2007
Exchange Loss
[(SF100,000)($ $0.94)]
$2,000
© 2008 Clarence Byrd Inc.

26. Foreign Currency Capital Transaction
Example
On December 31, 2008, a Canadian Company with a December 31 year end borrows €1,000,000. At this time €1 = $1.40.
On December 31, 2009, the rate for the Euro is €1 = $1.50 and on December 31, 2010, the rate is €1 - $ On this latter date the loan is repaid.
Ignore interest payments.
© 2008 Clarence Byrd Inc.

27. Foreign Currency Capital Transaction
December 31, 2008
Cash [(€1,000,000)($1.40)]
$1,400,000
Liabilities
December 31, 2009
Exchange Loss
[(€ 1,000,000)($ $1.40)
$100,000
© 2008 Clarence Byrd Inc.

28. Foreign Currency Capital Transaction
December 31, 2010
Exchange Loss
[(€1,000,000)($ $1.50)]
$50,000
Liabilities
Liabilities [€1,000,000)($1.55)]
$1,550,000
Cash
© 2008 Clarence Byrd Inc.

29. Held-To-Maturity Investments
Example
On January 1, 2008, Empire Inc. acquires £200,000 in long-term debt of a British company. At this time £1 = $2.15.
On December 31, 2008, when Empire Inc. closes its books, the exchange rate is £1 = $2.25.
© 2008 Clarence Byrd Inc.

30. Held-To-Maturity Investments
January 1, 2008
Bonds [(£200,000)($2.15)]
$430,000
Cash
December 31, 2008
Bonds [(£200,000)($ $2.15)]
$20,000
Exchange Gain
© 2008 Clarence Byrd Inc.

31. Available-For-Sale At Cost Investments
Example
On January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company.
At this time £1 = $ The investment is classified as available for sale and the shares do not have a quoted market price.
On December 31, 2008, when Empire Inc. closes its books, the exchange rate is £1 = $2.25.
© 2008 Clarence Byrd Inc.

32. Available-For-Sale At Cost Investments
January 1, 2008
Shares [(£200,000)($2.15)]
$430,000
Cash
December 31, 2008
No Entry Is Required
© 2008 Clarence Byrd Inc.

33. Held-For-Trading Investments
Example
On January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company.
At this time £1 = $ The investment is classified as held for trading.
On December 31, 2008, when Empire Inc. closes its books, the market value of the securities has increased to £215,000 and the exchange rate is £1 = $2.25.
© 2008 Clarence Byrd Inc.

34. Held-For-Trading Investments
January 1, 2008
Shares [(£200,000)($2.15)]
$430,000
Cash
December 31, 2008
Shares [(£215,000)($2.25) - $430,000]
$53,750
Fair Value Gain – Net Income
[(£215,000 - £200,000)($2.25)]
$33,750
Exchange Gain – Net Income
[(£200,000)($ $2.15)]
20,000
© 2008 Clarence Byrd Inc.

35. Available-For-Sale At Fair Value Investments
Example
On January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company.
At this time £1 = $ The investment is classified as available for sale.
On December 31, 2008, when Empire Inc. closes its books, the market value of the securities has increased to £215,000 and the exchange rate is £1 = $2.25.
© 2008 Clarence Byrd Inc.

36. Available-For-Sale At Fair Value Investments
January 1, 2008
Shares [(£200,000)($2.15)]
$430,000
Cash
December 31, 2008
Shares [(£215,000)($2.25) - $430,000]
$53,750
Fair Value Gain – OCI
[(£215,000 - £200,000)($2.25)]
$33,750
Exchange Gain - OCI
[(£200,000)($ $2.15)]
20,000
© 2008 Clarence Byrd Inc.

37. Available-For-Sale At Fair Value Investments
Reclassification
If investments are sold, the Other Comprehensive Income amounts will be reclassified into Net Income
© 2008 Clarence Byrd Inc.

38. Hedging An extremely complex area
Our coverage is limited to simple applications in the area of foreign exchange risk
© 2008 Clarence Byrd Inc.

39. Hedging
Paragraph Hedging is an activity designed to modify an entity's exposure to one or more risks by creating an offset between changes in the fair value of, or the cash flows attributable to, the hedged item and the hedging item (or changes resulting from a particular risk exposure relating to those items).
© 2008 Clarence Byrd Inc.

40. Hedged Items In General
Paragraph (c) A hedged item is all or a specified portion of a recognized asset, a recognized liability, an anticipated transaction, or a net investment in a self-sustaining foreign operation, or a group of similar recognized assets, recognized liabilities or anticipated transactions, having an identified risk exposure that an entity has taken steps to modify.
© 2008 Clarence Byrd Inc.

41. Hedged Items: Foreign Currency Applications
Foreign currency denominated monetary assets or monetary liabilities
Anticipated Transactions
Firm commitments
Forecasted transactions
Investments in self-sustaining foreign operations
© 2008 Clarence Byrd Inc.

42. Hedging Items In General
Paragraph (d) A hedging item is all or a specified percentage of a derivative, or all or a specified percentage of a group of derivatives offsetting a risk exposure identified in the hedged item. All or a specified percentage of:
(i) a non-derivative financial asset;
(ii) a non-derivative financial liability; or
(iii) a group of non-derivative financial assets or non-derivative financial liabilities, provided that all non-derivative items in a group are similar;
may be designated as a hedging item only for a hedge of a foreign currency risk exposure.
© 2008 Clarence Byrd Inc.

43. Hedging Items: Foreign Currency Applications
Example
On July 1, 2008, a Canadian company purchases merchandise in France for €200,000.
At this time €1 = $1.40.
The merchandise must be paid for on December 31, 2008.
© 2008 Clarence Byrd Inc.

44. Hedging Items: Foreign Currency Applications
Purchase Euros on July 1, 2008
Effective but costly (no return on funds)
Purchase financial asset denominated in Euros
Some rate of return
Low rates on short term investments
© 2008 Clarence Byrd Inc.

45. Hedging Items: Foreign Currency Applications
Purchase non-financial assets denominated in Euros
Inconvenient
May or may not be effective
Forward contract to take delivery of Euros on December 31, 2008
Effective
Requires no investment of funds
© 2008 Clarence Byrd Inc.

46. A Derivatives Primer
Paragraph (e) A derivative is a financial instrument or other contract within the scope of this Section with all three of the following characteristics:
(i) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable (sometimes called the "underlying"), provided in the case of a non-financial variable that the variable is not specific to a party to the contract;
(ii) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
(iii) it is settled at a future date.
© 2008 Clarence Byrd Inc.

47. A Derivatives Primer Types Contracts Options Forwards Futures
Both parties must perform
Options
Only one party required to perform
© 2008 Clarence Byrd Inc.

48. A Derivatives Primer Accounting procedures
Initial recognition at fair value (often nil)
Subsequent measurement at fair value
Gains and losses to Net Income (in general)
© 2008 Clarence Byrd Inc.

49. Forward Exchange Contracts
Example
(From Text Paragraph 9-99)
On January 1, 2007, Sandor Inc., a Canadian public company, enters into a forward exchange contract to take delivery of £100,000 on December 31, 2007 at a rate of £1 = $2.30.
On January 1, 2007, the exchange rate is £1 = $2.26.
© 2008 Clarence Byrd Inc.

50. Forward Exchange Contracts
Initial Recognition
No consideration for contract
Fair value = nil
No recognition in the financial statements
© 2008 Clarence Byrd Inc.

51. Forward Exchange Contracts
Settlement on December 31, 2007 when rate is £1 = $2.33.
December 31, 2007
Cash [(£100,000)($2.33)]
$233,000
Cash [(£100,000)($2.30)]
$230,000
Gain On Contract
3,000
© 2008 Clarence Byrd Inc.

52. Forward Exchange Contracts
If Balance Sheet date occurred prior to settlement of the contract, the fair value of the contract would have to be recorded in the Balance Sheet. This would result in a gain or loss to be included in Net Income.
© 2008 Clarence Byrd Inc.

53. Hedge Accounting Objective
Hedge accounting is a method for recognizing the gains, losses, revenues and expenses associated with the items in a hedging relationship such that those gains, losses, revenues and expenses are recognized in net income in the same period when they would otherwise be recognized in different periods.
© 2008 Clarence Byrd Inc.

54. Hedge Accounting Its use is optional
Often not necessary (e.g., contract hedging a monetary asset)
Sometimes cannot qualify
Management may decide not to use
© 2008 Clarence Byrd Inc.

55. Hedge Accounting Qualification Designation Documentation
Evaluation for effectiveness (Beyond the scope of this text)
© 2008 Clarence Byrd Inc.

56. Fair Value Hedges
Under this approach, gains and losses on the hedging item must be included in Net Income. Gains and losses on the hedged item that are attributable to the hedged risk must also be included in Net Income.
© 2008 Clarence Byrd Inc.

57. Fair Value Hedges
Fair value hedge accounting can be used when the hedge is a hedge of the exposure to changes in the fair value of:
a recognized asset or liability;
an unrecognized firm commitment; or
an identified portion of such an asset, liability, or firm commitment.
© 2008 Clarence Byrd Inc.

58. Cash Flow Hedge Accounting
Cash Flow Hedge Accounting Under this approach, gains and losses on the hedging item are treated as items of Other Comprehensive Income, rather than as items to be included in the determination of Net Income.
© 2008 Clarence Byrd Inc.

59. Cash Flow Hedge Accounting
Cash flow hedge accounting can be used when the hedge is a hedge of the exposure to variability in cash flows associated with:
a recognized asset or liability;
a forecasted transaction; or
the foreign currency risk in an unrecognized firm commitment.
© 2008 Clarence Byrd Inc.

60. Hedge Of Exposed Monetary Balance
Example
On November 1, 2008, Torcan Ltd. a Canadian company with a December 31 year end, sells merchandise in Switzerland for 1,000,000 Swiss Francs (SF, hereafter). Assume that, at this time, the exchange rate is SF1 = $0.90.
On December 31, 2008, the exchange rate is SF1 = $0.92.
The merchandise is paid for on February 1, 2009 when the exchange rate is SF1 = $0.95.
© 2008 Clarence Byrd Inc.

61. Example – No Hedge Accounting
November 1, 2008
Receivable [(SF1,000,000)($0.90)]
$900,000
Sales
December 31, 2008
Receivable [(SF1,000,000)($ $0.90)]
$20,000
Exchange Gain
© 2008 Clarence Byrd Inc.

62. Example – No Hedge Accounting
February 1, 2009
Receivable [(SF1,000,000)($ $0.92)]
$30,000
Exchange Gain
Cash
$950,000
Receivable
© 2008 Clarence Byrd Inc.

63. Example – Hedge With Forward Contract
On November 1, 2008, Torcan Ltd. a Canadian company with a December 31 year end, sells merchandise in Switzerland for 1,000,000 Swiss Francs (SF, hereafter). Assume that, at this time, the exchange rate is SF1 = $0.90.
On December 31, 2008, the exchange rate is SF1 = $0.92.
The merchandise is paid for on February 1, 2009 when the exchange rate is SF1 = $0.95.
Hedge
On November 1, 2008, Torcan enters a contract to deliver SF1,000,000 on February 1, 2009 at a rate of SF1 = $0.92.
On December 31, 2008 the one month forward rate is SF1 = $0.93, resulting in a fair value for the contract of $9,950.
© 2008 Clarence Byrd Inc.

64. Example – Hedge With Forward Contract
Do We Need Hedge Accounting?
Receivable at Fair Value
Contract at Fair Value
Hedge Accounting Not Required
© 2008 Clarence Byrd Inc.

65. Example – Hedge With Forward Contract
November 1, 2008
Receivable [(SF1,000,000)($0.90)]
$900,000
Sales
December 31, 2008
Receivable [(SF1,000,000)($ $0.90)]
$20,000
Exchange Gain
Exchange Loss
$9,950
Forward Contract (Liability)
© 2008 Clarence Byrd Inc.

66. Example – Hedge With Forward Contract
February 1, 2009
Receivable [(SF1,000,000)($ $0.92)]
$30,000
Exchange Gain
Exchange Loss – [(SF1,000,000)($ $0.92) - $9,950)]
$20,050
Forward Contract
© 2008 Clarence Byrd Inc.

67. Example – Hedge With Forward Contract
February 1, 2009
Cash
$950,000
Receivable
Cash [(SF1,000,000)($0.92)]
$920,000
Forward Contract ($9,950 + $20,050)
30,000
Cash [(SF1,000,000)($0.95)]
© 2008 Clarence Byrd Inc.

68. Hedge Of Exposed Monetary Balance
Example
On October 1, 2008, Ardin Ltd. commits to purchasing merchandise in Germany at a cost of €500,000. At this time the spot rate for Euros is €1 = $ The merchandise is to be delivered and paid for on May 1, 2009.
On October 1, 2008, Ardin also acquires a term deposit with a maturity value of €500,000 (ignore the interest that would accrue on this asset).
On December 31, 2008, when Ardin closes its books, the exchange rate has decreased to €1 = $ On May 1, 2009, the rate is €1 = $1.52.
© 2008 Clarence Byrd Inc.

69. Example – No Hedge Accounting
October 1, 2008
Term Deposit [(€500,000)($1.57)]
$785,000
Cash
December 31, 2008
Exchange Loss [(€500,000)($ $1.57)]
$10,000
Term Deposit
© 2008 Clarence Byrd Inc.

70. Example – No Hedge Accounting
May 1, 2009
Exchange Loss [(€500,000)($ $1.52)]
$15,000
Term Deposit
Cash [(€500,000)($1.52)]
$760,000
Merchandise [(€500,000)($1.52)]
Cash
© 2008 Clarence Byrd Inc.

71. Example – No Hedge Accounting
The Problem
The economic gain on the commitment (i.e., the purchase will now cost less) cannot be recognized.
© 2008 Clarence Byrd Inc.

72. Hedge Of Exposed Monetary Balance
Example
On October 1, 2008, Ardin Ltd. commits to purchasing merchandise in Germany at a cost of €500,000. At this time the spot rate for Euros is €1 = $ The merchandise is to be delivered and paid for on May 1, 2009.
On October 1, 2008, Ardin also acquires a term deposit with a maturity value of €500,000 (ignore the interest that would accrue on this asset).
On December 31, 2008, when Ardin closes its books, the exchange rate has decreased to €1 = $ On May 1, 2009, the rate is €1 = $1.52.
Document the hedging relationship and use Cash Flow Hedge Accounting.
© 2008 Clarence Byrd Inc.

73. Example – Cash Flow Hedge Accounting
October 1, 2008
Term Deposit [(€500,000)($1.57)]
$785,000
Cash
December 31, 2008
OCI - Exchange Loss [(€500,000)($ $1.57)]
$10,000
Term Deposit
© 2008 Clarence Byrd Inc.

74. Example – Cash Flow Hedge Accounting
May 1, 2009
OCI - Exchange Loss [(€500,000)($ $1.52)]
$15,000
Term Deposit
Cash [(€500,000)($1.52)]
$760,000
Merchandise [(€500,000)($1.52)]
Cash
© 2008 Clarence Byrd Inc.

75. Example – Cash Flow Hedge Accounting
Alternative 1 – Reclassify Immediately
May 1, 2009
Merchandise
$25,000
OCI – Reclassification Adjustment
© 2008 Clarence Byrd Inc.

76. Example – Cash Flow Hedge Accounting
Alternative 2 – Reclassify When Merchandise Sold
January 1, 2010
Cost Of Goods Sold
$760,000
Merchandise
$25,000
OCI – Reclassification Adjustment
© 2008 Clarence Byrd Inc.

77. Hedge Of Net Investment In Self-Sustaining Operation
Paragraph A hedge of a net investment in a self-sustaining foreign operation, including a hedge of a monetary item that is accounted for as part of the net investment (see “Foreign Currency Translation”, Section 1651), should be accounted for as follows:
(a) the portion of the gain or loss on the hedging item that is determined to be an effective hedge (see paragraphs ) should be recognized in other comprehensive income (see “Comprehensive Income”, Section 1530); and
(b) the ineffective portion of the gain or loss on the hedging item should be recognized in net income.
The gain or loss on the hedging item relating to the effective portion of the hedge that has been recognized in other comprehensive income should be recognized in net income in the same period during which corresponding exchange gains or losses arising from the translation of the financial statements of the self-sustaining foreign operation are recognized in net income. (October, 2006)
© 2008 Clarence Byrd Inc.

78. Hedge Of Net Investment In Self-Sustaining Operation
In Effect:
Cash Flow Hedge Accounting
© 2008 Clarence Byrd Inc.

79. Hedge Of Net Investment In Self-Sustaining Operation
Reduction In Net Investment
Paragraph An appropriate portion of the exchange gains and losses accumulated in the separate component of accumulated other comprehensive income should be included in the determination of net income when there is a reduction in the net investment. (October, 2006)
© 2008 Clarence Byrd Inc.

80. Discontinuance Of Hedge Accounting
Discontinue If:
The hedging item ceases to exist
The hedged item ceases to exist
It becomes probable that an anticipated transaction will not occur
The entity terminates the hedging designation
The hedging relationship ceases to be effective
© 2008 Clarence Byrd Inc.

81. International Convergence
Hedging covered in IAS No. 39, Financial Instruments
No differences that impact on the material covered in this text
Other foreign currency issues in Chapter 10
© 2008 Clarence Byrd Inc.

82. The End
© 2008 Clarence Byrd Inc.