Chapter 3 Accounting for Foreign Currency Friday, June 24, 20161

Learning Objectives Provide an overview of foreign exchange markets and define related terminology. Describe the different types of foreign exchange exposure and exchange difference. Understand foreign currency transaction. Describe foreign currency translation. Compare the different methods of accounting for foreign currency translation. Friday, June 24, 20162

Course Outline  Accounting for Foreign Currency Transactions  Hedging Foreign Exchange Rate Risk  Translation of Foreign Financial Statements Friday, June 24, 20163

Introduction Textbook P29-32 Friday, June 24, 20164

Accounting for Foreign Currency Transactions Friday, June 24, A transaction that requires payment or receipt (settlement) in a foreign currency is called a foreign currency transaction. Exchange difference is the difference resulting from reporting the same number of units of a foreign currency in the reporting currency at different exchange rates.

Accounting for Foreign Currency Transactions Friday, June 24,  Importing or Exporting of Goods or Services At the date the transaction is first recognized. At each balance sheet date that occurs between the transaction date and the settlement date. At the settlement date.

Accounting for Foreign Currency Transactions Friday, June 24,  Recognition of Exchange Differences the single- transaction approach the two- transaction approach

Hedging Foreign Exchange Rate Risk  A derivative instrument may be defined as a financial instrument that by its terms at inception or upon occurrence of a specified event, provides the holder (or writer) with the right (or obligation) to participate in some or all of the price changes of another underlying value of measure, but does not require the holder to own or deliver the underlying value of measure. Friday, June 24, 20168

Hedging Foreign Exchange Rate Risk  Two broad categories Forward-based derivatives, such as forwards, futures, and swaps, in which either party can potentially have a favorable or unfavorable outcome, but not both simultaneously (e.g., both will not simultaneously have favorable outcomes). Option-based derivatives, such as interest rate caps, option contracts, and interest rate floors, in which only one party can potentially have a favorable outcome and it agrees to a premium at inception for this potentiality; the other party is paid the premium, and can potentially have only an unfavorable outcome. Friday, June 24, 20169

Translation Of Foreign Financial Statements  Derivation of the Issue of Foreign Currency Translation Translation exposure, sometimes also called accounting exposure, refers to gains or losses caused by the translation of foreign currency assets and liabilities into the currency of the parent company for accounting purposes. The choice of any method for the translation of the financial statements of a foreign business operation involves two basic questions Friday, June 24,

Translation Of Foreign Financial Statements  Derivation of the Issue of Foreign Currency Translation The choice of any method for the translation of the financial statements of a foreign business operation involves two basic questions: how shall foreign currency financial statements be translated ——in particular what exchange rates are to be used for different assets/liabilities/equity accounts? how and when shall foreign exchange gains or losses be recognized? Friday, June 24,

 Translation Methods The current/non-current method The monetary/non-monetary method The temporal method The current rate method  Comparison of Four Translation Methods  Foreign currency translation methods--development Friday, June 24, Translation Of Foreign Financial Statements

Friday, June 24,