chapter 9 translation of foreign currency transactions

Chapter 9Chapter 9

Translation OfTranslation Of

Foreign Currency TransactionsForeign Currency Transactions

© 2008 Clarence Byrd In© 2008 Clarence Byrd Inc.c.

22

The Need For TranslationThe Need For Translation

Foreign Currency TransactionForeign Currency Transaction– Buying or selling goods or servicesBuying or selling goods or services– Borrowing or lending money Borrowing or lending money

denominated in a foreign currencydenominated in a foreign currency– Acquiring investments that must be paid Acquiring investments that must be paid

for in a foreign currencyfor in a foreign currency– Hedging transactionHedging transaction


33

The Need For TranslationThe Need For Translation

Foreign Currency Financial Foreign Currency Financial StatementsStatements– Significantly influenced companiesSignificantly influenced companies– SubsidiariesSubsidiaries

IntegratedIntegrated Self-sustainingSelf-sustaining

– Joint venturesJoint ventures


44

TerminologyTerminology SPOT RATESPOT RATE: The term spot rate is : The term spot rate is

used to refer to the exchange rate at a used to refer to the exchange rate at a particular point in time. particular point in time.

In accounting literature, the most In accounting literature, the most relevant spot rate is the one that relevant spot rate is the one that prevails at the Balance Sheet date and, prevails at the Balance Sheet date and, in this context, it is generally referred in this context, it is generally referred to as the to as the current ratecurrent rate..

There are at least two “spot” rates at There are at least two “spot” rates at any point in timeany point in time– Bid rateBid rate– Ask rateAsk rate


55

TerminologyTerminology

HISTORIC RATEHISTORIC RATE: : This term is used to refer This term is used to refer to the exchange rate that to the exchange rate that prevailed at the time a prevailed at the time a particular Balance Sheet particular Balance Sheet item was:item was:

- acquired (asset) or- acquired (asset) or- incurred (liability).- incurred (liability).


66

Alternative Methods of Alternative Methods of TranslationTranslation

Current / Non-Current MethodCurrent / Non-Current Method

Monetary / Non-Monetary MethodMonetary / Non-Monetary Method

Temporal MethodTemporal Method

Current Rate MethodCurrent Rate Method

CompletelyDiscredited


77

The Temporal MethodThe Temporal Method

The ConceptThe Concept– Items valued at current Items valued at current

values are translated values are translated using current exchange using current exchange rates.rates.

– Items valued at historic Items valued at historic values are translated values are translated using historic exchange using historic exchange rates.rates.


88

The Temporal MethodThe Temporal Method

ExampleExample– Inventories carried at cost Inventories carried at cost

would be translated at would be translated at historic rateshistoric rates

– Inventories carried at net Inventories carried at net realizable value would be realizable value would be translated at current ratestranslated at current rates


99

Temporal As Per Temporal As Per CICA HandbookCICA Handbook

Paragraph 1651.03(c)(i) Paragraph 1651.03(c)(i) The temporal method is a The temporal method is a method of translation that translates assets, liabilities, method of translation that translates assets, liabilities, revenues and expenses in a manner that retains their bases revenues and expenses in a manner that retains their bases of measurement in terms of the Canadian dollar (i.e., it uses of measurement in terms of the Canadian dollar (i.e., it uses the Canadian dollar as the unit of measure). In particular:the Canadian dollar as the unit of measure). In particular:– monetary items are translated at the exchange rate in effect at monetary items are translated at the exchange rate in effect at

the balance sheet date;the balance sheet date;– non-monetary items are translated at historical exchange non-monetary items are translated at historical exchange

rates, unless such items are carried at market, in which case rates, unless such items are carried at market, in which case they are translated at the exchange rate in effect at the they are translated at the exchange rate in effect at the balance sheet date;balance sheet date;

– revenue and expense items are translated at the exchange revenue and expense items are translated at the exchange rate in effect on the dates they occur;rate in effect on the dates they occur;

– depreciation or amortization of assets translated at historical depreciation or amortization of assets translated at historical exchange rates is translated at the same exchange rates as exchange rates is translated at the same exchange rates as the assets to which it relates.the assets to which it relates.


1010


Monetary Items DefinedMonetary Items DefinedParagraph 1651.03(b)Paragraph 1651.03(b) Monetary items are Monetary items are money and claims to money the value of which, money and claims to money the value of which, in terms of the monetary unit, whether foreign in terms of the monetary unit, whether foreign or domestic, is fixed by contract or otherwise. or domestic, is fixed by contract or otherwise. Future Income tax liabilities and assets are Future Income tax liabilities and assets are classified as monetary items.classified as monetary items.


1111


Items specified as non-monetaryItems specified as non-monetary– Investments in equity instruments carried at costInvestments in equity instruments carried at cost– Inventories carried at costInventories carried at cost– Prepaid itemsPrepaid items– Property, plant and equipment and accumulated amortizationProperty, plant and equipment and accumulated amortization– Patents, trademarks, licenses and formulasPatents, trademarks, licenses and formulas– GoodwillGoodwill– Other intangible assets (including deferred charges)Other intangible assets (including deferred charges)– Deferred incomeDeferred income– Share capital (see Paragraph 9-31)Share capital (see Paragraph 9-31)– Revenue and expenses related to non-monetary items, Revenue and expenses related to non-monetary items,

including:including:– Cost of goods soldCost of goods sold– Depreciation and amortization (including amortization of Depreciation and amortization (including amortization of

deferred income)deferred income)


1212


Other Guidance On Monetary ItemsOther Guidance On Monetary Items– Paragraph 1651.47Paragraph 1651.47 Preference shares of a Preference shares of a

foreign operation held by the reporting foreign operation held by the reporting enterprise are translated in the same enterprise are translated in the same manner as common shares (i.e., at historical manner as common shares (i.e., at historical rates) unless redemption is either required or rates) unless redemption is either required or imminent, in which case the current rate is imminent, in which case the current rate is used. ...used. ...

– Paragraph 1651.52Paragraph 1651.52 Future income tax Future income tax liabilities and assets are monetary items and, liabilities and assets are monetary items and, as such, are translated at the current rate.as such, are translated at the current rate.


1313

Conceptual Definition Vs. CICAConceptual Definition Vs. CICA

The two approaches The two approaches provide identical provide identical resultsresults

References to References to monetary confuse monetary confuse temporal with temporal with monetary vs. non-monetary vs. non-monetarymonetary


1414

Temporal Method and Temporal Method and FC TransactionsFC Transactions

Paragraph 1651.14Paragraph 1651.14 At the transaction At the transaction date, each asset, liability, revenue or date, each asset, liability, revenue or expense arising from a foreign currency expense arising from a foreign currency transaction of the reporting enterprise transaction of the reporting enterprise should be translated into Canadian dollars should be translated into Canadian dollars by the use of the exchange rate in effect at by the use of the exchange rate in effect at that date. [October, 2006]that date. [October, 2006]

Use Of Averages IfUse Of Averages If– Transactions occur uniformly over the periodTransactions occur uniformly over the period– Exchange rate changes uniformly over the Exchange rate changes uniformly over the

periodperiod


1515

Temporal Method and Temporal Method and FC TransactionsFC Transactions

Paragraph 1651.16Paragraph 1651.16 At each balance sheet date, At each balance sheet date, monetary items denominated in a foreign currency monetary items denominated in a foreign currency should be adjusted to reflect the exchange rate in should be adjusted to reflect the exchange rate in effect at the balance sheet date. (July, 1983)effect at the balance sheet date. (July, 1983)

Paragraph 1651.18Paragraph 1651.18 At each balance sheet date, At each balance sheet date, for non-monetary assets of the reporting enterprise for non-monetary assets of the reporting enterprise that are carried at market, the Canadian dollar that are carried at market, the Canadian dollar equivalent should be determined by applying the equivalent should be determined by applying the exchange rate in effect at the balance sheet date to exchange rate in effect at the balance sheet date to the foreign currency market price. (July, 1983)the foreign currency market price. (July, 1983)


1616

Exchange Gains And LossesExchange Gains And Losses

SourceSource– Some items are Some items are

translated at translated at current ratescurrent rates

– As the rate As the rate changes, gains and changes, gains and losses ariselosses arise


1717

Exchange Gains And LossesExchange Gains And Losses

Balance Balance Sheet ItemSheet Item

Exchange Exchange Rate Rate MovementMovement

Effect on Effect on IncomeIncome

AssetAsset IncreaseIncrease GainGain

AssetAsset DecreaseDecrease LossLoss

LiabilityLiability IncreaseIncrease LossLoss

LiabilityLiability DecreaseDecrease GainGain


1818

Required Treatment of Required Treatment of Gains and LossesGains and Losses

Paragraph 1651.120Paragraph 1651.120 An exchange gain An exchange gain or loss of the reporting enterprise that or loss of the reporting enterprise that arises on translation or settlement of a arises on translation or settlement of a foreign currency-denominated monetary foreign currency-denominated monetary item or a non-monetary item carried at item or a non-monetary item carried at market should be included in the market should be included in the determination of net income for the determination of net income for the current period. (January, 2002)current period. (January, 2002)


1919


An ExceptionAn Exception– Changes in fair value on available-for-Changes in fair value on available-for-

sale investments to Other sale investments to Other Comprehensive IncomeComprehensive Income

– Exchange gains and losses receive Exchange gains and losses receive comparable treatment comparable treatment


2020


Foreign Currency Foreign Currency Financial Financial Statements receive Statements receive different treatment different treatment (see Chapter 10)(see Chapter 10)


2121

DisclosureDisclosure Paragraph 1651.37Paragraph 1651.37 The amount of The amount of

exchange gain or loss included in net exchange gain or loss included in net income should be disclosed (see paragraphs income should be disclosed (see paragraphs 1651.20, 1651.24 and 1651.31). An entity 1651.20, 1651.24 and 1651.31). An entity may exclude from this amount those may exclude from this amount those exchange gains or losses arising on financial exchange gains or losses arising on financial instruments classified as held for trading in instruments classified as held for trading in accordance with "Financial Instruments — accordance with "Financial Instruments — Recognition And Measurement", Section Recognition And Measurement", Section 3855. 3855.

An entity may also exclude from this amount An entity may also exclude from this amount exchange gains or losses on available-for-exchange gains or losses on available-for-sale financial assets and cash flow hedges sale financial assets and cash flow hedges (see "Hedges", Section 3865) included in (see "Hedges", Section 3865) included in any gains or losses removed from any gains or losses removed from accumulated other comprehensive income accumulated other comprehensive income and included in net income for the period. and included in net income for the period. (October, 2006)(October, 2006)


2222

DisclosureDisclosure

Paragraph Paragraph 1520.031520.03 contains contains an identical an identical recommendationrecommendation


2323

Foreign Currency Foreign Currency Purchases and SalesPurchases and Sales

Two transaction approach Two transaction approach requiredrequired– Transaction recorded at Transaction recorded at

current ratecurrent rate

– Exchange gains and losses Exchange gains and losses into income as they ariseinto income as they arise


2424


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.


2525


December 12, 2007December 12, 2007

Inventory [(SF)($100,000)($0.94)]Inventory [(SF)($100,000)($0.94)] $94,000$94,000

Accounts PayableAccounts Payable $94,000$94,000


Exchange LossExchange Loss

[(SF100,000)($0.96 - $0.94)][(SF100,000)($0.96 - $0.94)] $2,000$2,000

Accounts PayableAccounts Payable $2,000$2,000


2626

Foreign Currency Foreign Currency Capital TransactionCapital 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 - $1.55. On this latter date the loan is repaid.

Ignore interest payments.


2727

Foreign Currency Foreign Currency Capital TransactionCapital Transaction


Cash [(€1,000,000)($1.40)]Cash [(€1,000,000)($1.40)]$1,400,00$1,400,00

00

LiabilitiesLiabilities$1,400,0$1,400,0

0000


Exchange LossExchange Loss

[(€ 1,000,000)($1.50 - $1.40)[(€ 1,000,000)($1.50 - $1.40) $100,000$100,000

LiabilitiesLiabilities $100,000$100,000


2828

Foreign Currency Capital Foreign Currency Capital TransactionTransaction


Exchange Loss Exchange Loss

[(€1,000,000)($1.55 - $1.50)][(€1,000,000)($1.55 - $1.50)] $50,000$50,000

LiabilitiesLiabilities $50,000$50,000


Liabilities [Liabilities [€1,000,000)($1.55)]€1,000,000)($1.55)]$1,550,00$1,550,00

00

CashCash$1,550,00$1,550,00

00


2929

Held-To-Maturity Held-To-Maturity InvestmentsInvestments

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.


3030

Held-To-Maturity Held-To-Maturity InvestmentsInvestments

January 1, 2008January 1, 2008

Bonds [(£200,000)($2.15)]Bonds [(£200,000)($2.15)] $430,000$430,000

CashCash $430,000$430,000


Bonds [(£200,000)($2.25 - $2.15)]Bonds [(£200,000)($2.25 - $2.15)] $20,000$20,000

Exchange GainExchange Gain $20,000$20,000


3131

Available-For-Sale At Cost Available-For-Sale At Cost InvestmentsInvestments

ExampleOn January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company.

At this time £1 = $2.15. 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.


3232

Available-For-Sale At Cost Available-For-Sale At Cost InvestmentsInvestments


Shares [(£200,000)($2.15)]Shares [(£200,000)($2.15)] $430,000$430,000

CashCash $430,000$430,000


No Entry Is RequiredNo Entry Is Required


3333

Held-For-Trading Held-For-Trading InvestmentsInvestments


At this time £1 = $2.15. 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.


3434

Held-For-Trading Held-For-Trading InvestmentsInvestments


Shares [(£200,000)($2.15)]Shares [(£200,000)($2.15)] $430,000$430,000

CashCash$430,00$430,00

00


Shares [(£215,000)($2.25) - $430,000]Shares [(£215,000)($2.25) - $430,000] $53,750 $53,750

Fair Value Gain – Net IncomeFair Value Gain – Net Income

[(£215,000 - £200,000)[(£215,000 - £200,000)($2.25)]($2.25)]

$33,75$33,7500

Exchange Gain – Net IncomeExchange Gain – Net Income

[(£200,000)($2.25 - $2.15)][(£200,000)($2.25 - $2.15)] 20,00020,000


3535

Available-For-Sale At Fair Value Available-For-Sale At Fair Value InvestmentsInvestments


At this time £1 = $2.15. 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.


3636



Shares [(£200,000)($2.15)]Shares [(£200,000)($2.15)] $430,000$430,000

CashCash $430,000$430,000


Shares [(£215,000)($2.25) - Shares [(£215,000)($2.25) - $430,000]$430,000] $53,750$53,750

Fair Value Gain – OCIFair Value Gain – OCI

[(£215,000 - £200,000)[(£215,000 - £200,000)($2.25)]($2.25)] $33,750$33,750

Exchange Gain - OCIExchange Gain - OCI

[(£200,000)($2.25 - $2.15)][(£200,000)($2.25 - $2.15)] 20,00020,000


3737


ReclassificationReclassificationIf investments are sold, the If investments are sold, the

Other Comprehensive Other Comprehensive Income amounts will be Income amounts will be reclassified into Net reclassified into Net IncomeIncome


3838

HedgingHedging

An extremely complex An extremely complex areaarea

Our coverage is limited Our coverage is limited to simple applications to simple applications in the area of foreign in the area of foreign exchange riskexchange risk


3939

HedgingHedging Paragraph 3865.02Paragraph 3865.02

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


4040

Hedged Items In GeneralHedged Items In General

Paragraph 3865.07(c)Paragraph 3865.07(c) A hedged item is all or a A hedged item is all or a specified portion of a recognized asset, a specified portion of a recognized asset, a recognized liability, an anticipated transaction, or recognized liability, an anticipated transaction, or a net investment in a self-sustaining foreign a net investment in a self-sustaining foreign operation, or a group of similar recognized assets, operation, or a group of similar recognized assets, recognized liabilities or anticipated transactions, recognized liabilities or anticipated transactions, having an identified risk exposure that an entity having an identified risk exposure that an entity has taken steps to modify.has taken steps to modify.


4141

Hedged Items: Hedged Items: Foreign Currency ApplicationsForeign Currency Applications

Foreign currency denominated Foreign currency denominated monetary assets or monetary monetary assets or monetary liabilitiesliabilities

Anticipated TransactionsAnticipated Transactions– Firm commitmentsFirm commitments– Forecasted transactionsForecasted transactions

Investments in self-sustaining foreign Investments in self-sustaining foreign operationsoperations


4242

Hedging Items In GeneralHedging Items In General

Paragraph 3065.07(d)Paragraph 3065.07(d) A hedging item is all A hedging item is all or a specified percentage of a derivative, or all or or a specified percentage of a derivative, or all or a specified percentage of a group of derivatives a specified percentage of a group of derivatives offsetting a risk exposure identified in the offsetting a risk exposure identified in the hedged item. All or a specified percentage of:hedged item. All or a specified percentage of:– (i) a non-derivative financial asset;(i) a non-derivative financial asset;– (ii) a non-derivative financial liability; or(ii) a non-derivative financial liability; or– (iii) a group of non-derivative financial assets or non-(iii) a group of non-derivative financial assets or non-

derivative financial liabilities, provided that all non-derivative financial liabilities, provided that all non-derivative items in a group are similar;derivative items in a group are similar;

may be designated as a hedging item only for a may be designated as a hedging item only for a hedge of a foreign currency risk exposure.hedge of a foreign currency risk exposure.


4343

Hedging Items: Hedging Items: Foreign Currency ApplicationsForeign Currency Applications

ExampleOn 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.


4444


Purchase Euros on July 1, 2008Purchase Euros on July 1, 2008– Effective but costly (no return on funds)Effective but costly (no return on funds)

Purchase financial asset Purchase financial asset denominated in Eurosdenominated in Euros– Some rate of returnSome rate of return– Low rates on short term investmentsLow rates on short term investments


4545


Purchase non-financial assets Purchase non-financial assets denominated in Eurosdenominated in Euros– InconvenientInconvenient– May or may not be effectiveMay or may not be effective

Forward contract to take delivery of Forward contract to take delivery of Euros on December 31, 2008Euros on December 31, 2008– EffectiveEffective– Requires no investment of fundsRequires no investment of funds


4646

A Derivatives PrimerA Derivatives Primer Paragraph 3855.19(e)Paragraph 3855.19(e) A derivative is a financial A derivative is a financial

instrument or other contract within the scope of this instrument or other contract within the scope of this Section with all three of the following characteristics:Section with all three of the following characteristics:

(i) its value changes in response to the change in a (i) its value changes in response to the change in a specified interest rate, financial instrument price, specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable rates, a credit rating or credit index, or other variable (sometimes called the "underlying"), provided in the case of (sometimes called the "underlying"), provided in the case of a non-financial variable that the variable is not specific to a a non-financial variable that the variable is not specific to a party to the contract;party to the contract;

(ii) it requires no initial net investment or an initial net (ii) it requires no initial net investment or an initial net investment that is smaller than would be required for other investment that is smaller than would be required for other types of contracts that would be expected to have a similar types of contracts that would be expected to have a similar response to changes in market factors; andresponse to changes in market factors; and

(iii) it is settled at a future date.(iii) it is settled at a future date.


4747

A Derivatives PrimerA Derivatives Primer

TypesTypes– ContractsContracts

ForwardsForwards FuturesFutures Both parties must performBoth parties must perform

– OptionsOptions Only one party required to performOnly one party required to perform


4848

A Derivatives PrimerA Derivatives Primer

Accounting proceduresAccounting procedures– Initial recognition at fair value (often nil)Initial recognition at fair value (often nil)– Subsequent measurement at fair valueSubsequent measurement at fair value– Gains and losses to Net Income (in general)Gains and losses to Net Income (in general)


4949

Forward Exchange ContractsForward 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.


5050


Initial RecognitionInitial Recognition– No consideration for contractNo consideration for contract– Fair value = nilFair value = nil– No recognition in the financial No recognition in the financial

statementsstatements


5151


Settlement on December 31, 2007 when Settlement on December 31, 2007 when rate is £1 = $2.33.rate is £1 = $2.33.


Cash [(£100,000)($2.33)]Cash [(£100,000)($2.33)] $233,000$233,000

Cash [(£100,000)($2.30)]Cash [(£100,000)($2.30)] $230,000$230,000

Gain On ContractGain On Contract 3,0003,000


5252


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.


5353

Hedge AccountingHedge 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.


5454


Its use is optionalIts use is optional– Often not necessary Often not necessary

(e.g., contract hedging a (e.g., contract hedging a monetary asset)monetary asset)

– Sometimes cannot qualifySometimes cannot qualify

– Management may decide not Management may decide not to useto use


5555


QualificationQualification– DesignationDesignation

– DocumentationDocumentation

– Evaluation for effectiveness Evaluation for effectiveness (Beyond the scope of this text)(Beyond the scope of this text)


5656

Fair Value HedgesFair Value Hedges

Under this approach, gains and Under this approach, gains and losses on the hedging item losses on the hedging item must be included in Net must be included in Net Income. Income.

Gains and losses on the Gains and losses on the hedged item that are hedged item that are attributable to the hedged risk attributable to the hedged risk must also be included in Net must also be included in Net Income. Income.


5757

Fair Value HedgesFair Value Hedges

Fair value hedge accounting can be used Fair value hedge accounting can be used when the hedge is a hedge of the when the hedge is a hedge of the exposure to changes in the fair value of:exposure to changes in the fair value of:

– a recognized asset or liability;a recognized asset or liability;

– an unrecognized firm commitment; oran unrecognized firm commitment; or

– an identified portion of such an asset, an identified portion of such an asset, liability, or firm commitment. liability, or firm commitment.


5858

Cash Flow Hedge Cash Flow Hedge AccountingAccounting

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


5959

Cash Flow Hedge Cash Flow Hedge AccountingAccounting

Cash flow hedge accounting can be Cash flow hedge accounting can be used when the hedge is a hedge of used when the hedge is a hedge of the exposure to variability in cash the exposure to variability in cash flows associated with:flows associated with:– a recognized asset or liability;a recognized asset or liability;

– a forecasted transaction; ora forecasted transaction; or

– the foreign currency risk in an the foreign currency risk in an unrecognized firm commitment.unrecognized firm commitment.


6060

Hedge Of Exposed Monetary BalanceHedge Of Exposed Monetary Balance

ExampleOn 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.


6161

Example – No Hedge Example – No Hedge AccountingAccounting

November 1, 2008November 1, 2008

Receivable [(SF1,000,000)($0.90)]Receivable [(SF1,000,000)($0.90)] $900,000$900,000

SalesSales $900,000$900,000


Receivable [(SF1,000,000)($0.92 - Receivable [(SF1,000,000)($0.92 - $0.90)]$0.90)] $20,000$20,000



6262


February 1, 2009February 1, 2009



CashCash $950,000$950,000

ReceivableReceivable $950,000$950,000


6363

Example – Example – Hedge With Forward ContractHedge With Forward Contract

ExampleOn 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.

HedgeOn 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.


6464



6565


November 1, 2008November 1, 2008

Receivable [(SF1,000,000)($0.90)]Receivable [(SF1,000,000)($0.90)]$900,00$900,00

00

SalesSales $900,000$900,000




Exchange LossExchange Loss $9,950$9,950

Forward Contract (Liability)Forward Contract (Liability) $9,950$9,950


6666





Exchange Loss – Exchange Loss – [(SF1,000,000)($0.95 - $0.92) - [(SF1,000,000)($0.95 - $0.92) - $9,950)]$9,950)] $20,050$20,050

Forward ContractForward Contract $20,050$20,050


6767



CashCash $950,000$950,000

ReceivableReceivable $950,000$950,000

Cash [(SF1,000,000)($0.92)]Cash [(SF1,000,000)($0.92)] $920,000$920,000

Forward Contract ($9,950 + $20,050)Forward Contract ($9,950 + $20,050) 30,00030,000

Cash [(SF1,000,000)($0.95)]Cash [(SF1,000,000)($0.95)] $950,000$950,000


6868


ExampleOn 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 = $1.57. 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 = $1.55. On May 1, 2009, the rate is €1 = $1.52.


6969


October 1, 2008October 1, 2008

Term Deposit [(€500,000)($1.57)]Term Deposit [(€500,000)($1.57)] $785,000$785,000

CashCash $785,000$785,000


Exchange Loss [(€500,000)($1.55 - Exchange Loss [(€500,000)($1.55 - $1.57)]$1.57)] $10,000$10,000

Term DepositTerm Deposit $10,000$10,000


7070


May 1, 2009May 1, 2009

Exchange Loss [(€500,000)($1.55 - Exchange Loss [(€500,000)($1.55 - $1.52)]$1.52)] $15,000$15,000


Cash [(€500,000)($1.52)]Cash [(€500,000)($1.52)] $760,000$760,000


Merchandise [(€500,000)($1.52)]Merchandise [(€500,000)($1.52)] $760,000$760,000

CashCash $760,000$760,000


7171


The economic gain on the commitment (i.e., the purchase will now cost less) cannot be recognized.


7272


ExampleOn 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 = $1.57. 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 = $1.55. On May 1, 2009, the rate is €1 = $1.52.

Document the hedging relationship and use Cash Flow Hedge Accounting.


7373

Example – Example – Cash Flow Hedge AccountingCash Flow Hedge Accounting

October 1, 2008October 1, 2008

Term Deposit [(€500,000)($1.57)]Term Deposit [(€500,000)($1.57)] $785,000$785,000

CashCash$785,00$785,00

00


OCI - Exchange Loss [(€500,000)($1.55 - OCI - Exchange Loss [(€500,000)($1.55 - $1.57)]$1.57)] $10,000$10,000



7474


May 1, 2009May 1, 2009

OCI - Exchange Loss [(€500,000)($1.55 - OCI - Exchange Loss [(€500,000)($1.55 - $1.52)]$1.52)] $15,000$15,000


Cash [(€500,000)($1.52)]Cash [(€500,000)($1.52)]$760,00$760,00

00

Term DepositTerm Deposit$760,00$760,00

00

Merchandise [(€500,000)($1.52)]Merchandise [(€500,000)($1.52)]$760,00$760,00

00

CashCash$760,00$760,00

00


7575


Alternative 1 – Reclassify ImmediatelyAlternative 1 – Reclassify Immediately

May 1, 2009May 1, 2009

MerchandiseMerchandise $25,000$25,000

OCI – Reclassification AdjustmentOCI – Reclassification Adjustment $25,000$25,000


7676


Alternative 2 – Reclassify When Merchandise SoldAlternative 2 – Reclassify When Merchandise Sold


Cost Of Goods SoldCost Of Goods Sold $760,00$760,0000

MerchandiseMerchandise $760,00$760,0000

Cost Of Goods SoldCost Of Goods Sold $25,000$25,000

OCI – Reclassification AdjustmentOCI – Reclassification Adjustment $25,000$25,000


7777

Hedge Of Net Investment Hedge Of Net Investment In Self-Sustaining OperationIn Self-Sustaining Operation

Paragraph 3865.58Paragraph 3865.58 A hedge of a net investment in a self- A hedge of a net investment in a self-sustaining foreign operation, including a hedge of a monetary item sustaining foreign operation, including a hedge of a monetary item that is accounted for as part of the net investment (see “Foreign that is accounted for as part of the net investment (see “Foreign Currency Translation”, Section 1651), should be accounted for as Currency Translation”, Section 1651), should be accounted for as follows:follows:– (a) the portion of the gain or loss on the hedging item that is (a) the portion of the gain or loss on the hedging item that is

determined to be an effective hedge (see paragraphs 3865.08 determined to be an effective hedge (see paragraphs 3865.08 -.45) should be recognized in other comprehensive income (see -.45) should be recognized in other comprehensive income (see “Comprehensive Income”, Section 1530); and“Comprehensive Income”, Section 1530); and

– (b) the ineffective portion of the gain or loss on the hedging (b) the ineffective portion of the gain or loss on the hedging item should be recognized in net income.item should be recognized in net income.

The gain or loss on the hedging item relating to the effective portion The gain or loss on the hedging item relating to the effective portion of the hedge that has been recognized in other comprehensive of the hedge that has been recognized in other comprehensive income should be recognized in net income in the same period income should be recognized in net income in the same period during which corresponding exchange gains or losses arising from during which corresponding exchange gains or losses arising from the translation of the financial statements of the self-sustaining the translation of the financial statements of the self-sustaining foreign operation are recognized in net income. (October, 2006)foreign operation are recognized in net income. (October, 2006)


7878



7979


Reduction In Net InvestmentReduction In Net Investment– Paragraph 1651.31Paragraph 1651.31 An appropriate An appropriate

portion of the exchange gains and losses portion of the exchange gains and losses accumulated in the separate component accumulated in the separate component of accumulated other comprehensive of accumulated other comprehensive income should be included in the income should be included in the determination of net income when there determination of net income when there is a reduction in the net investment. is a reduction in the net investment. (October, 2006)(October, 2006)


8080

Discontinuance Of Discontinuance Of Hedge AccountingHedge Accounting

Discontinue If:Discontinue If:– The hedging item ceases to existThe hedging item ceases to exist– The hedged item ceases to existThe hedged item ceases to exist– It becomes probable that an anticipated It becomes probable that an anticipated

transaction will not occurtransaction will not occur– The entity terminates the hedging designationThe entity terminates the hedging designation– The hedging relationship ceases to be effectiveThe hedging relationship ceases to be effective


8181

International ConvergenceInternational Convergence

Hedging covered in IAS Hedging covered in IAS No. 39, No. 39, Financial Financial InstrumentsInstruments– No differences that impact No differences that impact

on the material covered in on the material covered in this text this text

Other foreign currency Other foreign currency issues in Chapter 10 issues in Chapter 10


8282

chapter 9 translation of foreign currency transactions

Documents

rate slide

term spot rate

method of translation

terminology spot rate

relevant spot rate

historical exchange

time bid rate

terminology historic