Session VII & VIII
Foreign Currency
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-2
Foreign Exchange Basics
Exchange rates Conversion values Exchange rate factors
Inflation Interest rates Balance of payments
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-3
FX Gains and Losses
Realized gains and losses Result of FX transactions Exchange of currency takes place
Unrealized gains and losses Result of FX translations Conversion for F/S purposes
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-4
FX Transactions
Two-transaction approach for US GAAP Gain or loss recognized in the income
statement
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-5
Forward Exchange Contracts
Agreement to exchange currency at a specified time at a specified rate
Forward rate Spot rate
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-6
FX Translations
Current Rate Method (Modified Current Rate Method)
Temporal Method Only approaches approved under US GAAP
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-7
Current Rate Method
Local currency is the functional currency Method
Assets and liabilities translated at current rate Capital accounts translated at historical rate Dividends translated at current rate upon
declaration Revenue and expense translated at weighted
average rate Balancing amount recorded in OCI
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-8
Temporal Method Home currency is functional currency Method
Cash, A/R and A/P translated at current rate Other assets and liabilities translated at historical
rates Capital accounts translated at historical rate Revenue and expense other than items dependent
on non-monetary items translated at weighted average rate
Balancing amount recorded in income statement
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-9
Translation and Remeasurement
When local currency is functional currency, it is TRANSLATED into the home currency
When the local currency is not the functional currency, it is REMEASURED into the functional currency, which is usually the home currency
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-10
FX Risk Management
Self-sustaining operations support the local currency as the functional currency
Integrated operations support the home currency as the functional currency
Fixed rate currency Floating rate currency Intervention Arbitrage
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-11
Mundell-Fleming Model
Capital mobility offsets the ineffective nature of monetary and fiscal policy
Ineffective monetary policy with fixed rate currency
Ineffective fiscal policy with floating rate currency
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-12
FX Risk Exposure
CA > CL = positive exposure CA < CL = negative exposure Positive exposure & appreciation yields gain Negative exposure & depreciation yields gain FX risk includes both translations and
transactions
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-13
Transaction Risk Exposure
Transaction denominated in FX Settlement date is different from transaction
date Results from actual exchange of cash Results from actual changes in exchange rates Plan FX strategies and execute them
See Exhibit 2.7
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-14
Hedging Strategies
FX forward contract: most common Transaction denomination: US $ billing Risk sharing: agreed rate and price Price adjustment: price protection Currency options contract Cross-currency swap Currency swap
Contract based
strategies
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-15
Forward Exchange Contract Accounting
A/R
Sales revenue Deferred FX expense
Deferred credit FX expense
Deferred FX expense Cash
Deferred credit
A/R
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-16
The Euro
Legal tender for most of EU members Removal of exchange rate risk Lowers transaction costs Benefits consumer
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-17
Translation Risk Exposure
Accounting exposure only Increase net assets under appreciation Increase net liabilities under depreciation
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-18
Managing Economic Exposure
Consider location of operations Use the portfolio approach Use flexible planning Use pricing and promotional strategies
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-19
FX Forecasting
Implement effective information systems Consider all relevant factors on a collective basis
Political and social environment Political risk Economic growth Inflation Balance of payments Interest rates
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-20
US GAAP versusInternational Actg.
Stds. SFAS 52-FX Translation
If functional currency is US $, remeasure F/S If functional currency is local currency, translate
F/S Use two-transaction approach for FX transactions
SFAS 133-Derivatives and Hedging Report derivatives at fair value Hedging gains & losses are recognized
immediately
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-21
US GAAP versusInternational Actg.
Stds.-continued IAS 21-Foreign Currency
Temporal method required for integrated ops. Current method required for self-sustaining ops. Recommends two-transaction approach for FX
transactions IAS 39-Hedging
Similar to SFAS 133 (note the convergence!!)
Session IX
Changing Prices
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-23
General and Specific Price Increases
General price level increases (GPI) Based on market basket of goods & services
Specific price level increases (SPI) Relates to a particular item
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-24
Tight Money Policy
Monetary policy influence both inflation and economic growth
See Figure 3.1 on page 87
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-25
Constant Money Restatement
(Current Purchase Power Accounting) Balance sheet
I/D items as monetary or nonmonetary Extend monetary items at their face amount Adjust nonmonetary items for changes in purchasing power Roll-forward prior year balances
Income statement Adjust items based date of occurrence Compute depreciation based on adjusted historical cost Adjust other items based upon weighted average Compute cost of goods sold based on adj. Inventory items Calculate purchasing power gain or loss
See comprehensive example on pages 90 - 97.
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-26
Current Value Accounting
See pages 97 - 102 We will place limited focus on this topic due to
its subjective nature and lack of universal application
INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2005
7-27
IASC and Inflation
IAS 15: Price level accounting disclosures IAS 29: Hyperinflation report
Requirement for IAS countries Hyperinflation exists when 3-year cumulative
inflation exceeds 100 percent Restatement for GPI changes in primary
financial statements Hotly debated issue without firm resolution