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Upjohn Company is a U.S.-based pharmaceutical firm with extensive global operations. It must comply with U.S.

tax laws and tax laws of each country in which it does business. International taxation has dramatic impacts on management decisions, such as were a company should invest; what form of business organization is used; what products are produced where; how prices and transfer prices are set; which currency should be used to denominate transactions; and what financing should be used. A firm must have professional expertise on its staff or available to review its tax status and the impacts that changes in tax treaties, agreements, laws, and regulations will have. Government and taxpayers are equally aware of tax minimization strategies. Tax laws in each country reduce the management accountant’s flexibility. Even if we assume that they have a desire to be inherently fair, governments want to generate revenue, plug tax and cash-flow loopholes, get at least their share of tax revenues, promote specific types of economic growth, and perhaps build in subtle bases in favor of domestic firms. The European Community (EC), General Agreement on Tariffs and Trade (GATT), North America Free Trade Agreement (NAFTA), and other bilateral and multilateral agreements have as their main themes encouraging free trade. While free means loosening many barriers, reducing or eliminating import duties and other cross-border taxes and fees is of major importance. Avoidance of Financial Restrictions Foreign governments often place financial restrictions on international subsidiaries operating within their boundaries. Government restrictions are placed on the amount of cash that may leave the country and for management fees charged by the parent company. Thus, moving profits and, therefore, “stuck” cash by high transfer prices can reduce those restricted profits and increase firm-wide liquidity and financial mobility. Gaining Host Country Approval Governments are not naïve. They are becoming sophisticated and aware of the results of using high or low transfer prices. Prices are compared to arm’s-length sales price elsewhere. Products are analyzed for content. Price controls may be based on the transferred-in cost. For example, price increases may be limited by government regulators to cost increases. In the long run, companies find that transfer pricing policies which satisfy foreign authorities may be in the best interest of the company when compared to the greater profits that might be sacrificed. A foreign government’s requirements about domestic ownership, percentage of locally produced content, and approval for government sales can be significant factors in determining how an international market is entered and how a company will operate there. ACCOUNTING FOR TRANSACTIONS IN FOREIGN CURRENCY The management accountant must facilitate business activity wherever it occurs. Therefore, a basic understanding of currency trading and exchange is expected. Global business basically means buying and selling goods and services across national borders. For example, a manufacturer of computer-aided design

. . . March 3. . . Hedging operations. . Pound 1. .S.7130 Britain . . But. . . 1993.0077 0.2666 0. .3376 0. . . . . . . .8430 0. .7403 Chile . . . . Yuan 0. Baht 0. . . . .7367 1. March 2. . . . . . . . Rupee 0. . . . . . .1 Sample of Foreign Exchange Rates as of the First Monday of March U.0026 0.1830 0. . . a risk of loss exists. .8009 0. . . the latter expression is more common.0390 0. . .6040 0. . . . . . .2670 0. . . . . . an international transaction typically involves two currencies. . . . . . . Yen 0. . A foreign currency transaction is one in which settlement is in the currency of another country. . . exchanges.4225 0. . .3662 0. . . .1586 0. . . . Krona 0. . . . . . Borrowing from or lending to a foreign company with the amount to be paid or received denominated in a foreign currency. Foreign currency exchange rates are quoted in both currencies.0024 China (PRC) . . A transaction with a foreign company that is settled in a domestic currency is an international transaction but not a foreign currency transaction. . . . dollar (¥100 = $1) or one hundredth U. . .0305 0.6317 Sweden . Thus. .1186 0. . . . . . . .7045 $ 0. . . . . . . .1149 Germany . A third transaction type commonly undertaken to reduce foreign exchange risk is: 3. . . . . Importing (buying) or exporting (selling) goods or services on credit with the amount to be paid or received denominated in a foreign currency. . .0395 Source: Wall Street Journal. a disruptive event for foreign exchange markets. . . . . . . . .7530 1. . . . . . . . .0030 0. Notice the significant changes for Britain. . . .S. . . . . . China. . . . . 1992. . The values of currencies rise and fall daily in each relation to each other.0090 0.S. . . . 1994.0096 Mexico . .0316 0.3270 0. . . . . .4380 1. . . March 2.S. .0392 0.1712 0. dollar to one yen ($0. Peso 0. . .0322 Israel . 1995. . . . . 2. . . Dollar 0. . Peso 0. . .6078 0. . .0024 0. . . . . . . .6275 0. An international transaction itself may earn a profit. . . .4896 Canada . . . . . . These transactions are commonly denominated in the currency of the country in which the transaction takes place.7005 0. . . . These types of transactions create a payable or receivable with time elapsing before cash changes hands to complete the deal. . March 1995 $ 0. Or it might try to lower its costs by buying memory chips from ales expensive source in another country.6920 0. . The more common foreign currency transactions are: 1. . .equipment may expand its market by selling to foreign customers.3237 0. . .0106 0. . . .5855 Hungary . March 2. . . because the foreign currency exchange rates change. . . Of note is the fact that the March 1993 date comes three days after the bombing of the World Trade Center in New York City.01 = ¥1). . . A sample of currency rates as of a specific date for several years is shown in Figure 16. . . . . Dollar $ 0.7113 0. .0117 0. . FIGURE 16. . . . . . . Mark 0. . . . . . . . .2670 Singapore . . . . . . . . . On U. .0097 India . . . . . . . Shekel 0. Dollar Equivalent Country Currency March 1992 March 1993 March 1994 Australia . .1. . .1679 0. . Dollar 0.0393 0. . . and particularly Mexico between 1994 and 1995. . . . Forint 0.7533 $ 0. . . . .6086 0. . . such as 100 Japanese yen per one U. .3145 Saudi Arabia . .3339 Japan .2674 0. .0084 0.1376 0.0403 . . .0130 0. . . . . .6088 0. . . . Riyal 0. . .1281 0. .1248 Thailand . . This time interval creates the opportunity for exchange gain or loss from foreign currency transactions.

000 $200. The payment is recorded as follows: Cash (¥20. it pays either in its own currency or in the foreign currency.60 per mark. Our accounting records would reflect the purchase as follows: Accounts Payable. Japanese Company $200.0105).000 as follows: Sales $600.000 because it agreed to pay ¥20.000 Purchases $200. Let’s look at the financial impacts of these transactions. Assume that our U.000. More dollars were required to buy the same number of yen. the exchange value of the yen relative to the dollar increased.0100 per yen. Although the same rationale applies to sales. company incurred an exchange loss of $10.0105) $210. If both billings and payments are in the domestic currency.S. we record a sale of $600. the U.000.0100 to $0. Assume that our U.S. dollars. and. company incurs an gain or loss if the exchange rate changes between the dates of purchase and payment.S. Japanese Company $200. no exchange accounting problems arise. At the payment date. Assume that the exchange rate on the settlement date is $0.Importing or Exporting Goods or Services The most common form of foreign currency transaction is importing or exporting goods or services. When a domestic company purchases goods or services abroad. we spend to buy ¥20. company will incur an exchange gain or loss if the exchange rates change between the dates of billing and settlement. If the exchange rate is $0. company in yen and requests payment in yen. or payment. If the billing and subsequent payment are made in U.000 Here.000.S.S. company buys memory chips from a Japanese company in yen at a cost of ¥20.000.000.000 Exchange Loss $ 10.61.60 per mark rate.000 If the exchange exchange $210. between the dates of purchase and payment.000 × $0.000. date. Sales are the opposite of purchases.S.000. German Company $600.000 Accounts Receivable. company sells computer products to a German company in marks for DM1.000 Accounts Payable. exchange gains or losses are reserved.000 (¥20. Foreign Exchange Sales. changed from the $0. A normal payable and a cash payment are recorded.000. the U.0105 at the settlement. The sale is still recorded as .000.S.000 × $0. Foreign Exchange Purchases. or $200.000 when the exchange rate is $0.000 Japanese company bills our U.000 Using German marks (DM) for the transaction. Assume that the yen rate moves from $0. no foreign exchange accounting problem exists. the U.

500 (Fr500. For an accounts receivable in which foreign currency is received. the rate of exchange between two currencies that are being bought and sold for immediate delivery. $ 0. . . . German Company $600. . . . . . .000 The U. . . . . . . On the settlement. . On December 1.000. . . . .$600. date. company records a sale and accounts receivable at the domestic equivalent of $90.000 × $0. . . . . . . . .000. the German marks convert into more dollars at the collection date. The transaction is recorded as follows: Accounts Receivable. . . 2.000 (DM1. December 31. .180). .000 (Fr500. Balance sheet date: Balances that are denominated in a foreign currency are adjusted to reflect the exchange rate at any interim balance sheet date. On the balance sheet. revenue.000. . The receivable is $82. . . . . .S. . . company incurred an exchange gain of $10.000. . Settlement date (March 1) . . . . . . . the U. . . . . .000 × $0.000 $600. .61). assume that in 1998 our U. . . . . . . . . . . . The spot rate. . . . . . . . . . .000 (DM1. . . . or loss arising from the transaction is measured and recorded in the domestic currency at the current foreign exchange rate. The dates and the proper exchange rates used in translating foreign currencies are as follows: 1.000 × $0. . . . we receive DM1. . . . . . . .000 when the franc exchange rate was $0. . 2. . This is a requirement of current financial accounting reporting under SFAS 52. company sold computer products to a French company for Fr500. .000 × $0. The foreign exchange loss is as follows: . . . . . . .61) Exchange Loss $ 10. . Dates of Concern to Accountants. . . . the foreign currency must be converted to domestic currency. . . . . . . . . . . . three dates concern accountants. . .165 0. . . . . 3. . Settlement date: In the case of a foreign currency payable. . . . Transaction date: Each asset. . . . . .S. . . . . . . . . . .000. . . . . . Balance sheet date (December 31) . . gain. . a domestic company must convert the domestic currency into foreign currency units to settle the accounts payable. . . .000. . the receivable denominated in foreign currency is adjusted using the exchange rate in effect at the balance sheet date. . . .000 Cash $610. . .000. . . . The billing to the French company was for Fr500. This date is important to apportion the gains and losses to the proper reporting period. . . . . . . . . . . .S. .000 and the exchange rates changed between the billing and collection dates.180 0. . . . . or collection. But. . . . .000 of revenue. . . . . . .000 because it agreed to receive DM1. . .000 and represents DM1. . . . . . . the marks are now worth $610. . . In this case. . Because exchange gains and losses occur and must be reported properly.165). .18. . . . . expense. liability. . . . .170 1. . To illustrate the impacts of these dates. for francs at three dates is as follows: Transaction date (December 1) .

currency. . .500 $ 7. . .000 ($90. . . . a strong currency may weaken. . . . . . . . . if machining equipment is purchased from a foreign company using long-term credit. . . . . a periodic adjustment is made to the receivable account. .Initial receivable recorded (December 1) . . .200 82. 3. . . . . global politics. . The machine’s cost is not adjusted for subsequent changes in the exchange rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .000 and must convert them into U. . . . . . . . . . . . Borrowing or Lending Accounting for borrowing or lending in foreign currencies follows the same approach as for trade payables and receivables. . . . . . . .$85. . . . . . . . . .500 in 1998. . International economics. but the liability is adjusted at each balance sheet date using the spot exchange rate on that date. the cost of the asset is recorded at the acquisition date using the spot rate at the transaction date. .S. . $ 90. . . . . . . . . . . . . . accounting rules require companies to identify exchange gains and losses with the proper time interval. . . . Over time. . . . . . . . . .170. or revenue earned is accounted for independent of the loan receivable or note payable. . .170). . . . . . . . . . . . . Hedging As we have seen. . . . For the total transaction. . . . . . . and a 1999 exchange gain of $2. .000 82. . .S. and the economic health of any particular country relative to the others influence the value of currencies. When a balance sheet date comes between the transaction and settlement dates. . . . . . company receives Fr500. . Value of receivable at yearend (December 31) . .000 . . Foreign exchange loss . . . . . . . Foreign exchange gain . . . . . . . . . . company receives $85. . . . . . . . . . . . . . . asset acquired. . This accounting treatment suggests that companies need to develop policies covering borrowings and lendings (investments) internationally. . . $ 85. . March 1. . U. . . . . . . . a domestic firm doing business with companies in other countries and engaging in foreign currency transactions faces an exchange risk. . . . . . . . . . . . . .S. . . . . . . or a weak currency may strengthen. . . . . . With a conversion rate of $0. . . . . .500 $ 2.000). . . . . . . . the company realizes a net exchange loss of $5. . . Judgments about how currencies will move relative to each other are speculative at best. . . . . . . . . . . . . The foreign exchange gain is as follows: Value of francs received at settlement date (March 1). . . . . the U. . . . . . . . . Value of receivable at yearend (December 31) . . . . . . . . . . .500 The receivable is collected. . . . . . . . . . . .000 (Fr500. . . . On the settlement date. .500 is recognized. . . . . . If a loan receivable is involved instead of a liability. . . For example. . . . . Any cash flow.000 × $0. . . . . .S. the U. . . . . . . . . . . . . . . . 1999. . The interest expense recorded is the translation of the foreign currency needed to pay interest expense for the time interval. . . . . . . . Any currency adjustment creates a foreign exchange gain or loss on the income statement. . . .500 We record the receivable decrease and an exchange loss of $7. . . . .

. Hedging.0101. . . $ 0. Other hedges commonly used internationally are buy or sell options or currency swap contact in futures markets. . Forward rate (60 days) . . is any transaction with the specific purpose of offsetting loses or locking gains from transactions already under contract. . . The hedging transaction dates usually match the dates of the transaction to be hedged. . . in its broadest sense.S. . . . the same data from the foreign purchases section presented earlier are used. . The forward rate differs from the spot rate because of differences in the relative market rates between the two countries. . . .000. . . . . company made a purchase on credit. . and currencies. . Perhaps the most common hedge is a forward exchange contract (forward contract). The transaction is denominated in yen. Brokers deal in contracts with standard terms and notional amounts to facilitate buying and selling. . . . . the gains and losses are due to foreign currency exchange rate changes. . . . . assume that U. . The exchange rate for this transaction is the spot rate on the purchase date. Two simple examples using forward contracts follow. . . . . . . . . . not because the foreign currency is expected to strengthen or weaken over the next 60 days. . . .000 at $0. . . .000. . . The variety of financial instruments and contracts is growing dramatically. To illustrate the accounting necessary for a forward exchange contract to hedge an exposed liability position. The company could do nothing and assumes the risk of a foreign exchange loss. . A forward rate is the rate of exchange between two currencies being bought or sold for delivery at a future date. . . A completed hedging transaction consists of two parts: (1) a premium or discount paid which is the difference between the spot rate and the forward rate on the transaction date. (See the purchase entry made earlier. . . futures markets exist for commodities. . . The assumptions are: 1.S. . . . we crate an exposed liability. . Therefore. . . . . but this ties up cash for 60 days. we will deal only with the calculations .000. . . .) Recording all elements of a hedging transaction is straightforward but includes several accounts with which managers are not usually familiar.000 payable in yen. In most developed countries. . .0101. In a foreign purchase transaction where settlement occurs on a future date. . The company could immediately purchase yen at a cost of $200. 3. . Hedges can occur in a number of ways. companies use hedging. 2. . . interest rates. Memory chips were purchased for ¥20. . . . Exchange rates: Transaction date: Spot rate . . . Settlement date spot rate . Hedge for a Foreign Currency Exposed Liability. . The hedging transaction is treated separately from the actual memory chip purchase.To minimize this exchange risk. a liability is created on the transaction date. . . . The treasurer could also go into the foreign currency market and purchase a 60-day forward contract to buy ¥20. It is an agreement to exchange currencies of two different countries at a specified rate (the forward rate) on a stipulated future date. . . . A forward contract can be written for a specific amount.0101 $ 0. . company entered into a forward contract to buy ¥20.000. . . .000 on the settlement date for $0. . . . The liability will be settled in 60 days in yen. . If the transaction is denominated in a foreign currency. .0105 The U. .0100 $ 0. . For our illustration. . In this case. . . . and (2) an exchange gain or loss which is the difference between the spot rates on the transaction and settlement dates.