Foreign Currency Transactions and Hedging Foreign Exchange

Risk

 Foreign Currency Transactions

Two major issues that must be addressed when financial statements are
translated from a foreign currency into JD:
- Which exchange rate should be used to translate foreign currency balances
to domestic currency?
- How should translation gains and losses be accounted for? Should they be
included in income?

 Foreign Exchange Rates

o An Exchange Rate is the cost of one currency in terms of another.
o Spot Exchange Rate: The exchange rate that is available today.
o Forward Exchange Rate: The exchange rate that can be locked in today
for an expected future exchange transaction.

 Functional currency
o The currency of the primary economic environment in which the entity
operates
o The transaction is often denominated in the currency of the foreign

 IFRS requires a two-transaction perspective.

o Account for the original sale in JD.
o Account for gains/losses from exchange rate fluctuations.
o Gains/losses are recorded on the Income Statement.

Example (1): Hana Corporation acquired Inventory on account from a foreign

supplier on November 1, 2014, for 200,000 €. It paid the foreign currency
account payable on January 15, 2015. The following exchange rates for 1 € are
known:

November 1, 2014 0.450

December 31, 2014 0.420
January 15, 2015 0.460

Required

Prepare all journal entries for Hana Company in connection with the purchase
and payment. Assume that the company uses a Periodic inventory system.
Dr. Nidal Zalloum Advanced Accounting last update 3/31/2019

SOLUTION

Hana’s journal entry on November 1, 2014

Purchases 90,000
Accounts payable (€) 90,000

Hana’s journal entry on December 31, 2014

Accounts payable (€) 6,000

Foreign Exchange Gain 6,000

Hana’s journal entries on January 15, 2015

Foreign Exchange Loss 8,000

Accounts payable (€) 8,000

Cash (€) 92,000

Cash 92,000

Accounts payable (€) 92,000

Cash (€) 92,000

Example (2): On September 1, 2014, Ahmad sold parts to a foreign customer at

a price of 100,000 €. Payment is received on March 1, 2015.
Currency exchange rates for 1 € are as follows:

September 1, 204 0.150

December 31, 2014 0.145
March 1, 2015 0.160

Required

Prepare all journal entries for Ahmad in connection with this sale. Assume that
the company uses a Periodic inventory system.

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Dr. Nidal Zalloum Advanced Accounting last update 3/31/2019

SOLUTION

Ahmad’s journal entry on November 1, 2014

Accounts Receivable (€) 15,000

Sales 15,000

Ahmad’s journal entry on December 31, 2014

Foreign Exchange Loss 500

Accounts Receivable (€) 500

Ahmad’s journal entries on March 1, 2015

Accounts Receivable (€) 1,500

Foreign Exchange Gain 1,500

Cash (€) 16,000

Accounts Receivable (€) 16,000

Cash 16,000
Cash (€) 16,000

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 Dr. Nidal Zalloum Advanced Accounting last update 3/31/2019

 Hedging Foreign Exchange Risk

- Companies will seek to reduce the risks associated with foreign currency
fluctuations by hedging.
- This means they will give up a portion of the potential gains to offset the
possible losses.
- A company enters into a potential transaction whose exposure is the
opposite of the one that has the associated risk.

Example (3): On September 1, 2014, Ahmad sold parts to a foreign customer at

a price of 100,000 Euros. Payment is received on March 1, 2015. Ahmad enters
into a forward contract on September 1, 2014, to sell 100,000 Euros on March
1, 2015. Relevant exchange rates for the Euro on various dates are as follows:

hedge contract
Date Spot Rate
(to March 1, 2015)
September 1, 204 0.150 0.140
December 31, 2014 0.145
March 1, 2015 0.160

prepare journal entries for these transactions in Jordanian Dinars. What is the
impact on 2014 net income? What is the impact on 2015 net income?

SOLUTION
Ahmad’s journal entry on November 1, 2014
hedge contract
Accounts Receivable (€) 15,000 Accounts Receivable/ hedge contract 14,000
Sales 15,000 Discount on Forward contract 1,000
Accounts payable (€)/ hedge contract 15,000

Ahmad’s journal entry on December 31, 2014

hedge contract
Foreign Exchange Loss 500 Accounts payable (€)/ hedge contract 500
Accounts Receivable (€) 500 Foreign Exchange Gain 500
Discount Expense 667
Discount on Forward contract 667

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 Dr. Nidal Zalloum Advanced Accounting last update 3/31/2019

Ahmad’s journal entries on March 1, 2015

hedge contract
Accounts Receivable (€) 1,500 Foreign Exchange Loss 1,500
Foreign Exchange Gain 1,500 Accounts payable (€)/ hedge contract 1,500
Discount Expense 333
Discount on Forward contract 333
Cash (€) 16,000 Accounts payable (€)/ hedge contract 16,000
Accounts Receivable (€) 16,000 Cash (€) 16,000
Cash 14,000
Accounts Receivable/ hedge contract 14,000

Example (4): On September 1, 2014, Ahmad sold parts to a foreign customer at

a price of 100,000 Euros. Payment is received on March 1, 2015. Ahmad enters
into a forward contract on September 1, 2014, to sell 100,000 Euros on March
1, 2015. Relevant exchange rates for the Euro on various dates are as follows:

hedge contract
Date Spot Rate
(to March 1, 2015)
September 1, 204 0.150 0.155
December 31, 2014 0.145
March 1, 2015 0.160

prepare journal entries for these transactions in Jordanian Dinars. What is the
impact on 2014 net income? What is the impact on 2015 net income?

SOLUTION
Ahmad’s journal entry on November 1, 2014
hedge contract
Accounts Receivable (€) 15,000 Accounts Receivable/ hedge contract 15,500
Sales 15,000 Premium on Forward contract 500
Accounts payable (€)/ hedge contract 15,000

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 Dr. Nidal Zalloum Advanced Accounting last update 3/31/2019

Ahmad’s journal entry on December 31, 2014

hedge contract
Foreign Exchange Loss 500 Accounts payable (€)/ hedge contract 500
Accounts Receivable (€) 500 Foreign Exchange Gain 500
Premium on Forward contract 333
Premium Gain 333

Ahmad’s journal entries on March 1, 2015

hedge contract
Accounts Receivable (€) 1,500 Foreign Exchange Loss 1,500
Foreign Exchange Gain 1,500 Accounts payable (€)/ hedge contract 1,500
Premium on Forward contract 167
Premium Gain 167
Cash (€) 16,000 Accounts payable (€)/ hedge contract 16,000
Accounts Receivable (€) 16,000 Cash (€) 16,000
Cash 15,500
Accounts Receivable/ hedge contract 15,500

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