Chapter 6 - Foreign Currency Transactions

Tuesday, 7 December 2021 7:54 pm

• Many companies engage in international activities

• Recording and reporting problems are encountered when transactions are measured in a currency
other than Philippine Currency
• Receivables and payables dominated in foreign currencies are subject to gains and losses
• Transactions to be settled in foreign currency must be translated
by multiplying the number of
Foreign Currency Transaction units of the foreign currency
→ To be settled in foreign currency by direct exchange rate
→ FS of the affiliate maintained in a foreign currency are translated into pesos

Foreign Currency Translation

→ Process of expressing monetary amounts that are stated in terms in a foreign currency into the
currency of the reporting entity by using an appropriate exchange rate

Foreign currency ---> appropriate exchange rate ---> currency of the reporting entity

HOW EXCHANGE RATES ARE QUOTED

Foreign Exchange Rate

→ Price of a currency expressed in terms of another currency
→ May be expressed:
○ Direct quotation
→ The exchange rate is quoted in terms of how many units of the domestic currency can
be converted into one unit of foreign currency
→ X Units of domestic = 1 unit of foreign currency
○ Indirect quotation
→ Converting one unit of the domestic currency into units of a foreign currency
→ Opposite of direct
→ 1 unit of domestic = X units of foreign currency
○ Spot rate
→ Rate for the immediate delivery of currencies exchanged
→ Rate in which currencies can be exchanged today
→ May move above or below the contracted forward rate before the currencies are
exchanged
→ Foreign exchange trader provides a quotation:
□ Buying (the bid rate) Contract to exchange at specified rate
□ Selling (the offer rate) foreign currency (the forward rate) currencies of
○ Forward rate different countries on a specified future
→ Rate at which currencies can be exchanged at some future date date
→ Established at the time a forward exchange contract is negotiated
→ Has no effect when the spot rate move
○ Floating rates
→ Supply and demand factors that determine the relationship between major currencies
→ Increase the risk to companies doing business with a foreign company
→ After a rate change occurs, all transactions are conducted at the new rate until the
next change occurs

Measured Usually the domestic currency of the

→ Transactions are measured and recorded in terms of the currency in which the reporting entity country in which the company is
prepares its financial statement domiciled

Denominated Called reporting currency

→ Assets and liabilities amounts are fixed in terms of that currency

Transactions:
1. Between two Philippine firms
Require payment of a fixed number of pesos
→ Both measured and denominated in pesos
→ No foreign currency gain or loss
2. Between Philippine firm and a foreign firm
• In pesos
→ No foreign currency gain or loss
• In domestic currency of the foreign company
→ Foreign currency transaction
→ Foreign currency gain or loss is recognized
3. Require payment of a fixed amount of foreign currency
• Philippine firm
→ Measures the receivables and payables in pesos
→ Transaction is denominated in the specified foreign currency
→ Foreign currency gain or loss is recognized
• Foreign firm
→ Both measured and denominated in its domestic currency

FOREIGN EXCHANGE RATE EXPOSURE

Accounting Exposure
→ Exposure to changes in exchange rates when:
• Entity enters into foreign currency transactions
Resulted - contractual rights and obligations dominated in foreign currencies
• Entity have to translate the foreign currency FS of foreign operations
Local currency --> group's reporting currency
For preparing consolidated FS
→ Quantifiable and directly impacts the income statement or balance sheet
→ Transaction exposure
→ Arises from foreign currency transactions
→ Results in transaction gain or losses
→ Recorded in the books of the individual entity
→ Typically, occur at one date and are settled at a later date
→ Affects the cash flows of the company
→ Translation exposure
→ Arises from translation of foreign currency FS of foreign operations

Book Notes Page 1

 → Arises from translation of foreign currency FS of foreign operations
→ Results in translation gain or losses (Translation differences)
→ Presented in the consolidated FS
→ Do not affect cash flows

Operating Exposure
→ Not easily quantifiable and reflects the impact of changes in real exchange rates on a firm's
operations

THE CONCEPT OF FUNCTIONAL CURRENCY

• PAS 21 "The effects of changes in foreign exchange rates"

Functional Currency
→ Currency of the primary economic environment in which the entity operates
→ Should be the currency that influences the sales prices of goods and services
→ Should be the currency in which a firm receives most of its cash receipts and expends cash outlays Primary indicators
→ Economic environment in which a firm operates is not determined by national or political
boundaries

Factors to indicate an entity's functional currency

1. Mainly influences the sales prices of goods and services
Supportive evidence
2. Whose competitive forces and regulations determine the sales prices of goods and services
3. Mainly influences the labor, material, and other costs of goods and services
4. In which financing is obtained
5. In which receipts from operating activities are usually retained

More pesos are needed to acquire foreign currency units

• Direct exchange rate is often said to be increasing
• Foreign currency unit to be strengthening

Fewer pesos are needed

• Foreign currency is weakening or depreciating in relation to the peso
• Direct exchange rate is decreasing

Book Notes Page 2