Multinational Accounting: Foreign Currency Transactions and Financial Instruments

Chapter 11
Multinational
Accounting: Foreign
Currency Transactions
and Financial
Instruments
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 11-1
Understand how to make

calculations using foreign
currency exchange rates.
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 11-2
The Accounting Issues (1 of 2)
⬥ Foreign currency transactions of a U.S. company
include sales, purchases, and other transactions
giving rise to a transfer of foreign currency or the
recording of receivables or payables that are
denominated in a foreign currency.
⬥ Translation is the process of restating foreign
currency transactions to their U.S. dollar–equivalent
values.
The Accounting Issues (2 of 2)
⬥ Many U.S. corporations have
multinational operations.
■ The foreign subsidiaries prepare their
financial statements in their home
■
currencies.
The foreign currency amounts in these
P U.S.
financial statements have to be

translated into their U.S. dollar
equivalents before they can be
consolidated with the U.S. parent’s
S Foreign
financial statements that use the U.S.

dollar as their reporting currency unit.
Foreign Currency Exchange Rates
(1 of 2)
⬥ Foreign currency exchange rates between currencies
are established daily by foreign exchange brokers
who serve as agents for individuals or countries
wishing to deal in foreign currencies.
■ Some countries maintain an official fixed rate of currency
exchange and have established fixed exchange rates for
dividends remitted outside the country.
Foreign Currency Exchange Rates
(2 of 2)
⬥ The determination of exchange rates
■ Exchange rates change because of a number of economic
factors affecting the supply of and demand for a nation’s
currency.
■ Factors causing fluctuations in exchange rates include:
● Level of inflation
● Balance of payments
● Changes in interest rate
● Changes in investment levels
● Stability and process of governance
Functional Currency
⬥ In preparing financial statements with foreign currency items

or transactions, the first task of each entity is to determine its
functional currency.
⬥ Functional currency is defined as:
■ The currency of the primary economic
environment in which the entity operates.
⬥ Foreign currency is in turn defined as:
■ A currency other than the functional currency of
the entity.
Determining Functional Currency (1 of 3)
⬥ The primary economic environment in which an entity

operates is normally the one in which it primarily generates
and expends cash.
⬥ However, if its operation is exposed to different economic
environment, it will be required to determine its functional
currency by considering some factors or indicators, which
can be divided into
■ primary indicators and
■ other indicators.
⬥ Primary Indicators
■ In determining its functional currency,
a reporting entity considers the following primary
indicators:
1. the currency:
a) that mainly influences sales prices for goods and services (this
will often be the currency in which sales prices for its goods and
services are denominated and settled); and
b) of the country whose competitive forces and regulations mainly
determine the sales price of its goods and services.
2. the currency that mainly influences labour, material and other costs
of providing goods or services (this will often be the currency in
which such costs are denominated and settled).
⬥ Other Indicators
■ In addition to the primary indicators, a
reporting entity can consider the following
indicators which may also provide evidence of
its functional currency:
1. the currency in which funds from financing activities (i.e. issuing
debt instruments and equity instruments) are generated.
2. the currency in which receipts from operating activities are
usually retained.
Direct versus Indirect Exchange Rates (1 of 3)
⬥ The direct exchange rate (DER) is the number of local

currency units (LCUs) needed to acquire one foreign
currency unit (FCU).
■ From the viewpoint of a U.S. entity, the direct
exchange rate ratio is expressed as follows
■ Example: Assume that $1.20 can acquire 1 euro
U.S. dollar–equivalent value of 1FCU

DER = 1FCU
$1.20
DE = 1.20 $/€
€1
R
⬥ The indirect exchange rate (IER) is the reciprocal

of the direct exchange rate.
■ From the viewpoint of a U.S. entity:
1 FCU
IER = U.S. dollar–equivalent value of 1FCU
■ Example: Assume a U.S.-based company can
purchase one euro for $1.20.
€1
IER = = 0.8333 €/$
$1.20
⬥ DER is identified as American terms

■ To indicate that it is U.S. dollar–based and represents an
exchange rate quote from the perspective of a person in
the United States.
⬥ IER is identified as European terms

■ To indicate the direct exchange rate from the perspective
of a person in Europe, which means the exchange rate
shows the number of units of the European’s local
currency units per one U.S. dollar.
⬥ The terms currency is the numerator and the base
currency is the denominator in the exchange rate
ratio.
Relationships between Currencies and
Exchange Rates
Figure 11-2
Spot Rates versus Current Rates
⬥ The spot rate is the exchange rate for immediate
delivery of currencies.
⬥ The current (closing) rate is defined simply as the
spot rate on the entity’s balance sheet date.
⬥ The forward rate on a given date is not the same as
the spot rate on the same date.
⬥ Expectations about the relative value of currencies
are built into the forward rate.
⬥ The spread:
■ The difference between the forward rate and the spot rate on a
given date.
■ Gives information about the perceived strengths or
weaknesses of currencies.
Learning Objective 11-2
Understand the accounting

implications of and be able to
make calculations related to
foreign currency transactions.
Foreign Currency Transactions (1 of 4)
⬥ Foreign currency transactions are economic
activities denominated in a currency other than the
entity’s recording currency.
⬥ These transactions include the following:
1. Purchases or sales of goods or services (imports or
exports), the prices of which are stated in a foreign
currency.
2. Loans payable or receivable in a foreign currency.
3. Purchase or sale of foreign currency forward exchange
contracts.
4. Purchase or sale of foreign currency units.
⬥ For financial statement purposes, transactions
denominated in a foreign currency must be
translated into the functional currency as the
reporting currency.
⬥ At each balance sheet date, account balances
denominated in a currency other than the entity’s
reporting currency must be adjusted to reflect
changes in exchange rates during the period.
⬥ The adjustment in equivalent U.S. dollar values is a
foreign currency transaction gain or loss for the
entity when exchange rates have changed.
⬥ Based on PSAK 10, at each balance
sheet date:
a)foreign currency monetary items
Retranslation required
⇒ shall be translated using the closing rate;
b)non-monetary items that are measured in
terms of historical cost in a foreign NO retranslation
currency
⇒ shall be translated using the exchange rate at
the date of the transaction
c) non-monetary items that are measured at Retranslation at
fair value in a foreign currency revaluation date
⇒ shall be translated using the exchange rates at

the date when the fair value was determined.
Assume that a U.S. company acquires €5,000 from its bank on January 1,
20X1, for use in future purchases from German companies. The direct
exchange rate is $1.20 = €1; thus, the company pays the bank $6,000 for
€5,000, as follows:
U.S. dollar–equivalent value = Foreign currency units × Direct
exchange rate
$6,000 = €5,000 × $1.20
The following entry records this exchange of currencies:
January 1, 20X1
Foreign Currency Units (€ ) 6,000
Cash 6,000
On July 1, 20X1, the exchange rate is $1.10 = €1. The following adjusting
entry is required in preparing financial statements on July 1:
July 1, 20X1
Foreign Currency Transaction Loss 500
Foreign Currency Units (€ ) 500
Foreign Currency Import and Export
Transactions (1 of 3)
⬥ An overview of the required accounting for an
import or export transaction denominated in a
foreign currency, assuming the company does not
use forward contracts, is as follows:
■ Transaction date:
● Record the purchase or sale transaction at the U.S.
dollar–equivalent value using the spot direct
exchange rate on this date.
■ Balance sheet date:
● Adjust the payable or receivable to its U.S.
dollar–equivalent, end-of-period value using the
current direct exchange rate.
● Recognize any exchange gain or loss for the change in
rates between the transaction and balance sheet
dates.
■ Settlement date:
● Adjust the foreign currency payable or receivable for
any changes in the exchange rate between the
balance sheet date (or transaction date if transaction
occurs after the balance sheet date) and the
settlement date, recording any exchange gain or loss
as required.
● Record the settlement of the foreign currency payable
or receivable.
Illustration of Foreign Purchase Transaction (1
of 2)
⬥ Assume the following information:
■ On October 1, 20X1, Peerless Products, a U.S. company,
acquired goods on account from Tokyo Industries, a
Japanese company, for $14,000, or 2,000,000 yen.
■ Peerless Products prepared financial statements at its
year-end of December 31, 20X1.
■ Settlement of the payable was made on April 1, 20X2.
Illustration of Foreign Purchase Transaction (2
of 2)
⬥ Assume the following information:
■ The direct spot exchange rates of the U.S.
dollar–equivalent value of 1 yen were as follows:
Comparative U.S. Company Journal Entries for Foreign
Purchase Transaction Denominated in U.S. Dollars versus
Foreign Currency Units
Figure 11-3
QUIZ
Quantum Company imports goods from different countries. Some transactions
are denominated in U.S. dollars and others in foreign currencies. A summary of
accounts receivable and accounts payable on December 31, 20X8, before
adjustments for the effects of changes in exchange rates during 20X8, follows:
Required:
Prepare the adjusting entries on December 31, 20X8 and collection of
receivable in 20X9.
Quiz- Solution
The End

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Chapter 11

Understand how to make

financial statements have to be

financial statements that use the U.S.

⬥ In preparing financial statements with foreign currency items

⬥ The primary economic environment in which an entity

⬥ The direct exchange rate (DER) is the number of local

U.S. dollar–equivalent value of 1FCU

⬥ The indirect exchange rate (IER) is the reciprocal

⬥ DER is identified as American terms

⬥ IER is identified as European terms

Understand the accounting

⇒ shall be translated using the exchange rates at

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