INSTRUCTOR MANUAL FOR ESSENTIALS OF

ADVANCED FINANCIAL ACCOUNTING BAKER, 1ST

EDITION

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INSTRUCTOR MANUAL FOR ESSENTIALS OF ADVANCED FINANCIAL ACCOUNTING BAKER, 1ST EDITION

Chapter 08 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

CHAPTER 8

MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY

TRANSACTIONS AND FINANCIAL INSTRUMENTS

OVERVIEW OF CHAPTER

Chapter 8 presents students with a foundation in the language of international business

and the effects of changes in foreign currency exchange rates. The chapter begins with an
introduction to the global business environment. The six major currencies, the European Union,
and major regional agreements are mentioned. The chapter then provides examples of foreign
currency transactions that are denominated in a foreign currency, which require revaluations into
their U.S. dollar equivalent values as of the date of the transaction, the end of the fiscal year, and
the settlement date.
Pertinent provisions of FASB 52, 133, 138, and 149 and their applications are discussed
in the chapter. The chapter emphasizes the journal entries and financial disclosures required for
foreign currency transactions. Methods for managing international currency risk utilizing foreign
currency forward contracts are discussed and illustrated in detail. Derivatives and forward
contracts are fully discussed. Four cases are utilized to illustrate the major uses of forward
exchange contracts: (1) managing an exposed foreign currency net asset or liability position, (2)
hedging an unrecognized foreign currency firm commitment, (3) hedging a forecasted foreign
currency transaction - cash flow hedge, and (4) speculation in foreign currency markets.
For hedges of an exposed foreign currency payable or receivable, the gain or loss from
the change in value of the forward exchange contract offsets the loss or gain on the underlying
item being hedged. For hedges of an unrecognized foreign currency commitment, the gain or loss
on the forward exchange contract offsets the loss or gain on the financial instrument component
of the firm commitment. The basis of the nonfinancial component of the commitment (e.g.,
inventory that will be acquired in the future) is adjusted at the date of the future transaction. For
hedges of a forecasted foreign currency transactions, the revaluation of accounts payable or
receivable is recognized in current income, while the effective portion of the forward contract
revaluation is recorded in other comprehensive income. An amount equal to the related foreign
exchange transaction gain or loss is reclassified each period from comprehensive income to
earnings. For speculation, the forward exchange contract is measured using its forward exchange
rate for the remaining term, and the gain or loss is recognized in income.

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Chapter 08 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

In the case of a hedge of a net investment in a foreign entity, the gain or loss on the hedge is
reported as part of other comprehensive income.
As a general rule, derivative financial instruments should be reported at their fair values,
and the gain or loss for the period should be recognized.
Appendix 8A presents illustrations of valuing forward exchange contracts and hedges.
Appendix 8B discusses use of other financial instruments by multinational companies.

LEARNING OBJECTIVES

When students finish studying this chapter, they should be able to:

LO1 Understand how to make calculations using foreign currency exchange rates.
LO2 Understand the accounting implications of and be able to make calculations related to
foreign currency transactions.
LO3 Understand how to hedge international currency risk using foreign currency forward
exchange financial instruments.
LO4 Know how to measure hedge effectiveness, make interperiod tax allocations for foreign
currency transactions, and hedge net investments in a foreign entity.

SYNOPSIS OF CHAPTER 8

Multinational Accounting: Foreign Currency and Transactions and Financial Instruments

Microsoft’s Multinational Business

LO1 Understand how to make calculations using foreign currency exchange rates.

Doing Business in a Global Market

The Accounting Issues
Foreign Currency Exchange Rates
The Determination of Exchange Rates
Direct versus Indirect Exchange Rates
Changes in Exchange Rates
Spot Rates versus Current Rates
Forward Exchange Rates

LO2 Understand the accounting implications of and be able to make calculations related to
foreign currency transactions.

Foreign Currency Transactions

Foreign Currency Import and Export Transactions

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Chapter 08 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

LO3 Understand how to hedge international currency risk using foreign currency forward
exchange financial instruments.

Managing International Currency Risk with Foreign Currency Forward Exchange

Financial Instruments
Derivatives Designated as Hedges
Forward Exchange Contracts
Case 1: Hedging an Exposed Foreign Currency Net Asset or Liability
Position: Not a Designated Hedging Instrument
Case 2: Hedging an Unrecognized Foreign Currency Firm
Commitment: A Foreign Currency Fair Value Hedge
Case 3: Hedging a Forecasted Foreign Currency Transaction: A
Foreign Currency Cash Flow Hedge
Case 4: Speculation in Foreign Currency Markets
Foreign Exchange Matrix

LO4 Know how to measure hedge effectiveness, make interperiod tax allocations for foreign
currency transactions, and hedge net investments in a foreign entity.

Additional Considerations
A Note on Measuring Hedge Effectiveness
Interperiod Tax Allocation for Foreign Currency Gains (Losses)
Hedges of a Net Investment in a Foreign Entity

Appendix 8A: Illustration of Valuing Forward Exchange Contracts with Recognition for the
Time Value of Money

Appendix 8B: Use of Other Financial Instruments by Multinational Companies

Definitions and Descriptions

Forward and Futures Contracts Swaps
Example of the Use of an Option to Hedge an Anticipated Purchase of Inventory: A Cash
Flow Hedge
Example of an Option Contract to Hedge Available-For-Sale Securities: A Fair Value
Hedge
Example of an Interest-Rate Swap to Hedge Variable-Rate Debt: A Cash Flow Hedge
Reporting and Disclosure Requirements: Disclosures about Fair Value of Financial
Instruments

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Chapter 08 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

NOTES ON POWERPOINT SLIDES

We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.

If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.

We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.

The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple-choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.

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Chapter 08 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

LO1 Understand how to make calculations using foreign currency exchange rates.
• Slides 3-4 summarize key issues related to foreign currency transactions
• Slides 5-13 explain important concepts related to foreign currencies.

LO2 Understand the accounting implications of and be able to make calculations related to
foreign currency transactions.
• Slides 17-18 explain how to record foreign currency transactions.
• Slide 19 provides an example illustrating how to account for foreign currency
transactions.
• Slides 20-24 summarize additional details and provide an illustration showing journal
entries for foreign currency transactions.

LO3 Understand how to hedge international currency risk using foreign currency forward
exchange financial instruments.
• Slides 28-30 introduce the concept of hedging of foreign currency transactions.
• Slides 31-39 explain how derivatives can be used to hedge foreign currency
transactions. These slides also explain the differences between fair value and cash
flow hedges.
• Slides 40-43 provide four cases illustrating forward exchange contracts.

LO4 Know how to measure hedge effectiveness, make interperiod tax allocations for foreign
currency transactions, and hedge net investments in a foreign entity.
• Slides 47-49 cover additional topics:
o Measuring the effectiveness of hedges
o Interperiod tax allocations for foreign currency transactions
o Hedges of a net investment in a foreign entity.

TEACHING IDEAS

1. Students could be assigned to locate a current set of currency quotations. This may be
found in any Wall Street Journal or other major business press. Students could then be
asked to determine the current U.S. dollar equivalent value of 100,000 (Euro), or £5,000
(British pounds). In addition, students could be asked to compare the current spot rate for
a foreign currency with the forward rate for 180 days to determine which way (increase
or decrease) the market expects the exchange rate to change in the future. Finally,
students could be asked to compare the direct and indirect rate and determine if they are
exactly reciprocal to each other. A slight difference is normally found due to slight
differences in brokerage commissions and fees.

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Chapter 08 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

2. Students could perform a historical review of currency exchange rates to determine if the
dollar has strengthened or weakened relative to another currency (e.g., the yen) for the
last two years and determine the impact that change has had on import and export
transactions with companies in that country (e.g., Japan). Exchange rates are available in
the daily business press so students may obtain these historical rates from past copies of
the Wall Street Journal.

3. Students could review an actual annual report to determine the magnitude of the foreign
exchange gain or loss of the company. Many firms may list these only in the footnotes as
an item included in other income. Students could then determine the relative contribution
to income or loss from the foreign currency transactions' gains or losses during a period.
In addition, students could review the financial instruments footnote to determine the
types of hedging activities used by the company. Larger companies typically have a
variety of hedging activities.

4. Students could be asked to review the financial statement notes of a Fortune 500
company and write a report describing their disclosures regarding derivatives.

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

DESCRIPTIONS OF CASES, EXERCISES, AND PROBLEMS

C8-1 Effects of Changing Exchange Rates

LO1 Students are asked to identify and explain the major factors affecting exchange
30 min. rates and to show the impact of changing exchange rates on U.S. consumers and
M businesses.
A

C8-2 Reporting a Foreign Currency Transaction on the Financial Statements

LO2 [AICPA Adapted] A purchase transaction denominated in a foreign currency is
15 min. presented. The dollar's value declined between the transaction date and the end
E of the year, but is expected to recover by the time the liability is paid. Students
J must discuss and evaluate the required disclosures.

C8-3 Changing Exchange Rates

LO1 This research case asks students to access database resources to determine the
60 min. monthly changes over the last two years between the U.S. dollar and (a) the
M Japanese yen, (b) the European Euro, (c) the British pound, and (d) the Mexican
R peso. A graph of the exchange rates over the 2-year period is then requested.
Students must then assess possible reasons for the changes in the exchange rates.

C8-4 Accounting for Foreign Currency-Denominated Accounts Payable

LO2 Students must review the authoritative accounting standard pertaining to foreign
40 min. currency transactions and write a memorandum from the perspective of an audit
M staff addressing the client’s accounting for its purchase transactions with a Swiss
R supplier.
FARS
C8-5 Accounting for Foreign Currency-Forward Contacts
LO3 Students must review the authoritative accounting standard for foreign currency
30 min forward contracts and write a memo to the treasurer outlining the accounting for
M these types of contracts. References to the authoritative standard must be
R included.
FARS
C8-6 Accounting for Hedges of Available-for-Sale Securities
LO3 An insurance company holding an extensive portfolio of available-for-sale
40 min. securities is considering entering into a interest rate future contract to hedge its
H exposure to interest rate changes. Students are asked to review the pertinent
R accounting standard and determine whether hedge accounting can be utilized by
FARS the company. A memorandum to the CFO must include authoritative cites.

E8-1 Exchange Rates

LO1 The direct exchange rates are given and students must compute indirect
15 min. exchange rates and determine the amount of currency required to purchase
E goods.

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E8-2 Changes in Exchange Rates

LO1 An analysis is required to determine exchange rates and to determine foreign
15 min. currency gain or loss for an individual traveling in a foreign country.
E
E8-3 Basic Understanding of Foreign Exposure
LO2 Students must analyze the effects of changes in foreign exchange rates, both
20 min. direct and indirect rates.
E
E8-4 Account Balances
LO2 T-accounts are required to analyze export and import transactions at the date of
20 min. the transaction, the year-end adjustments, and the settlement date.
E
E8-5 Determining Year-End Account Balances for Import and Export
LO2 Transactions
20 min. Students must determine year-end balances for import and export transactions
M affecting accounts receivable, accounts payable, and foreign currency transaction
gain or loss for four separate cases.

E8-6 Transactions with Foreign Companies

LO2 Two transactions must be analyzed and journal entries prepared, first assuming
20 min. the transactions are denominated in U.S. dollars, and then assuming the
E transactions are denominated in the applicable local currency unit.

E8-7 Foreign Purchase Transaction

LO2 Journal entries are required as of the date of the transaction, the year-end
10 min. adjustment, and the settlement date.
E
E8-8 Adjusting Entries for Foreign Currency Balances
LO2 Pre-adjusted balances in foreign currency denominated accounts payable and
30 min. accounts receivable are provided. Students must prepare adjusting journal entries
M and date of settlement entries.

E8-9 Purchase with Forward Exchange Contract

LO3 Journal entries are required for a foreign currency payable that is hedged with a
25 min. forward exchange contract. Entries are required at date of transaction and
M settlement date.

E8-10 Purchase with Forward Contract and Intervening Fiscal Year-End

LO3 Students must provide journal entries for a hedged foreign currency payable.
25 min. Entries are required at date of transaction, end of fiscal period, and settlement
M date.

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E8-11 Foreign Currency Transactions

LO2 [AICPA Adapted] Seven multiple-choice questions on foreign currency payable
20 min. and receivable transactions.
E
E8-12 Sale in Foreign Currency
LO2 Journal entries are required for a foreign currency denominated receivable.
20 min. Dollar weakens between transaction date and end of year, and dollar strengthens
M between end of year and settlement date in next year.

E8-13 Sale with Forward Exchange Contract

LO2 Journal entries are required on the date of the transaction and the settlement date
35 min. for a foreign currency payable. The company enters into a forward contract to
M manage its exposed foreign currency receivable. The forward contract is not
designated as a hedge.

E8-14 Foreign Currency Transactions

LO2 [AICPA Adapted] Seven multiple-choice questions requiring students to
25 min. compute the foreign currency transaction gain or loss for selected transactions.
M
E8-15 Sale with Forward Contract and Fiscal Year-End
LO3 Journal entries are required for an export transaction. The company enters into a
20 min. 60-day forward contract to manage exposure. The forward contract is not
M designated as a hedge. Entries are required at the date of the transaction, the
fiscal year-end, and the settlement date.

E8-16A Hedge of a Purchase (Commitment without and with Time Value of Money
LO3 Considerations)
40 min. Students are required to prepare journal entries for a hedge of a foreign currency
H commitment at the transaction date, the end of the fiscal year, and finally the
settlement date.

E8-17 Gain or Loss on Speculative Forward Exchange Contract

LO3 Students prepare schedules to show the effects of a speculative forward exchange
20 min. contract on income before taxes for two years.
E
E8-18 Speculation in a Foreign Currency
LO3 Journal entries are required for a speculative forward exchange contract in which
35 min. the company obtains a foreign currency receivable forward contract.
M

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E8-19 Forward Exchange Transactions

LO3 [AICPA Adapted] Five multiple-choice questions on forward exchange
15 min. transactions cover hedging, forward exchange commitments, and speculation.
E

P8-20 Multiple-Choice Questions on Foreign Currency Transactions

LO2 Five multiple-choice questions on a hedged foreign currency payable. Questions
20 min. focus on elements of journal entries that would be made.
M
P8-21 Foreign Sales
LO2 Journal entries are required for foreign sales, the use of a forward exchange
40 min. contract, and the settlements.
M
P8-22 Foreign Currency Transactions
LO2 Students must make journal entries for a series of foreign currency transactions,
60 min. some of which are hedged with forward exchange contracts. Both transaction
H date and settlement date entries are required. Settlement dates are in the same
fiscal period as transaction dates.

P8-23A Four Uses of Forward Exchange Contracts without and with Time Value of
LO2 Money Considerations
60 min. Journal entries are required for alternative uses of forward exchange contracts:
H (1) a hedge of an exposed foreign currency position, (2) a hedge of a foreign
currency commitment, (3) a hedge of an anticipated foreign currency transaction,
and (4) a speculation.

P8-24 Foreign Purchases and Sales Transactions and Hedging

LO2 This two-part problem includes a number of foreign exchange transactions,
35 min. several of which are hedged with forward exchange contracts. Students are
M asked to prepare journal entries and then to determine the income statement
effects of the transactions.

P8-25 Understanding Foreign Currency Transactions

LO2 Students must work with incomplete data and answer a variety of questions
40 min. about the account balances and the exchange rates that must have existed at the
M time of various transactions.

P8-26 Matching Key Terms

LO1, Fifteen terms are presented for which students must select the best description or
LO2, LO3 explanation of each term.
20 min.
M

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P8-27B Multiple -Choice Questions on Derivatives and Hedging Activities

LO3 Six multiple-choice questions dealing with derivatives and hedging activities
15 min. must be answered.
M

P8-28B A Cash Flow Hedge: Use of an Option to Hedge an Anticipated Purchase

LO3 An entity is utilizing a call option as a price-risk-hedging device. Students must
25 min. prepare journal entries to record the option purchase, the year-end adjusting entry
M for the change in time and intrinsic value, the expiration of the time value of the
option, the sale of the option, the purchase of the commodity, and the sale of the
commodity.

P8-29B A Fair Value Hedge: Use of an Option to Hedge Available-for-Sale

LO3 Securities
25 min. An entity purchases a put option to hedge available-for-sale securities. Students
M must prepare the journal entries to record the purchase of the securities and the
put options, the change in the intrinsic and time value of the options, the
revaluation of the securities, the exercise of the put potion, and the sale of the
securities.

P8-30B Matching Key Terms-Hedging and Derivatives

LO3 Fifteen items must be matched with fifteen descriptions or explanations.
30 min.
M
P8-31 Determining Financial Statements Amounts
LO3 Students must determine the appropriate financial statement amounts for four
35 independent transactions.
H

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

OTHER RESOURCES

CHANGES IN EXCHANGE RATES:

Direct Exchange Rate = ($U.S. / 1 FCU)

1. IF DIRECT EXCHANGE RATE INCREASES

(More U.S. dollars are needed to acquire one unit of foreign currency)

Implications:

Dollar weakens relative to foreign currency

Imports become more expensive to U.S.

U.S. exports become less expensive to foreign country

2. IF DIRECT EXCHANGE RATE DECREASES

(Fewer U.S. dollars are needed to acquire one unit of foreign currency)

Implications:

Dollar strengthens relative to foreign currency

Imports become less expensive to U.S.

U.S. exports become more expensive to foreign country

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Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

FOREIGN EXCHANGE RATES:

Dollars ($) and Euros ( )

DIRECT INDIRECT
($ / 1 EU ) ( EU / $1)
7/1/X8 $1.167 EU 0.855
12/31/X8 1.176 0.850
12/31/X9 1.156 0.865

Dollar weakens 7/1 to 12/31/X8

Dollar strengthens 12/31/X8 to 12/31/X9

Company holds 20,000 Euros (EU):

(Must revalue account denominated in foreign

currency units to equivalent U.S. dollar value)

FOREIGN CURRENCY UNITS (EU)

7/1/X8 20,000 x 1.167 = $23,340

12/31/X8 20,000 x 1.176 = $23,520 Gain: $180
12/31/X9 20,000 x 1.156 = $23,120 Loss: $400

Financial Statement Amounts:

Balance Sheet:
12/31/X8: Asset: $23,520
12/31/X9: Asset: $23,120

Income Statement, year ended

12/31/X8: Other income or loss: Gain: $180
12/31/X9: Other income or loss: Loss: $400

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INSTRUCTOR MANUAL FOR ESSENTIALS OF ADVANCED FINANCIAL ACCOUNTING BAKER, 1ST EDITION

Chapter 8 - Multinational Accounting: Foreign Currency Transactions and Financial Instruments

FORWARD EXCHANGE CONTRACTS

1. HEDGE OF AN EXPOSED POSITION

Spot rate
Gain (or loss) on forward exchange contract offsets loss (or gain) on exposed position

2. HEDGE OF AN UNRECOGNIZED FOREIGN CURRENCY

COMMITMENT

Value forward exchange contract at fair value

Gain or loss on financial instrument component of commitment is offset
against loss or gain on forward exchange contract
Adjust basis of hedged item for gain or loss on financial instrument
component of commitment

3. HEDGING A FORECASTED FOREIGN CURRENCY TRANSACTION: CASH FLOW

HEDGE
Fair value is recognized for derivative contract
Change in fair value of hedging instrument recognized in other comprehensive income
An amount equal to the foreign exchange gain or loss from the hedged transaction is
reclassified from other comprehensive income to current income

4. SPECULATION
Current forward rate for remaining term
Exchange gain or loss included in current period income

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