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Chapter 11

Multinational
Accounting: Foreign
Currency Transactions
and Financial
Instruments
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Learning Objective 11-1

Understand how to make


calculations using foreign
currency exchange rates.

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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.

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The Accounting Issues (2 of 2)
 Many U.S. corporations have
multinational operations.
 The foreign subsidiaries prepare their

P
financial statements in their home
currencies. U.S.
 The foreign currency amounts in these
financial statements have to be

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

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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.

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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

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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
DER = = 1.20 $/€
€1
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Direct versus Indirect Exchange Rates
(2 of 3)

 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
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Direct versus Indirect Exchange Rates
(3 of 3)
 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.
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Changes in Exchange Rates (1 of 3)
 Weakening of the U.S. dollar—direct exchange rate
increases.
 Strengthening of the U.S. dollar—direct exchange
rate decreases.

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Changes in Exchange Rates (2 of 3)
 Weakening of the U.S. dollar—direct exchange rate
increases, implies:
 Taking more U.S. currency to acquire one foreign
currency unit.
 One U.S. dollar acquiring fewer foreign currency units.
 Example: DER increases from $1.33/€ to $1.45/€.

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Changes in Exchange Rates (3 of 3)
 Strengthening of the U.S. dollar—direct exchange
rate decreases, implies:
 Taking less U.S. currency to acquire one foreign currency
unit.
 One U.S. dollar acquiring more foreign currency units.
 Example: DER decreases from $1.45/€ to $1.26/€.

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Relationships between Currencies and
Exchange Rates
Figure 11-2

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U.S.-Dollar Foreign-Exchange Rates,
May 4, 2018
Country/ In U.S.$ U.S.$ VS. % CHG PER U.S.$
Currency Fri Thurs 1-Day YTD Fri Thurs
Americas
Argentina 0.0458 0.0449 –1.78 17.5 21.8548 22.2515
peso
Brazil real 0.2384 0.2836 0.08 6.5 3.5290 3.5263
Canada 0.7784 0.7784 –0.01 2.2 1.2847 1.2848
dollar
Chile peso 0.001607 0.001617 0.60 1.1 622.30 618.60
Ecuador U.S. 1 1 unch unch 1 1
dollar
Mexico peso 0.0519 0.0525 1.07 –2.1 19.2666 19.0622
Uruguay 0.03451 0.03493 1.22 0.6 28.9800 28.6300
peso
Venezuela 0.0000145 0.00001451 0.02 666270. 68915.0001 68900.0001
bolivar
1 1

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U.S. Dollar Index Futures

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Spot Rates versus Current Rates

 The spot rate is the exchange rate for immediate


delivery of currencies.
 The current rate is defined simply as the spot
rate on the entity’s balance sheet date.

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Forward Exchange Rates (1 of 2)

 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.

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Forward Exchange Rates (2 of 2)
 Example:
 Assume a U.S.-based company purchases inventory for
€1,000 on 3/31 and the contract requires payment on
9/30.

180-day
Forward rate = $1.40/€

Spread = $0.05/€
Spot rate = $1.35/€

3/31 9/30

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Practice Quiz Question #1

Which of the following statements is false?


a. Most currency exchange rates are
determined by brokers on a daily basis.
b. Economic factors rarely affect exchange
rates.
c. Some countries maintain control over
their exchange rates.
d. When the U.S. dollar strengthens, it has
greater buying power overseas and can
buy more units of foreign currencies.
e. A spot rate is the exchange rate for
immediate delivery of a currency.
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Learning Objective 11-2

Understand the accounting


implications of and be able
to make calculations related
to foreign currency
transactions.

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Foreign Currency Transactions (1 of 3)
 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.

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Foreign Currency Transactions (2 of 3)
 For financial statement purposes, transactions
denominated in a foreign currency must be
translated into the currency the reporting company
uses.
 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.

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Foreign Currency Transactions (3 of 3)
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
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Foreign Currency Import and Export
Transactions (1 of 4)
 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.

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Foreign Currency Import and Export
Transactions (2 of 4)
 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:
 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.

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Foreign Currency Import and Export
Transactions (3 of 4)
 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:
 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.
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Foreign Currency Import and Export
Transactions (4 of 4)
 The two-transaction approach
 Views the purchase or sale of an item as a separate
transaction from the foreign currency commitment.
 The FASB established that foreign currency exchange
gains or losses resulting from the revaluation of assets or
liabilities denominated in a foreign currency must be
recognized currently in the income statement of the
period in which the exchange rate changes.
 There are a few exceptions to this general rule.

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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.

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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:

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Comparative U.S. Company Journal Entries for Foreign
Purchase Transaction Denominated in U.S. Dollars versus
Foreign Currency Units
Figure 11-3

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Practice Quiz Question #2

Which of the following statements is false?


a. Foreign currency transactions of a U.S.
Firm involve the exchange of goods from a
foreign country denominated in $ U.S.
b. The purchase or sale of an item is a
separate transaction from the foreign
currency commitment under the two
transaction approach.
c. Foreign currency exchange gains or losses
from the revaluation of assets or liabilities
denominated in a foreign currency must
be recognized in the period when the
exchange rate changes
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