Accounting for

Foreign Currency Transactions

and Hedging Foreign
Exchange Risk

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 Foreign Currency Transactions

 transactions are normally measured and recorded in the

currency in which the reporting entity prepares its financial
statements.
 A foreign currency transaction is a transaction that requires
settlement (payment or receipt) in a foreign currency.
 Examples:
A. Importing or exporting goods on credit.
B. Forward contract (importing and exporting).
C. Hedging a commitment in a foreign currency.
D. Speculation in a foreign currency.
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 Exchange Rates

 Direct exchange rate

 how many units of the domestic currency can be
converted into one unit of foreign currency
 e.g., 1.517: $1.517 1 British pound
 Indirect exchange rate
 how many units of the foreign currency can be
converted into one unit of domestic currency
 e.g., .6592: $1 .6592 British pound

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 Exchange Rates

 Spot rate
 exchange rate for immediate (today) delivery of
currencies exchanged.
 Forward or future rate
 The rate which currencies can be exchanged at some
future date.
 Forward exchange contract
A contract to exchange at a specific rate currencies on a
stipulated future date.
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 A. Importing or Exporting Goods or
Services

Transaction Balance Settlement

date sheet date date

Record: Record: Record:

a. Importing (Purchase – AP) Transaction gains/loss a. Settle accounts
b. Exporting (Sales-AR)
b. Gains/loss
c. Cash paid/received

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 Transaction gain/loss

Increase in exchange Decrease in

rate exchange rate

Import (purchase-AP) AP increase AP decrease

AP-liability Loss Gain

Export (Sales-AR) AR increase AR decrease

AR-asset Gain Loss

transaction gain/loss = units of foreign currency x change in exchange rate

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 Ex1:
On December 1, 2007, a US firm purchased 100 units of
inventory from a French firm for €500,000 to be paid on
March 1, 2008. the firm’s fiscal year-end is December
31. The spot rates for euros at various times are as
follows:
Spot rate
December 1, 2007 €1= $1.25
December 31, 2007 €1= $1.28
March 1, 2008 €1= $1.27
Instructions:
1. Prepare the journal entry(ies) to record the transactions
in the US firm.

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Transaction Balance
Settlement
date Dec 1 sheet date
date March 1
Dec 31

↑ Loss ↓ Gain
1.25 1.28 1.27

€500,000 to
be paid on March 2008

U.S. firm French firm

Inventory delivered
Dec 2007 12 - 8
 Dr Cr
Dec 1, 2007 (Transaction date)
Purchases (€500,000 x $1.25) 625,000
Accounts Payable 625,000

Dec 31, 2007 (Balance sheet date)

Transaction loss (€500,000 x $(1.28-1.25) 15,000
Accounts Payable 15,000

*AP= 625,000 + 15,000 = 640,000 or (€500,000 X 1.28)

March 1, 2008 (Settlement date)
Accounts Payable 640,000
Transaction gain (€500,000 x $(1.28-1.27) 5,000
Cash (€500,000 x $1.27) 635,000

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 Ex2:
On December 1, 2007, a US firm sold100 units of
inventory to a French firm for €100,000 to be received
on March 1, 2008. the firm’s fiscal year-end is
December 31. The spot rates for euros at various times
are as follows:
Spot rate
December 1, 2007 €1= $1.25
December 31, 2007 €1= $1.28
March 1, 2008 €1= $1.27
Instructions:
1. Prepare the journal entry(ies) to record the transactions
in the US firm.

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Transaction Balance
Settlement
date Dec 1 sheet date
date March 1
Dec 31

↑ Gain ↓ Loss
1.25 1.28 1.27

€100,000 to
be paid on March 2008

U.S. firm French firm

Inventory delivered
Dec 2007 12 - 11
 Dr Cr
Dec 1, 2007 (Transaction date)
Accounts Receivable (€100,000 x $1.25) 125,000
Sales 125,000

Dec 31, 2007 (Balance sheet date)

Accounts Receivable (€100,000 x $(1.28-1.25)) 3,000
Transaction gain 3,000

*AR= 125,000 + 3,000 = 128,000 or (€100,000 X 1.28)

March 1, 2008 (Settlement date)
Cash (€100,000 x $1.27) 127,000
Transaction loss (€100,000 x $(1.28-1.27) 1,000
Accounts Receivable 128,000

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 B. Forward Exchange Contracts

 An agreement to exchange currencies of two different

countries at a specified rate (the forward rate) on a
stipulated future date. Those contracts could be used to:
1. Hedge a foreign currency import/export transaction
2. Hedge a firm commitment
3. Speculate changes in foreign currency

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 B.1. Hedge a foreign currency
import transaction
 The firm is going to purchase some inventory from AP on
credit.
 In this case the firm wish to be protected form changes in
currency exchange rate.
 So, the firm agree with an exchange dealer to receive a specific
amount of foreign currency at a specific date on future at an
agreed exchange rate.
 At the settlement date, the firm paid the agreed amount to the
exchange dealer and receive the foreign currency.
 The firm deliver the foreign currency to the AP.

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 Inventory delivered
U.S. firm French firm
€ Accounts AP
Payable - liability
Forward contract
$ amount to be paid

U.S. firm Exchange

FC (€) receivable from dealer
exchange dealer - Asset
Increase in Decrease in Exchange rate
direct direct exchange
exchange rate
rate
AP - liability ↑- loss ↓- gain Spot rate
FC receivable from exchange ↑ - gain ↓- loss Forward rate
dealer - asset
Payable to exchange dealer - - Agreed rate
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 EX3:
1. On December 1, 2007, a US firm purchased 100 units of
inventory from a French firm for €500,000 to be paid on March
1, 2008. The firm’s fiscal year-end is December 31.
2. On December 1, 2007, the US firm entered into a forward
contract to buy €500,000 on March 1, 2008, for $1.052.
3. The spot rates for euros at various times are as follows:
Spot rate Forward rates
(for March 1, 2008)
December 1, 2007 €1= $1.05 €1= $1.052
December 31, 2007 €1= $1.055 €1= $1.059
March 1, 2008 €1= $1.07 €1= $1.07
Instructions:
1. Prepare the journal entry(ies) to record the transactions in the US
firm.

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 Dec 1, Dec 31, March
2007 2007 1,
2008
AP - liability 1.05 1.055 1.07 Spot
FC receivable from exchange dealer - 1.052 1.059 1.07 Forward
Asset
Payable to exchange dealer 1.052 - - agreed

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 Dr Cr

Dec 1, 2007 (transaction date)

1. Record the purchase

Purchase (€500,000 * 1.05) 525,000

Accounts Payable 525,000

2. Record the forward contract

FC receivable from exchange dealer 526,000

Payable to exchange dealer (€500,000 * 1.052) 526,000

Dec 31, 2007 (end of the year date)

3. Transaction loss on AP

Transaction loss 2,500

Accounts Payable (€500,000 * (1.055 – 1.05) 2,500

Accounts Payable = 525,000 + 2,500 = 527,500

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 Dr Cr
4. Transaction gain on FC receivable
FC receivable from exchange dealer 3,500
Transaction gain(€500,000 * (1.059 – 1.052)) 3,500
FC receivable = 526,000 + 3,500 = 529,500
March 1, 2008 (settlement date)
5. Transaction loss on AP
Transaction loss 7,500
Accounts Payable (€500,000 * (1.07 – 1.055) 7,500
6. Transaction gain on FC receivable
FC receivable from exchange dealer 5,500
Transaction gain(€500,000 * (1.07 – 1.059)) 5,500
7. Payment to exchange dealer
Payable to exchange dealer 526,000
Cash (€500,000 * 1.052) 526,000

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 Dr Cr
8. Foreign currency received from dealer
Investment in FC 535,000
FC receivable from exchange dealer (€500,000 *(1.07) 535,000
9. Delivering foreign currency to AP
Accounts Payable 535,000
Investment in FC 535,000

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 B.2. Hedge a foreign currency
Export transaction
 The firm is going to sell some inventory to AR on credit.
 In this case the firm wish to be protected form changes in
currency exchange rate.
 The firm agree with an exchange dealer to deliver a specific
amount of foreign currency at a specific date on future at
an agreed exchange rate.
 The firm receive the foreign currency from the AR.
 The firm deliver the foreign currency to the dealer and
receive the agreed amount.

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 Inventory sold
U.S. firm French firm
€ Accounts AR
Receivable- Asset
Forward contract
$ amount to be received

U.S. firm Exchange

FC (€) payable to exchange dealer
dealer - liability
Increase Decrease Exchange rate
in direct in direct
exchange exchange
rate rate

AR - Asset ↑- gain ↓- loss Spot rate

FC payable to exchange dealer – liability ↑ - loss ↓- gain Forward rate
Receivable from exchange dealer - - Agreed rate
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 EX4:
1. On December 1, 2007, a US firm sell100 units of inventory for a
French firm for €100,000 to be received on March 1, 2008.
2. the firm’s fiscal year-end is December 31.
3. On December 1, 2007, the US firm entered into a forward
contract to sell €100,000 on March 1, 2008, for $1.052.
4. The spot rates for euros at various times are as follows:
Spot rate Forward rates
(for March 1, 2008)
December 1, 2007 €1= $1.05 €1= $1.052
December 31, 2007 €1= $1.06 €1= $1.057
March 1, 2008 €1= $1.07 €1= $1.07
Instructions:
1. Prepare the journal entry(ies) to record the transactions in the US
firm.

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 Dec 1, Dec 31, March
2007 2007 1,
2008
AR- asset 1.05 1.06 1.07 Spot
FC payable to exchange dealer - liability 1.052 1.057 1.07 Forward
Receivable from exchange dealer 1.052 - - agreed

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 Dr Cr

Dec 1, 2007 (transaction date)

1. Record the sales

Accounts Receivable (€100,000 * 1.05) 105,000

sales 105,000

2. Record the forward contract

Receivable from exchange dealer (€100,000 * 1.052) 105,200

FC payable to exchange dealer 105,200

Dec 31, 2007 (end of the year date)

3. Transaction gain on AR

Accounts Receivable 1,000

Transaction gain (€100,000 * (1.06 – 1.05) 1,000

Accounts Receivable = 105,000 + 1,000 = 106,000

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 Dr Cr
4. Transaction loss on FC payable
Transaction loss 500
FC payable to exchange dealer 500
(€100,000 * (1.057 – 1.052))
FC payable = 105,200 + 500 = 105,700
March 1, 2008 (settlement date)
5. Transaction gain on AR
Accounts Receivable (€100,000 * (1.07 – 1.06)) 1,000
Transaction gain 1,000
6. Transaction loss on FC payable
Transaction loss (€100,000 * (1.07 – 1.057)) 1,300
FC payable to exchange dealer 1,300
7. Foreign currency received from AR
Investment in FC 107,000
AR (€100,000 * 1.07) 107,000

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 Dr Cr
8. Delivering foreign currency to exchange dealer
FC payable to exchange dealer 107,000
Investment in FC (€100,000 *1.07) 107,000
9. Cash Received from exchange dealer
Cash (€100,000 *1.052) 105,200
Receivable from exchange dealer 105,200

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 C. Hedge Firm Foreign Currency
Commitment
 A U.S. firm may commit to a foreign firm to sell or buy
goods, and the price is established in foreign currency.
 change in exchange rate between the commitment date
and transaction date is reflected in the cost or sale price,
not a separate gain or loss.
 The U.S. firm may enter a forward contract to hedge its
commitment.

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Commitment Transaction
date date

Record transaction as: Record: any changes recorded as

a. Forward contract gain and loss on forward contract
and firm commitment

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 EX5:
1. On march 1, 2007, a US firm contracts to sell equipment to a
foreign customer located in Argentina for 200,000 pesos. The
equipment is expected to cost $60,000 to manufacture and is to
be delivered, and the account to be settled one year later on
March 1, 2008.
2. On March 1, 2007, the US firms enters a forward contract to
sell 200,000 pesos in 12 month at the forward rate of $.39.
3. Spot and forward rates for pesos on selected dates are:
Date Spot rate March 1, 2008 forward rate
March 1, 2007 $.40 $.39
Dec 31, 2007 $.397 $.382
March 1, 2008 $.38 $.38
Instructions:
1. Prepare the journal entry(ies) to record the transactions in the US
firm.
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 Commitment End of the Transaction
date year date and
settlement
date

March 1, Dec 31, March 1,

2007 2007 2008
AR- asset .38 spot
FC payable to exchange dealer - liability .39 .382 .38 Forward
Receivable from exchange dealer .39 - - agreed

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 Dr Cr

March 1, 2007 (commitment date)

1. Record the forward contract

Receivable from exchange dealer (200,000 pesos* .39) 78,000

FC payable to exchange dealer 78,000

Dec 31, 2007 (end of the year date)

2. Transaction gain on FC payable

FC payable to exchange dealer (200,000 pesos * (.39 – .382)) 1,600

Transaction gain 1,600

FC payable = 78,000 - 1,600 = 76,400

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 Dr Cr
3. Transaction loss on commitment
Transaction loss 1,600
Firm commitment (200,000 * (.39 – .382)) 1,600
March 1, 2008 (transaction and settlement date)
4. Transaction gain on FC payable
FC payable to exchange dealer (200,000 pesos * (.382 – .38)) 400
Transaction gain 400
5. Transaction loss on commitment
Transaction loss 400
Firm commitment (200,000 * (.382 – .38)) 400
6. Recording sales and closing firm commitment
AR (200,00 pesos * .38) 76,000
Firm commitment (1,600 + 400) 2,000
Sales 78,000

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 Dr Cr
7. Foreign currency received from AR
Investment in FC (200,000 pesos * .38) 76,000
AR 76,000
8. Recording cost of goods sold
Cost of goods sold 60,000
Inventory 60,000
9. Foreign currency delivered to exchange dealer
FC payable to exchange dealer (200,000 pesos *.38) 76,000
Investment in FC 76,000
10. Cash received from exchange dealer (agreed rate)
Cash (200,000 pesos * .39) 78,000
Receivable from exchange dealer 78,000

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 EX5A:
1. On October1, 2007, a US firm contracts to purchase inventory
from a foreign customer located in UK for £100,000. The
inventory is expected to be delivered on March 1, 2008, and the
account to be settled one year later on October1, 2008.
2. On October1, 2007, the US firms enters a forward contract to
purchase £100,000 at the forward rate of $1.7.
3. Spot and forward rates for pesos on selected dates are:
Date Spot rate Oct1, 2008 forward rate
Oct1, 2007 $1.69 $1.7
Dec 31, 2007 $1.71 $1.72
March 1, 2008 $1.735 $1.745
Oct 1, 2008 $1.73 $1.73
Instructions:
1. Prepare the journal entry(ies) to record the transactions in the US
firm.
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 Commitment End of the Transaction Settlement
date year date date date

Oct 1, Dec 31, March 1, Oct 1,

2007 2007 2008 2008
AP- liability 1.735 1,73 spot
FC receivable from exchange 1.7 1.72 1.745 1.73 Forward
dealer - Asset
Payable to exchange dealer 1.7 agreed

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 Dr Cr
1. Recording forward contract March 1, 2007 (commitment date)
FC receivable from exchange dealer 170,000
Payable to exchange dealer (£100,000 * 1.7) 170,000
2. Recording gain on Forward contract Dec 31, 2007 (end of year)
FC receivable from exchange dealer 2,000
Gain on transaction ((£100,000 * (1.72-1.7)) 2,000
3. Recording loss of firm commitment Dec 31, 2007
Loss on transaction 2,000
Firm commitment 2,000
5. Recording gain on Forward contract March1, 2008
(transaction date)
FC receivable from exchange dealer 2,500
Gain on transaction ((£100,000 * (1.745-1.72)) ,500
6. Recording loss of firm commitment March 1, 2008
Loss on transaction 2,500
Firm commitment 2,500

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 Dr Cr
7. Recording the receive of inventory March1, 2008
Purchase 169,000
Firm Commitment (2000 + 2500) 4,500
AP (£100,000 * 1.735) 173,500
8. Recording loss on forward contract March 1, 2008
(settlement date)
Loss on transaction (£100,000 * (1.745-1.73)) 1,500
FC receivable from exchange dealer 1,500
9. Recording gain on AP March 1, 2008
AP (£100,000 * (1.735-1.73)) 500
Gain on transaction 500
10. Recording payment to exchange dealer
Payable to exchange dealer 170,000
Cash (£100,000 * 1.7) 170,000

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 Dr Cr
11. Recording currency received
Investment in FC (£100,000 * 1.73) 173,000
FC receivable from exchange dealer 173,000
12. Recording payment to AP
Investment in FC 173,000
AP 173,000

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 D. Using Forward Contract to
Speculate on Foreign Currency
 Forward contract used to for speculation in
anticipation of realizing a gain.
 The firm agree with exchange dealer to purchase or
sell certain amount of foreign currency at specific
date in future at agreed exchange rate.

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 EX6:
On December 1, 2007, A US firm signs a forward contract to
purchase £100,000 on March 1, 2008. the exchange rates are:
Date Spot rate Forward rate
(march 1, 2008)
Dec 1, 2007 $1.85 $1,86
Dec 31, 2007 $1.88 $1.87
March 1, 2008 $1.92 $1.92
Instruction:
1. Prepare the journal entry(ies) to record the abovementioned
transactions

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 Dec 1, Dec 31, March 1,
2007 2007 2008
FC receivable from exchange 1.86 1.87 1.92 Forward
dealer
Payable to exchange dealer 1.86 agreed

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 Dr Cr
1. Recording forward contract Dec1, 2007
FC receivable from exchange dealer 186,000
Payable to exchange dealer (£100,000 * 1.86) 186,000
2. Recording gain on forward contract Dec 31, 2007
FC receivable from exchange dealer 1,000
Transaction gain (£100,000 * (1.87 -1.86)) 1,000
3. Recording gain on forward contract Mar 1, 2008
FC receivable from exchange dealer 5,000
Transaction gain (£100,000 * (1.92 -1.87)) 5,000
4. Recording payment to exchange dealer Mar 1, 2008
Payable to exchange dealer (£100,000 * 1.86) 186,000
Cash 186,000
5. Recording foreign currency received Mar 1, 2008
Investment in FC 192,000
FC receivable from exchange dealer (£100,000 * 1.92) 192,000

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 Dr Cr
6. Convert foreign currency to cash Mar 1, 2008
Cash 192,000
Investment in FC 192,000

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 EX6A:
On December 1, 2007, A US firm signs a forward contract to sell
£100,000 on March 1, 2008. the exchange rates are:
Date Spot rate Forward rate
(march 1, 2008)
Dec 1, 2007 $1.75 $1,76
Dec 31, 2007 $1.78 $1.77
March 1, 2008 $1.82 $1.82
Instruction:
1. Prepare the journal entry(ies) to record the abovementioned
transactions

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 Dec 1, Dec 31, March 1,
2007 2007 2008
FC payable to exchange dealer 1.76 1.77 1.82 Forward
Receivable from exchange dealer 1.76 agreed

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 Dr Cr
1. Recording forward contract Dec1, 2007
Receivable from exchange dealer 176,000
FC payable to exchange dealer (£100,000 * 1.76) 176,000
2. Recording loss on forward contract Dec 31, 2007
Transaction loss (£100,000 * (1.77 -1.76)) 1,000
FC payable to exchange dealer 1,000
3. Recording loss on forward contract Mar 1, 2008
Transaction loss (£100,000 * (1.82 -1.77)) 5,000
FC payable from exchange dealer 5,000
4. Recording purchase of Foreign Currency Mar 1, 2008
Investment in FC (£100,000 * 1.82) 182,000
Cash 182,000
5. Recording foreign currency delivered to dealer Mar1, 2008
FC payable to exchange dealer 182,000
Investment in FC (£100,000 * 1.82) 182,000

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 Dr Cr
6. Recoding cash received from dealer Mar 1, 2008
Cash 176,000
Receivable from exchange dealer 176,000

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