1

Baker / Lembke / King

12
Multinational
Accounting:
Foreign Currency
Transactions and
Financial
Instruments
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Companies,
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Factors Affecting Exchange Rates

• Level of inflation
• Balance of payments
• Changes in interest rate and
investment level
• Stability and process of governance

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Direct Exchange Rate

U. S. Dollar Equivalent Value

1 Foreign Currency Unit

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Direct Exchange Rate

See Figure
12-1
$1.612
1 English Pound Sterling

= $1.612

Or $1.612 = 1

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Indirect Exchange Rate

1 Foreign Currency Unit

U. S. Dollar Equivalent Value

1 English Pound Sterling

U. S. Dollar Equivalent Value

1 = .6203
$1.612
or .6203 = $1

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Relationships Between Currencies and Rates

January 1 July 1 December 31

Direct exchange rate $.6000 $.5500 $.5800

U.S. dollar relative to
foreign currency Dollar strengthens Dollar weakens
Direct exchange rate Decreases Increases
Price of 1 FCU (mark) Decreases Increases
Imports into U.S. Less expensive More expensive
Exports from U. S. More expensive Less expensive
Indirect exchange rate:
$1 = DM 1.6667 DM 1.8182 DM 1.7241
FCU relative to U.S. dollar FCU weakens FCU strengthens

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Foreign Currency Transactions May Be--

 Purchases or sales of goods or services

(imports or exports), the prices of which are
stated in a foreign currency.
 Loans payable or receivable in a foreign
currency.
 The purchase or sale of forward exchange
contracts in a foreign currency.
 Purchase or sale of foreign currency units.

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Foreign Currency Transaction Loss

January 1, 19X1 July 1, 19X1

(Acquire marks)

$.60 Direct exchange rate $.58

Equivalent dollar value of DM 1,000 on

January 1: DM 10,000 x $.60 $6,000
Equivalent dollar value of DM 10,000 on
July 1: DM 10,000 x $.58 5,800
Foreign currency transaction loss $ 200

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Foreign Currency Transaction Loss

Foreign Currency Transaction Loss 200

Foreign Currency Units (DM) 200

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Foreign Currency Transactions

Required accounting for an

import or export foreign
currency transaction on credit for
the following dates:

 Transaction date
 Balance sheet date
 Settlement date

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Foreign Currency Transactions

Required accounting for an import

or export foreign currency
transaction on credit is as follows:
Record the purchase
 Transaction date or sale transaction at
the U.S. dollar
 Balance sheet date
equivalent value
 Settlement date using the spot rate of
exchange on this date.

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Foreign Currency Transactions

Required accounting for an import

or export foreign currency
transaction on credit is as follows:
Adjust the payable or
 Transaction date receivable to its U.S.
 Balance sheet date dollar equivalent ,
end-of-period value
 Settlement date using the current
exchange rate.

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Foreign Currency Transactions

Required accounting for an import

or export foreign currency
transaction on credit is as follows:

 Transaction date First, adjust the

 Balance sheet date foreign currency
payable or receivable
 Settlement date for any changes in the
exchange rate from
the balance sheet date
to the settlement date.
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Foreign Currency Transactions

Required accounting for an import

or export foreign currency
transaction on credit is as follows:

 Transaction date
 Balance sheet date Then, record the
 Settlement date settlement of the
foreign currency
payable or receivable.

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Illustration of Foreign Purchase Transaction

On October 1, 19X1, Peerless Products, a U.S. company,

acquired goods on account from Tokyo Industries, a Japanese
company, for $14,000, or 2,000,000 yen. Settlement is made on
April 1, 19X2, in the next fiscal period.

October 1, 19X1
(Direct exchange rate = $.0070)

Inventory 14,000
Accounts Payable (Y) 14,000

Y2,000,000 x $.0070 spot rate = $14,000

If Denominated in Japanese Yen

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Illustration of Foreign Purchase Transaction

An adjusting entry is needed on the balance sheet date to reflect

the current exchange rate. The direct exchange rate on
December 31, 19X1 is $.0080.

December 31, 19X1

(Direct exchange rate = $.0080)

Foreign Currency Transaction Loss 2,000

Accounts Payable (Y) 2,000
Y2,000,000 x $.0080 Dec. 31 spot rate = $16,000
Y2,000,000 x $.0070 Oct. 1 spot rate = 14,000
$ 2,000
If Denominated in Japanese Yen
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Illustration of Foreign Purchase Transaction

Settlement of the payable was made on April 1, 19X2.

April 1, 19X2
(Direct exchange rate = $.0076)

Accounts Payable (Y) 800

Foreign Currency Transaction Gain 800
Y2,000,000 x $.0076 Apr. 1 spot rate = $15,200
Y2,000,000 x $.0080 Dec. 31 spot rate = 16,000
$ 800
Step 1

If Denominated in Japanese Yen

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Illustration of Foreign Purchase Transaction

Settlement of the payable was made on April 1, 19X2.

April 1, 19X2
(Direct exchange rate = $.0076)

Foreign Currency Units (Y) 15,200

Cash 15,200
Accounts Payable (Y) 15,200
Foreign Currency Units (Y) 15,200

Step 2

If Denominated in Japanese Yen

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Forward Exchange Contracts

 To hedge an exposed
The FASB recognizes
three major purposes foreign currency net
of forward exchange asset or liability
contracts. position.
 To hedge an
identifiable foreign
currency commitment.
 To speculate in
foreign currency
markets.

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Hedging an Exposed Position: Time Line

10/1/X1 12/31/X1 4/1/X2

Transaction date Balance sheet date Settlement date

• Incur liability • Obtain yen by settling

denominated in yen forward exchange
• Sign 180-day forward contract
contract to receive yen • Pay yen to settle
account payable

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Hedging an Exposed Position: Main Points

> Account payable or receivable denominated

in foreign currency valued at U.S. dollar
equivalent value
> Foreign currency receivable or payable with
exchange broker valued at U.S. dollar
equivalent value
> Exchange gain (or loss) from account
payable or receivable offset by exchange
loss (or gain) from foreign currency
receivable or payable with exchange broker
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Premium or Discount on Forward
Exchange Contract

Premium = Forward rate > Spot rate

Discount = Forward rate < Spot rate
Amortized to Financial Expense over term of
forward contract

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Hedging an Identifiable Foreign Currency
Commitment: Time Line
8/1/X1 10/1/X1 12/31/X1 4/1/X2

Sign contract Receive Balance Pay account

for goods and goods sheet date payable (yen)
enter into 240- with foreign
day forward currency units
exchange received from
contract to completion of
hedge foreign forward
currency exchange
payable contract
commitment

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Hedging an Identifiable Foreign Currency
Commitment: Major Points
 On date of commitment (8/1/X1) FASB 133
specifies separation of forward exchange contracts
into components:
– Financial instrument component (obligation to pay yen)
– Nonfinancial asset component (right to receive
inventory)
 At point of receipt of inventory goods (10/1/X1):
– Revalue forward contract to fair value, recognizing loss or
gain
– Record gain or loss on financial instrument component of
commitment
– Amortize premium or discount on forward exchange contract
– Close Firm Commitment account to inventory

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Speculation with Forward Contracts: Time
Line
10/1/X1 12/31/X1 4/1/X2

Enter 180-day Balance sheet date Deliver Swiss

speculative francs and
forward receive dollars
contract to settle
forward
contract

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Speculation with Forward Contracts: Major
Points
• Value forward
contract using
forward exchange
rate for remainder of
term
• No separate
accounting for
premium or discount
on forward contracts
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Chapter Twelve

The
End

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