Foreign Currency

Transactions and Hedging

Strategy
 Currency Exchange Rate
• Exchange Rate – the rate in which the currencies of
two countries are exchanged at a particular time.
Exchange rate is always viewed at the bank’s point of
view of transactions.
Buying Spot Rate – The rate in which the bank
buys one unit of a foreign currency.
Selling Spot Rate – The rate in which the bank
sells one unit of a foreign currency.
• Spot Rate – exchange rate when the real transaction
occurred.
• Forward Exchange Rate – applies to forward exchange
contracts.
 Direct Quotation – When one unit of foreign currency is
equivalent to certain units of local currency. (1US Dollar =
56 Phil. Peso)
--1$ can be exchanged for P56
Indirect Quotation – When one unit of a local currency is
equivalent to certain units of a foreign currency. (1 Phil.
Peso = .00179)
--P1 can be exchanged for $.00179
** Examples given are in a Philippine Company which
is based and reports in the Philippine Currency (local
currency).
**NOTE: the two exchange rates are reciprocals.
INDIRECT QUOTATION: P1 = $0.0179
**It must be converted into a direct
quotation before it can be applied
into a transaction of a Phil. Co.

P1
$1 =
0.0179
$1 = P56
“Direct Quotation”
Cont. of Terms….

 Foreign Currency Transactions

- These are transactions that require settlement or
payment in a foreign currency . However even though
transactions are settled or paid in a foreign currency, the
reporting company must account it in terms of its local
currency unit.
Issues in Importing and Exporting Goods

1. A transaction (first recognition) is measured and

recorded in the Philippine pesos (local currency) by
multiplying the units of foreign currency by the closing
exchange rate, “spot rate” in effect on a given date.
2. When a transaction is unsettled or unpaid at the
balance sheet date, the balances denominated in
foreign currency are adjusted to reflect the closing
exchange rate on the balance sheet date. Normally,
FOREX Gains or Losses are recognize for the
difference in the exchange rate between the
transaction date & the balance sheet date.
3. At the settlement date, payment of a Phil. Co. must
convert Philippine pesos into foreign currency units
to settle the account, while the foreign currency
received to settle a foreign currency A/R must be
converted into pesos. Certain amount of FOREX
Gains or Losses will be recognized, if there is any.
Exporting Transactions (Net Asset Position)

-- Sale of Merchandise to a Foreign Buyer

Phil Co. sold goods to US Co. on Dec 1, 2005 for $1,000 to be
paid on Jan. 30, 2006 in US Dollars. The relevant exchange
rates are as follows:

Relevant Dates Buying Rates Selling Rates

Dec. 1, 2005 1$=49 1$=50

Dec. 31, 2005 1$=50 1$=51
Jan. 30, 2006 1$=48 1$=52
For a Better Understanding:
1. Understand the 3 relevant dates/applicable rates:
transaction date/rate, closing FS date/rate, and
settlement/payment date/rate. Since we are in the asset
position (export), and the Phil Co will have to sell US
Dollars, we will use the BUYING SPOT RATES.
2. Recognize FOREX Gain or Loss in the closing FS date
and settlement date. In an Asset Position, an INCREASE
in the BUYING SPOT RATE on each J.E. date will result
into FOREX Gain because the more PESO units will be
given when 1unit of US$ is sold. On the other hand, a
DECREASE in the BUYING SPOT RATE results to
FOREX Loss because lesser peso units will be given for
every $1
3. At the settlement date, payment of a Phil. Co. must
convert Philippine pesos into foreign currency units
to settle the account, while the foreign currency
received to settle a foreign currency A/R must be
converted into pesos. Certain amount of FOREX
Gains or Losses will be recognized, if there is any.
JOURNAL ENTRIES:
DR. CR.
Dec. 1, 2005 (trans. Date)
Accounts Receivable (fc) P49000
Sales (1000 x P49) P49000
Dec. 31, 2005 (BS/Closing Date)
Accounts Receivable (fc) P 1000
FOREX Gain (49-50 x 1000) P 1000
Jan. 30, 2006 ( Settlement Date)
Cash (fc) (48 x 1000) P 48000
FOREX Loss (50-48 x 1000) 2000
Accounts Receivable (50 x 1000) P50000
**NOTE: FOREX Gains or Losses will be
REFLECTED in the Income Statement of the year
when the Gains or Losses were Recognized.
**The Given exchange rates are stated in a
DIRECT QUOTATION. That is why the dollar value
is multiplied on the appropriate exchange rate.
Otherwise, if INDIRECT QUOTATION is used, a
different approach will be used (DIVISION)
JOURNAL ENTRIES:
Importing Transactions (Net Liability Position)
- Purchase of Merchandise from Foreign Supplier:
Phil Co. purchased goods from US Co. on Dec 1, 2005 costing
$1,000 to be paid on Jan. 30, 2006 in US Dollars. The relevant
exchange rates are as follows:
Relevant Dates Buying Selling
Rates Rates
Dec. 1, 2005 1$=49 1$=50
Dec. 31, 2005 1$=48 1$=49
Jan. 30, 2006 1$=51 1$=52
For a Better Understanding:
1. Understand the 3 relevant dates/applicable rates:
transaction date/rate, closing FS date/rate, and
settlement/payment date/rate. Since we are in the liability
position (import), and the Phil Co will have to purchase
US Dollars, we will use the SELLING SPOT RATES.
2. Recognize FOREX Gain or Loss in the closing FS date
and settlement date. In a Liability Position, an
INCREASE in the SELLING SPOT RATE on each J.E.
date will result into FOREX Loss because the more
PESO units are needed to purchase 1unit of US$. On the
other hand, a DECREASE in the SELLING SPOT RATE
results to FOREX GAIN because lesser peso units are
needed to purchase 1US$.
JOURNAL ENTRIES: Dr. Cr.

Dec.1,2005
Purchases P50000
Accounts Payable (fc) P50000
($1000 x P50selling spot rate)

Dec. 31, 2005 (BS date)

Accounts Payable(fc) P 1000
FOREX Gain P 1000
(50-49 x $1000)

Jan 30, 2005 (settlement date)

Accounts Payable (fc) ($1000xP49) P49000
FOREX Loss (49-51 x $1000) 2000
Cash(fc) ($1000xP51) P51000
**NOTE: FOREX Gains or Losses will be
REFLECTED in the Income Statement of
the year when the Gains or Losses were
Recognized.
**The Given exchange rates are stated in a
DIRECT QUOTATION. That is why the
dollar value is multiplied on the appropriate
exchange rate. Otherwise, if INDIRECT
QUOTATION is used, a different approach
will be used (DIVISION)
FOREX GAIN or LOSS: a Tabular Explanation
B.S. Effect on Income
account balance Statement
Affected reported effect
Increase in exchange rate
“SPOT RATE”
Importing Transaction Payable Increase Loss
Exporting Transaction Receivable Increase Gain

Decrease in exchange rate

Importing Transaction Payable Decrease Gain
Exporting Transaction Receivable Decrease Loss
FORWARD EXCHANGE COTNRACTS

 An agreement to exchange currencies of different countries

on a specified future date at the specified rate (Forward
Rate) in effect when the contract was made
In an Asset Position (export)- Forward Rate is Lower than
the prevailing Spot Rate. (broker’s advantage)
 In a Liability Position (import)- Forward Rate is Greater than
the prevailing Spot Rate. (broker’s advantage)
 Entering into this, a company may “MINIMIZE” the potential
loss due to the exchange rate fluctuations.
PURPOSES OF ENTERING A FORWARD CONTRACT

 To speculate in FOREX exchange price movement

 To designate a fair value hedge
- to hedge an exposed FOREX asset or liability
- to hedge a FOREX denominated firm commitment
- to hedge a net investment in a foreign operation
- to hedge a foreign currency forecasted transaction
Speculation
 NO Actual Import or export of goods
 The company just speculates that there might be potential loss
due to fluctuations of exchange rate. MINIMIZE LOSSES
 Relevant rates are:
- Forward Contract Rate
a.) Is used on the date when the contract was entered into.
b.) is used on the closing balance sheet date if contract on that
date is still unsettled.
 - Spot Rate
It is used on the Contract Settlement Date.
* if foreign currency is purchased from a broker, use
the buying spot rate of the bank.
* if foreign currency is sold to a broker, use the
selling spot rate of the bank.
 New Accounts:
Forward Contract Receivable
Forward Contract Payable
HEDGING an Exposed Net Asset Position
 The excess of assets denominated in a foreign currency over
the liabilities denominated in that foreign currency and
translated at the current rate.
There is a presence of two transactions, that is the presence of
the export transactions, and the hedging transactions.
FOREX Gains or Losses maybe incurred.
Any Gains/Losses are offset to reflect the NET FOREX Gains
or Losses
Forward Rate is Less than the Spot Rate.
Illustration:
Phil Co. sold goods to US Co. on Dec 1, 2005 costing
$1,000 to be paid on Jan. 30, 2006 in US Dollars. On the
same date, Phil. Co. enters into a forward contract to sell
$1000 to be given on Jan 30, 2006. The relevant
exchange rates are as follows:
60- day Buying Selling
RELEVANT DATES forward rate spot rate spot rate

Dec.1, 2005 P50 P51 P52

Dec. 31, 2005 P52 P50 P51

January 30, 2005 P51 P51 P53
For Better Understanding:
 Follow the guidelines in recording the export transactions.
In addition, there would be two recognitions of
Gains/Losses; one for the Export Transactions and another
for the Hedging Transactions.
 At the closing date, if receivables in FOREX are unsettled,
make use of closing buying spot rate to recognize
Gains/Losses for export transactions, while use the closing
forward contract rate for the hedging transactions.
On the settlement date, another sets of Gains/Losses for
both transactions shall be recognized, if there is any.
 Export Transactions Hedging Transactions
DR CR DR CR

12/1: Accounts Receivable (fc)** 51000

Sales 51000
**(51x1000) at buying rate
For. Cont. Receivable 50000
For Cont. Payable (fc)* 51000
*(50x1000) at forward rate
12/31:FOREX Loss* 1000
Accounts Receivable (fc) 1000
(51-50 x 1000) buying s.r.
FOREX Loss (50-52x1000) 2000
For. Cont. Payable (fc) 2000
 Export Transactions Hedging Trans.
DR CR DR CR

1/30: Cash (fc) 51000

FOREX Gain 1000
Accounts Receivable (fc) 50000

For. Cont. Payable (fc) 52000

FOREX Gain 1000
Cash (fc)* 51000
(51x1000) at buying s.r.

Cash 50000
For. Cont. Receivable 50000
HEDGING An Exposed Net Liability Position
 it is the excess of liabilities denominated in a foreign
currency over the assets denominated in that foreign
currency and translated at the current rate. To hedge an
exposed net liability position, a co. may enter into a Forward
Contract to purchase foreign currency.
 There is a presence of two transactions, that is, the
presence of import transaction to be hedge and the hedging
transaction.
 FOREX Gains or Losses may be incurred.
Any gains or losses are offset to reflect the Net FOREX
gains or Losses.
Illustration:
Phil Co. purchased goods from US Co. on Dec 1, 2005
costing $1,000 to be paid on Jan. 30, 2006 in US Dollars.
On the same date, Phil. Co. enters into a forward contract
to purchase $1000 to be given on Jan 30, 2006. The
relevant exchange rates are as follows:

60- day Buying Selling

RELEVANT DATES forward rate spot rate spot rate
Dec.1, 2005 P50 P51 P52
Dec. 31, 2005 P52 P50 P51
January 30, 2005 P51 P51 P53
For Better Understanding:
 Follow the guidelines in recording the import transactions.
In addition, there would be two recognitions of
Gains/Losses; one for the Import Transactions and another
for the Hedging Transactions.
 At the closing date, if liabilities in FOREX are unsettled,
make use of closing selling spot rate to recognize
Gains/Losses for import transactions, while use the closing
forward contract rate for the hedging transactions.
On the settlement date, another sets of Gains/Losses for
both transactions shall be recognized, if there is any.
 Import Transactions Hedging Transactions
JOURNAL ENTRIES: DR CR DR CR

12/1: Purchases 52000

Accounts Payable (fc)** 52000
**(1000 x 52) selling s.r.
For. Cont. Receivable (fc)* 50000
For Cont. Payable 50000
*(50x1000) for.rate 12/1
12/31: Accounts Payable (fc) 1000
FOREX Gain (52-51x1000) 1000
For. Cont. Receivable (fc) 2000
FOREX Gain (50-52x1000) 2000
 Import Transactions Hedging Transactions
DR CR DR CR

1/30: For. Cont. Payable 50000

Cash (50x1000) 50000

Cash(fc)** 51000
FOREX Loss* 1000
For. Cont Receivable (fc) 52000
**(51x1000) at buying s.r.
*(52-51x1000) buying s.r vs.
forw. cont. rate(12/31)
Accounts Payable(fc) 51000

Cash 51000