international accounting Chap 006

7/25/2019 international accounting Chap 006

1/39

McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc !ll

$%&'IG( C)&&'(C* T&!(+!CTI%(+ !(

H'GI(G $%&'IG( 'CH!(G' &I+.

Chapter 6


2/39

6-2

Foreign Currency Transactions and

Hedging Foreign Exchange Risk

Chapter Topics Foreign exchange markets

Foreign exchange risk Accounting for foreign currency transactions Hedging Foreign currency forward contracts and options Accounting for hedges

Cash flow hedges and fair value hedges


3/39

6-3

Learning Objectives1. Provide an overview of the foreign exchange market.2. Explain how fluctuations in exchange rates give rise to foreign

exchange risk.3. emonstrate the accounting for foreign currency transactions.4. escri!e how foreign currency forward contracts and foreign

currency options can !e used to hedge foreign exchange risk.




4/39

6-4

Learning Objectives5. escri!e the concepts of cash flow hedges" fair value hedges" and

hedge accounting.6. emonstrate the accounting for forward contracts and options

used as cash flow hedges and fair value hedges to hedge foreigncurrency assets and lia!ilities" foreign currency firm commitments"and forecasted foreign currency transactions.




5/39

6-5

#earning $!%ective &

Foreign Exchange Markets

Foreign exchange rate Purchase price of a foreign currency'' e.g." in ecem!er ())* it

cost a!out ).)+ ,.-. dollars nine cents/ to purchase one 0exicanpeso.

From &+12 to &+*3 countries had exchange rates fixed to the ,.-.dollar.

,.-. dollar was fixed to gold at 432 per ounce. 5alance'of'payments deficits in the ,.-. during the &+6)s doomed

this system" so" !y 0arch &+*3 most currencies were allowed tofloat in value.


6/39

6-6

Exchange Rate echanis!s Independent float7 currency value allowed to move freely with

little government intervention. Pegged to another currency7 currency value fixed pegged/ in

terms of a particular foreign currency e.g." ,.-. dollar/" andcentral !ank intervenes to maintain the exchange rate.

European Monetary System (Euro7 twelve countries use a

single currency" which floats against other currencies such as the,.-. dollar.




7/396-!

Foreign Exchange Rates Exchange rates" to the ,.-. dollar" are pu!lished in many places on the

internet and in newspapers. Exchange rates are reflected !oth as ,-4 e8uivalent direct 8uotes/

and currency per ,-4 indirect 8uotes/. For example" on Fe!ruary &2" ())9 the direct 8uote for a Euro was

4&.12+2 and the indirect 8uote was 4).692(. As a point of comparison"the direct 8uote when the Euro first appeared in &++9 was

approximately 4&.&* and the indirect 8uote was approximately 4).92. A direct 8uote is the reciprocal of an indirect 8uote and vice'versa.




8/396-"

"pot rates an# For$ar# rates Spot rate7 today:s price for purchasing or selling a foreign

currency. #or$ard rate7 today:s price for purchasing or selling a foreign

currency for some future date. Prem%um'' when the forward rate is greater than the spot rate for

a particular day.

&%scount'' when the forward rate is less than the spot rate for aparticular day.




9/396-'

Option contracts

#ore%gn currency opt%on7 gives the right" !ut not the o!ligation" totrade foreign currency for some period.Put opt%on7 the option to sell the foreign currency.Call opt%on7 the option to !uy the foreign currency.Str%e pr%ce7 the exchange rate at which currency will !e

exchanged when option is exercised.




10/396-)*

Option contracts +pt%on prem%um7 cost of purchasing the option" which is a

function of the option:s intrinsic value and time value. Intr%ns%c ,alue7 is the gain that could !e made !y immediate

exercise of the option. %me ,alue7 the value that derives from the fact that the currency

value could increase during the remainder of the option period.




11/396-))

Exchange Rates and ForeignExchange Risk

Ter!ino%og& E.port sale7 a company sells to a foreign customer and later

receives payment in the customer:s currency. Import purchase7 a company purchases from a foreign supplier

and later pays in the supplier:s currency. #ore%gn e.change r%s7 the chance that the exporter will receive

less or that the importer will pay more than anticipated as a result

of a change in the exchange rate.

#earning $!%ective (


12/396-)2

Exa!p%e ;oe 4).&)/.


Exchange Rates and Foreign

Exchange Risk


13/396-)3

;oe has foreign exchange risk exposure !ecause he may receiveless than 4&))"))).

-uppose the peso decreases such that in 3) days the exchangerate is 4).)+ per & peso.

;oe will receive &")))"))) pesos which will !e worth 4+)")))&")))"))) x 4).)+/ and ;oe receives 4&)"))) less due toexchange rate fluctuation.


Exchange Rates and Foreign

Exchange Risk


14/39

6-)4

Accounting for ForeignCurrency Transactions

'cco(nting ) sa%e transaction

+ne transact%on perspect%,e =reats sale and collection as one transaction =ransaction is complete when foreign currency is received and

converted" and sale is measured at converted amount. =his approach is not allowed under


15/39

6-)5

$o transact%on perspect%,e =reats sale and collection as two transactions

-ale is one transaction and collection is a second transaction. -ale is !ased on current exchange rate.


16/39

6-)6

Transaction t&pes* expos(re t&pe an# gain or %oss )export sa%es

Export saleasset exposure''if foreign currency appreciates foreign exchange gain.

Export saleasset exposure''if foreign currency depreciates foreign exchange loss.

#earning $!%ective 3

Accounting for Foreign

Currency Transactions


17/39

6-)!

Transaction t&pes* expos(re t&pe an# gain or %oss )i!port p(rchases


18/39

6-)"

Export sa%e ) exa!p%e 1 Fe!ruary &" ())9" ;oe


19/39

6-)'

Export sa%e ) exa!p%e 1;oe"


20/39

6-2*

Export sa%e ) exa!p%e 1$n 0arch (" ())9" the spot rate is 4).)+ per peso.

;oe


21/39

6-2)

Export sa%e ) exa!p%e 2

/ssume the follo$%ng facts are added or changed0 ;oe


22/39

6-22



23/39

6-23



24/39

6-24


1edg%ng'' protecting against losses from exchange ratefluctuations. Companies often use foreign currency forward

contracts and foreign currency options. #ore%gn currency for$ard contract7 an agreement to !uy or

sell foreign currency at a future date. #ore%gn currency opt%on7 the right to !uy or sell foreign

currency for a period of time.



25/39

6-25


+e#ging ris, on an export sa%e ) exa!p%e 1 Previously" ;oe


26/39

6-26


+e#ging ris, on an export sa%e ) exa!p%e 1 ,nder the contract" ;oe would have agreed to sell &")))")))

pesos for 4).&)2 on 0arch (" ())9.


27/39

6-2!


+e#ging ris, on an export sa%e ) exa!p%e 2 Previously" ;oe


28/39

6-2"


+e#ging ris, on an export sa%e ) exa!p%e 2 ;oe would now have the option sell &")))"))) pesos for 4).&& on

0arch (" ())9.


29/39

6-2'

Cash Flow Hedges, Fair ValueHedges, and Hedge Accounting

1edge account%ng7 an offsetting gain or loss from the hedge isrecogniBed in net income during the same period as the gain or

loss from the hedged item. Cash flo$ hedge7 an accounting designation for hedges that

offset varia!ility in cash flows of hedged items. #a%r ,alue hedge7 an accounting designation for hedges that

offset the varia!ility in fair value of hedged assets and lia!ilities.



30/39

6-3*

Hedge Accounting

+e#ge acco(nting exa!p%es&. FC asset>forward contract>cash flow hedge

(. FC asset>forward contract>fair value hedge3. FC asset>option>cash flow hedge1. FC firm commitment>forward contract>fair value hedge2. FC firm commitment>option>fair value hedge6. Forecasted FC transaction>option>cash flow hedge



31/39

6-3)

Hedge Accounting

'ss(!ptions -or exa!p%es 1 an# 2 ecem!er &" ())*" ;oe


32/39

6-32

Hedge Accounting

;oe enters a foreign currency forward contract on ecem!er &"())*.

=he contract calls for ;oe to sell &")))"))) pesos at a forward rateof 4).&)2" on 0arch (" ())9.

=he forward rate on ecem!er 3&" ())* for 0arch (" ())9delivery is 4).)+6.



33/39

6-33

Hedge Accounting

Exa!p%e 1* FC asset-or$ar#cash -%o$ he#ge

&(>)&>)*Accounts receiva!le &&)")))

-ales &&)")))

&(>3&>)*Foreign exchange loss &)")))

Accounts receiva!le &)")))

Accumulated $ther Comprehensive


34/39

6-34

Hedge Accounting


&(>3&>)*Forward contract 9"+&&Accumulated $ther Comprehensive


35/39

6-35

Hedge Accounting


3>)(>)9Foreign exchange loss 2")))Accounts receiva!le 2")))

Accumulated $ther Comprehensive


36/39

6-36

Hedge Accounting


3>)(>)9iscount expense 3"333 Accumulated $ther Comprehensive


37/39

6-3!

Hedge Accounting

Exa!p%e 2* FC asset-or$ar#-air va%(e he#ge

&(>)&>)*Accounts receiva!le &&)")))-ales &&)")))

&(>3&>)*Foreign exchange loss &)")))

Accounts receiva!le &)")))

Forward contract 9"+&&?ain on forward contract 9"+&&



38/39

6-3"

Hedge Accounting


3>)(>)9Foreign exchange loss 2")))

Accounts receiva!le 2")))

Forward contract &")9+?ain on forward contract &")9+



39/39

Hedge Accounting


3>)(>)9Foreign currency +2")))Accounts receiva!le +2")))

Cash &)2")))Foreign currency +2")))Forward contract &)")))

# i $!% ti 6

international accounting Chap 006

Documents