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Foreign Currency Transactions

Foreign Currency Transactions. 9- 1. A U.S. company buys or sells goods or services to a party in another country. This is often called “foreign trade.” The transaction is often denominated in the currency of the foreign party. The major accounting issue:

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Foreign Currency Transactions

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  1. Foreign Currency Transactions 9-1 • A U.S. company buys or sells goods or services to a party in another country. This is often called “foreign trade.” • The transaction is often denominated in the currency of the foreign party. The major accounting issue: How do we account for the changes in the value of the foreign currency?

  2. Foreign Currency Transactions 9-2 • FASB No. 52 • Requires a two-transaction perspective. • Account for the original sale in US $ • Account for gains/losses from exchange rate fluctuations.

  3. Foreign Currency Transactions When a transaction occurs on one date (for example a credit sale) . . . . . . but the cash flow is at a later date . . . . . . fluctuating exchange rates can result in exchange rate gains or losses. 9-3 ?

  4. Foreign Currency Transactions 9-4 When the rate is expressed as the US $ equivalent of 1 unit of foreign currency, the rate is called a “DIRECT QUOTE” ?

  5. Foreign Currency Transactions 9-5 When the rate is expressed as the US $ equivalent of 1 unit of foreign currency, the rate is called a “DIRECT QUOTE” When the rate is expressed as the number of foreign currency units that $1 will buy, the rate is called an “INDIRECT QUOTE”

  6. Foreign Exchange Transaction Example 9-6 On 12/1/08, Nuuk sells inventory to Coventry Corp. on credit. Coventry will pay Nuuk 10,000 British pounds in 90 days. The current exchange rate is $1 = .6425 £. Prepare Nuuk’s journal entry.

  7. Foreign Exchange Transaction Example 9-7 On 12/31/08, the exchange rate is $1 = .6400 £. At the balance sheet date we have to “remeasure”, or adjust, the original A/R to the current exchange rate.

  8. Foreign Exchange Transaction Example 9-8 On 3/1/09, Coventry Corp. pays Nuuk the 10,000 £ for the 12/1/08 sale. The exchange rate on 3/1/09, was $1 = .6500 £. On 3/1/09, we have to do TWO things. First, we must “remeasure” the A/R.

  9. Foreign Exchange Transaction Example 9-9 On 3/1/09, Coventry Corp. pays Nuuk the 10,000 £ for the 12/1/08 sale. The exchange rate on 3/1/09, was $1 = .6500 £. On 3/1/09, we have to do TWO things. Second, we must record receipt of the £.

  10. Hedging Foreign Exchange Risk 9-10 • Companies will seek to reduce the risks associated with foreign currency fluctuations by “hedging” their exposure • This means surrendering a portion of potential gains to offset possible losses by entering into a potential transaction whose exposure is the opposite of that for the existing transaction.

  11. Hedging Foreign Exchange Risk 9-11 To control for the risk of exchange rate fluctuation, a forward contract for currency can be purchased. Hedging effectively reduces the uncertainty associated with fluctuating exchange rates.

  12. Hedging Foreign Exchange Risk 9-12 • To hedge a foreign currency transaction, companies may use foreign currency derivatives • Two common tools: • Foreign currency forward contracts • Foreign currency options

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