Accounting for Foreign

Currency Transactions

Module 8

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 1

 OBJECTIVES

Define an entity's functional currency.

Account for foreign currency transactions.
Translate the financial statements of a
foreign operation.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 2

 Objective

PAS 21

• how to include foreign currency transactions

and foreign operations in the financial
statements of an entity; and
• how to translate financial statements into a
presentation currency.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 3

 Two ways of conducting foreign activities

1. Foreign currency transactions - individual

entities often enter into transactions in a foreign
currency.
2. Foreign operations - groups often include
overseas entities.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 4

 Two main accounting issues

1. Which exchange rate(s) to use; and

2. How to report the effects of changes in exchange
rates in the statements.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 5

 Scope

a. Accounting for foreign currency denominated

transactions and balances, except derivatives and
hedge accounting which are within the scope of
PFRS 9 Financial Instruments;
b. Translation of financial statements of foreign
operations that are accounted for by consolidation
or by the equity method; and
c. Translation of an entity's financial statements into
a presentation currency.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 6
 Definitions of currencies
1. An entity’s functional currency is the currency of the primary
environment in which it operates. This is normally the currency
in which it generates and spends cash. Company management
determines the functional currency.

2. Foreign currency is a currency other than the entity’s

functional currency.

3. Local currency is the currency of a particular country being

referred to.

4. Reporting currency is the currency in which an enterprise

prepares its financial statements.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 7
 Foreign Exchange Concepts
and Definitions
Illustration 1
ABC Co. is a mining company registered in Canada
whose shares are traded in Toronto Stock Exchange.
ABC’s operating activities take place in the gold and
Silver mines in the Philippines.
a. What is the functional currency?
b. What is the reporting currency?
c. ABC acquired mining equipment from Japan, in-
voiced in Japanese yen. What type of currency is the
©2003 Japanese yen?
Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 8
 Change in functional currency

a. If the functional currency is changed, the change is

accounted for prospectively from the date of the change.
b. The entity shall translate all items into the new
functional currency using the exchange rate at the date of
the change.
c. The resulting translated amounts for non-monetary items
are treated as their historical cost.
d. Exchange differences arising from the translation of a
foreign operation previously recognized in other
comprehensive income are not reclassified from equity
to profit or loss until the disposal of the operation.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 9
 Learning Objective 2

Account for foreign currency

transactions.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 10

 Foreign Currency Transactions
Other Than Forward Contracts

Local Foreign
transactions transactions

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 11

 Foreign Currency Transactions

1. Importing and exporting goods on credit with the

receivable or payable denominated in foreign
currency.
2. Borrowing or Lending denominated in foreign
currency.
3. Entering into a forward exchanged contract to buy
or sell foreign currency
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 12
 Spot, Current, and Historical
Exchange Rates

Spot rate – is the rate currencies can

be exchanged today
Closing/ Current rate – the exchange rate at
the balance sheet date.
Historical rate – the exchange rate existed
when a specific transaction or event occurred

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 13

 Measured vs. Denominated vs. Translation
A Philippine importer purchases goods worth $2000
on credit from a US exporter which is to be paid in
US dollars.
The transaction is denominated in US dollars because the amount is
fixed in terms of that currency and will settled in that currency.

However, the transaction is measured and recorded by

Philippine importer in Philippine peso
For the purpose of consolidation, foreign branches or
subsidiaries translates assets & liabilities to PhP.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 14
 Initial recognition

On initial recognition, a foreign currency transaction

is recognized by translating the foreign currency
amount at the spot exchange rate at the date of the
transaction.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 15

 Foreign Exchange Concepts
and Definitions

Exchange rate is the ratio between a unit of one

currency and the amount of another currency for
which that unit can be exchanged at a particular time.

= 49.77 PhP
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 16
 Subsequent measurement

a. Foreign currency monetary items shall be re-translated

using the closing rate;
b. Non-monetary items that are measured in terms of
historical cost in a foreign currency shall be translated
using the exchange rate at the date of the transaction;
and
c. Non-monetary items that are measured at fair value in a
foreign currency shall be translated using the exchange
rates at the date when the fair value was determined.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 17

 Direct and Indirect Quotation
of Exchange Rates

Assume that $1 can be exchanged for P44.77

Direct quotation (Philippine Peso equivalent):
P44.77
= P44.77
1
Indirect quotation (foreign currency per PhP):
1
= $.022
P44.77

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 18

 Learn foreign-currency-
denominated transactions
accounting.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 19

 Recognition of exchange differences

Exchange difference - is the difference resulting from

translating a given number of units of one currency into
another currency at different exchange rates.

Exchange differences arising from translating or settling

monetary items are recognized in profit or loss, except when
they are required by other PFRSs to be recognized in other
comprehensive income.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 20

 Importing and Exporting of goods

1. Transaction Date
2. Balance Sheet Date
3. Settlement Date

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 21

 Recognition of exchange differences

When a foreign currency transaction occurred in one period

and settled in another period:

a. The exchange difference between the transaction date

and the end of reporting period is recognized in the
period of transaction, while
b. The exchange difference between the end of the previous
reporting period and the date of settlement is recognized
in the period of settlement.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 22

 Translation at the Spot Rate

A Pinoy corporation imports inventory

from an American firm when the spot
rate for US dollars is P43.
The invoice calls for payment of 10,000
US dollars in 30 days.
How does the Pinoy importer record the transaction?

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 23

 Translation at the Spot Rate

Inventory 430,000
Accounts Payable (fc) 430,000
(Translation 10,000 US dollars × 43 spot rate)

If the account payable is settled when the

spot rate is P42, how is it recorded?

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 24

 Translation at the Spot Rate

Accounts payable (fc) 430,000

ForEx Gain 10,000
Cash 420,000
(Cash required equals 10,000 US dollars
× the P42 spot rate)

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 25

 Purchases Denominated
in Foreign Currency

Philippine Trading Company purchased goods from

Kimetz Company on December 1, 2008, for 1,000
euros when the spot rate for euros was P66.
PT closed its books at December 31, 2008,
when the spot rate for euros was P65.50,
and settled the account on January 30, 2009,
when the spot rate was P66.50.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 26

 Purchases Denominated
in Foreign Currency
December 1, 2008
Inventory 66,000
Accounts Payable (fc) 66,000
To record purchase of merchandise from Kimetz
Company (1,000 euros × P66 rate)
December 31, 2008
Accounts Payable (fc) 500
ForEx Gain 500
To adjust accounts payable to exchange rate at
year end [1,000 euros × (P66 – P65.50)]
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 27
 Purchases Denominated
in Foreign Currency

January 30, 2009

Accounts Payable (fc) 65,500
ForEx Loss 1,000
Cash 66,500
To record payment in full to Kimetz Company
(1,000 euros × P66.50 spot rate)

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 28

 Sales Denominated
in Foreign Currency
On December 16, 2008, Philippine Trading sold
merchandise to Kimetz for 2,000 euros when
the spot rate for euros was P66.
PT closed its books at December 31, when the
spot rate was P65.50, collected the account on
January 15, 2009, when the spot rate was P67.00,
and held the cash until January 20, when it
converted the euros into PhP at a P67.25 rate.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 29
 Sales Denominated
in Foreign Currency
December 15, 2008
Accounts Receivable (fc) 132,000
Sales 132,000
To record sales to Kimetz
(2,000 euros × P66.00 spot rate)
December 31, 2008
ForEx Loss 1,000
Accounts Receivable (fc) 1,000
To adjust accounts receivable year end
[2,000 euros × (P65.50 – P66.00)]
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 30
 Sales Denominated
in Foreign Currency
January 15, 2009
Cash 134,000
Accounts Receivable (fc) 131,000
ForEx Gain 3,000
To record collection in full from Kimetz
(2,000 euros × P67.00) and recognize exchange gain
for 2009 [2,000 euros × (P67.00 – P65.50)]
January 20, 2009
Cash 134,500
Exchange Gain 500
Cash (fc) 134,000
To convert 2,000 euros into Philippine pesos
(2,000 euros × P67.25)
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 31
 Summary
Balance Effect on Income
Sheet balance Statement
Account reported effect
Affected
Increase in Exchange 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 32

 Illustration: Loan transaction
On July 1, 20x1, ABC Co. obtained a $10,000 loan that
bears 10% annual interest when the spot exchange rate is
P50.$1. The closing rate on December 31, 20x1 is P55:$1.
No payments had been made on the loan during the year.

Requirement: Compute for the foreign exchange gain/loss to

be recognized in the year-end statement of profit or loss.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 33

Carrying amounts at initial exchange rate:
Loan payable ($10,000 x 50) P500,000
Interest payable ($10,000 x 10 % x 6/12 x P50) 25,000
Total payables at initial exchange rate P525,000

Carrying amounts at closing rate:

Loan payable ($10.000 x P55) P550,000
Interest payable ($10,000 x 10 % x 6/12 x P55) 27,500
Total payables at closing rate P577,500

Increase in payables - FOREX loss P 52,500

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 34

Pertinent Entries:

FOREX loss P 52,500

Loan payable (P550,000 - 500,000) 50,000
Interest payable (27,500 – 25,000) 2,500

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 35

Illustration: Cash account
ABC Co., a domestic corporation based in the Philippines, frequently
sells goods overseas through the internet. All online sales are on cash
basis. The movements in ABC's US dollar account are shown below:

Cash in bank - U.S. dollar

Jan. 1 (P48:$1) Dr. $10,000
Sept. 30 (P45:$1) Dr. 20,000
Dec. 16 (P44:$1) Cr. 5,000
Dec. 31 (P45:$1) Dr. $25,000

Requirements: Compute for the following:

a. Amount of cash in bank to be presented in the year-end statement of
financial position.
b. Net foreign exchange gain or loss to be recognized in the year end
statement of profit or loss.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 36
Requirement (a): Cash in bank at year-end = ($25,000 x P45)
= P1,125,000

Requirement (b): Net foreign exchange gain or loss. The unadjusted

balance of the cash in bank account translated to Philippine pesos using
spot exchange rates on transaction dates is determined as follows:

CIB-in Philippine pesos

Jan. 1 (P48:$1) Dr. P480,000
Sept. 30 (P45:$1) Dr. 900,000
Dec. 16 (P44:$1) Cr. 220,000
Dec. 31 (P45:$1) Dr. P1,160,000

Cash in bank- unadjusted balance P1,160,000

Cash in bank at closing rate ($25,000 x P45) 1,125,000
Decrease in cash in bank - Net foreign exchange loss P35,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 37
Illustration: Average rate
On December 15, 20x1, ABC Co. sent one of its key management
personnel to a seminar in Malaysia. ABC Co. advanced MYR 10,000
(ringgits) to the manager subject to liquidation. The exchange rate on
December 15, 20x1 is P14: MYR1.

The liquidation report submitted by the key manager showed the

following:
MYR 8,000 were spent from December 15 to December 31, 20x1. The
exchange rate on December 31, 20x1 is P13: MYR 1.
MYR 1,500 were spent from January 1, 20x2 to January 3, 20x2. The
manager returned the MYR 500 excess to the cashier on January 3, 20x2.
The exchange rate on January 3, 20x2 is P12: MYR 1.

Requirements: Compute for the following:

a. FOREX gain or loss on December 31, 20x1.
b. FOREX gain or loss on January 3, 20x2.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 38
Items measured at other than historical cost
a. Inventories are measured at the lower of cost and net realizable value
in accordance with PAS 2 Inventories.
b. Property, plant and equipment are measured using either the cost
model or revaluation model in accordance with PAS 16 Property,
plant and equipment.
c. Non-current assets are measured at the lower of carrying amount and
recoverable amount in accordance with PAS 36 Impairment of
Assets.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 39

When such an asset is non-monetary and is measured in a foreign
currency, the carrying amount is determined by comparing:
a. the cost or carrying amount, as appropriate, translated at the
exchange rate at the date when that amount was determined (i.e., the
rate at the date of the transaction for an item measured in terms of
historical cost); and
b. the net realizable value or recoverable amount, as appropriate,
translated at the exchange rate at the date when that value was
determined (e.g., the closing rate at the end of the reporting period).

The effect of this comparison may be that an impairment loss is

recognized in the functional currency but would not be recognized in the
foreign currency, or vice versa.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 40

Illustration: Items measured at other than historical cost
ABC Co. had the following foreign currency transactions during the year:
• Acquired equipment on January 1, 20x1 for THB 10,000 (bahts) from a Thailand-
based company when the current exchange rate was P1.2: THB 1. The equipment is
depreciated over 5 years using the straight-line method.
• Purchased inventories on December 1, 20x1 for ZAR 1,000 (rands) from a company
based in South Africa when the current exchange rate was P5: ZAR 1.

Both the acquisitions described above are on cash basis. At year end, ABC Co.
determined the following:
• The equipment was found to have a recoverable amount of THB 7,000. The closing
rate is 1.3: THB 1.
• Half of the inventories purchased remain unsold. ABC estimated that the net
realizable value of the unsold inventories is ZAR 300. The closing rate is P6.

Requirement: Provide the year-end adjustments.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 41

Solutions:

Equipment at carrying amount translated at original spot rate

(10,000 x 1.2 x 4/5) 9,600
Equipment at recoverable amount translated at the spot rate
when the recoverable amount is determined,
i.e., Dec. 31, 20x1 (7,000 x P1.3) 9,100
Decrease in carrying amount - Impairment loss 500

Inventory at carrying amount translated at original spot rate

(10,000 x P1.2 x 4/5) 2,500
Inventory at net realizable value translated at the spot rate
when the net realizable value is determined,
i.e., Dec. 31, 20x1 (300 x P6) 1,800
Decrease in carrying amount - Impairment loss 700

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 42

Several exchange rates
Exchange rates may also be classified as either buying or selling rates.
Buying and selling rates refer to the rate a currency broker (e.g., a bank)
is willing to pay or sell a currency.

Example 1
You have 100 US dollars. You go to a bank to exchange your dollars to
pesos. The bank gives you P43 for each dollar you have. P43 refers to
buying rate.

Example 2
You purchased goods worth 100 US dollars to be settled in US dollars.
You go to a bank to purchase 100 US dollars to be used in settling the
purchase of goods you have made. The bank gives you 1 US dollar for
every P45 you have. P45 refers to selling rate.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 43

Illustration: Buying and selling rates
ABC Co. had the following foreign currency transactions on April 1, 20x1:
Purchased goods worth CHF 10,000 (francs) from Swiss Company, a company based in
Switzerland.
Sold goods with sale price of VEB 1,000 (bolivars) to Venezuelan Company, a
company based in Venezuela.

Both the transactions were settled on April 30, 20x1. The following were the spot
exchange rates:
Buying Selling
Swiss Francs
April 1, 20x1 P44: CHF1 P48: CHF1
April 30, 20x1 P47: CHF1 P50: CHF1
Bolivars
April 1, 20x1 P10: BEV1 P12: BEV1
April 30, 20x1 P13: BEV1 P16: BEV1

Requirements: Compute for the FOREX gain/loss from the transactions:

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 44

Solutions:

Purchase transaction:
[10,000 x (P50 selling rate - P48 selling rate)] = P20,000 FOREX loss

Sale transaction:
[1,000 x (P13 buying rate-P10 buying rate)] = P3,000 FOREX gain
bank.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 45

 Learning Objective 4

Comprehend cash flow hedge

accounting and fair value
hedge accounting.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 46

 Foreign Currency Derivatives
and Hedging Activities

Derivative is the name given to a

broad range of financial securities.

The derivative contract’s value to the investor

is directly related to the fluctuations in price,
rate, or some other variable that underlies it.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 47

 Characteristics of Derivatives
1. Whose value changes in response to
changes in a specified variable or underlying

2. It requires no initial investment or an initial

net investment that is smaller than would be
Required for other types of contracts that
would be expected to have a similar response
to changes in market factors

3. It is settled at a future date.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 48
 Derivative Instruments

Option contracts

Forward contracts

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 49

 Derivative Instruments

Options are rights to take an action,

but the holder is not obligated to do so.

A forward contract is negotiated between the parties. It

bind both parties (the writer and the holder) to perform.
It is an agreement to exchange currencies of different
countries on a specified future date at specified rate.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 50
 Hedging and Hedge Accounting
Hedging
 It is a risk management technique that involves
using one or more derivatives or other hedging
instrument to offset changes in fair value or
cash flow of hedged items.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 51

 Hedging and Hedge Accounting
Hedged Item
It is an asset, liability, firm commitment, highly probable forecast
transaction, or net investment in a foreign operation. To be design-
ated as a hedged item, the designated hedge item should expose the
entity to risk of changes in fair value or future cash flows

Hedge Instrument
It is a designated derivative whose FV or cash flows are
expected to offset changes in FV or cash flows of a designated
hedge item.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 52
 Hedging Relationships

A cash flow hedge is designed to limit

the company’s exposure to price
changes in forecasted transactions.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 53

 Distinction Fair Value Hedge Cash Flow Hedge
1. Certainty of transaction Transaction is certain Transaction is uncertain
2. Update to Fair Value Accounts are upfdated to Fair Value No Update
3. Recognition of change in FV of Change in Intrinsic Value - Other
Hedging Instrument using split Change in Intrinsic Value - Profit/ Loss Comp. Income
Accounting Change in Time Value- Profit/ Loss Change in Time Value- Profit/ Loss
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 54
 Learning Objective 5

Apply foreign-currency-
denominated derivative
accounting.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 55

 Fair Value Hedge- Call Option

Illustration
On October 1, 2013, Phil Comp took a delivery from Bahrain firm
of inventory costing 1,140,000 dinar . Payment is due on January 30,
2014. Concurrently, Phil Co paid P15,700 cash to acquire at- the
money call option for 1,140,000 dinar. Strike price is P12.40

10/1/13 12/31/13 1/30/14

Market Price P12.40 P12.423 P12.427
FV of Call Option P28,200 P30,780

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 56

 Fair Value Hedge- Put Option
Illustration
On December 1, 2013, F Comp acquired 4,600 shares of QRS at a
Cost of P28 per share. F comp classifies them as AFS. On the same
Date, F decides to hedge against a possible decline in the value of
Securities by purchasing at a cost of P11,900 an at-the-money put
Option to sell the 4,600 shares. The option expires on April 1, 2014

12/1/13 12/31/13 4/1/14

M shares (cost/share) P28.00 P26.50 P23.50
FV of Put Option P15,400 P20,700

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 57

 Cash Flow Hedge
Illustration
On August 1, 2013, EFG Co. forecasted to purchase of 60,000 units
Of inventory from Bangladesh Co. The purchase would probably
Occur on Nov 2 and require the payment of 2,340,000 taka. It is
anticipated that the inventory could be further processed and deli-
Vered to customers by early December. On august 1, the company
Purchased P8,850 call option to buy 2,340,000 taka at strike price
of P7.95.
Aug 1 Aug 31 Sept 30 Nov 2
Spot rate P7.93 P7.952 P7.963 P7.97
FV of Call Option P15,690 P34,410 P46,800
On Nov 2, EFG purchased 60,000 units of inventory. The
option was exercise on that date.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 58
 Forward
Illustration
Exchange Contract
M sold merchandise for 111,200 rupees to a customer in India on
Nov 2, 2013. Collection in Indian rupees was due on January 31,
2014. On the same date, to hedge this foreign currency exposure, M
Entered into futures contract to sell 111,200 rupees to a bank for
delivery on January 31, 2014. Exchange rate for rupees as follows:

Nov 2 Dec 31 Jan 31

Offer Rate P81.70 P80.50 P80.30
Bid Spot rate P81.90 P80.70 P80.10
30-day futures P82.3 P80.4 P83.9
60-day futures 81.8 80.3 82.6
90-day futures P80.60 P81.60 P83.40
120-day futures 80.10 81.40 82.80
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 59
 Hedging of a Foreign Currency
Purchase Commitment
Illustration
On October 1,2013, Pinoy Corp entered into a firm commit-
Ment with a Japanese firm to acquire a machine, delivery and
Passage of title on March 31,2014, at a price of 37,800 dirhams.
On the same date, to hedge against unfavourable changes in the
exchange rate of the dirhams, Pinoy Corp entered into 180-day
forward contract with BPI for 37,800 dirhams. Exchange rate
Were as follows:
Spot Rate Forward Rate
10/1/13 P96.50 P94.30
13/31/13 97.25 96.50
3/31/14 99.70 99.70
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 60
 Hedging in Net Investment in a
Foreign Entity
Illustration
Pinoy Corp, a Philippine comp, has a 30% equity investment in Hong
Kong Comp, King Inc. On December 31,2013, the balance in Pinoy’s
investment in King account is P3,120,000 equal to 30% of King’s net
assets of 2,000,00 HKg$ times a P5.20 ear-end exchange Rate. On this
date, Pinoy has no translation adjustment balance Relative to its investmen
in king. To hedge its net investment in King, Pinoy borrows 500,000 Hkg$
for one year at 12% interest on January 1,2014 at a spot rate of P5.20.
The loan is denominated in HKg$, with principal and interest payable on
January 1,2015. assume That November 2,2014, King declares and pays
a 100,000 HKg$ Dividend when the spot rate is P5.35. On December 31,
King reports net income of 400,000 HKg$. Weighted average for the year
is P5.30 and the closing exchange rate on Dec 31 is P5.40.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 61
 Speculation

Exchange gains or losses on derivative

instruments that speculate in foreign
currency price movements are included
in income in the period in which the
forward exchange rates change.

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 Speculation

On November 2, 2007, U.S. International

enters into a 90-day forward contract
(future) to purchase 10,000 euros (€).
The current quotation for 90-day futures is €5,400.
The spot rate for euros on November 2 is $0.5440.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 63

 Speculation

December 31, 2007 January 30, 2008

30-day futures $0.5450 $0.5480

Spot rate $0.5500 $0.5530

What are the journal entries of U.S. International

to account for the speculation?

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 64

 Speculation

November 2, 2007
Contract Receivable (fc) 5,400
Contract Payable 5,400
To record contract for 10,000 euros × $0.5400
exchange rate for 90-day futures

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 65

 Speculation

December 31, 2007

Contract Receivable (fc) 50
Exchange Gain 50
To adjust receivable from exchange broker
and recognize exchange gain
10,000 euros × ($0.5450 forward exchange rate
for 30-day futures – $0.5400 per books)

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 66

 End of Chapter 12

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 12 - 67