International Accounting
Dr. Shorouk Esam El-Din Yassien
Lecturer at Accounting
Department (English Section),
Faculty of Commerce, Benha University
Foreign Currency Transactions and
Hedging Foreign Exchange Risk
Foreign Exchange Markets
• Foreign Exchange Rate
• Purchase price of a foreign currency or the price at which the foreign currency
can be acquired )definition)
• A variety of factors determine the exchange rate between two currencies;
unfortunately for those engaged in international business, the exchange rate
fluctuates. In some cases, a change in the exchange rate is quite large and
unexpected
• 1945-1973
• Exchange rate fixed in U.S dollar
• US dollar was fixed in gold
• US dollar was fixed to gold at 35$ per ounce
• 1960s Balance of payments deficit s in the US
• March 1973 most currencies float in value
• Exchange rate mechanisms:
• Independent Float
• Currency value allowed to move freely
• Little government intervention
• Pegged to another currency
• Currency value fixed in terms of a foreign currency
• E. g U.S dollar
• Central bank maintains the exchange rate
• European Monetary System (Euro)
• Nineteen countries use a single currency ,…..(European union 27 country-
2020)
• Floats against other countries
• E. g. U.S dollar
• Foreign Exchange rates
• Interbank rates
• Wholesale prices
• Banks charge one another
• Exchange of currencies
Spread: difference between buying and selling rates
• Published on the internet and in newspapers
• Reflected
• Direct quotes (US $ equivalent):number of domestic currency units needed to
acquire one unit of foreign currency
• In Canada, a direct quote for U.S dollars would be (1$U.S= C$1.17)
Indirect quotes (currency per US $):number of foreign currency units
needed to acquire one unit of domestic currency
• In Canada, an indirect quote for U.S dollars would be (1C$= U.S$o.85)indirect =1\direct
Direct quote reciprocal of indirect quote
Indirect quote reciprocal of direct quote
Spot rates
Today’s price for purchasing or selling a foreign currency
Forward rate
Today’s price for purchasing or selling a foreign currency
sometime in a future date
Premium
Forward rate is greater than the spot rate
Discount
Forward rate is less than the spot rate
Differences in interest rates cause premium/discount
Interest rate foreign > interest rate local gives discount
Option contracts :To provide companies more flexibility than exists with a
forward contract, a market for foreign currency options has developed.
Foreign currency option
Gives right, no obligation
Trade foreign currency
Trade in future
Put option
Option to sell the foreign currency
Call option
Option to buy the foreign currency
Strike price
Exchange rate at which currency will be exchanged if option is
exercised
Option contracts
Option premium
Cost of purchasing the option
Function of the option’s intrinsic value and time value
Intrinsic value
Immediate exercise of the option [either ‘in the money’ or value of zero]
Gain
Time value
Derived value
Currency value increase
During the remainder of the option period
Value from adaptation of Black-Scholes option pricing formula
Foreign Currency Transactions
Transaction exposure
Exposure to foreign exchange risk
Export sale [risk is foreign currency declines in value]
Sale to foreign customer
Later payment
In customer’s currency
Import purchase [risk is foreign currency increases in value]
Purchases from foreign supplier
Payment in the supplier’s currency
Later payment
Foreign exchange risk
Change in the exchange rate results in
Exporter will receive less
Importer will pay more than anticipated
Foreign Currency Transactions (2)
Example
Joe Inc., a U.S. company, makes a sale and ships goods to Jose,
SA, a Mexican customer
Sales price is $100,000 (U.S.) and Joe allows Jose to pay in
pesos in 30 days
The current exchange rate is $0.10 per 1 peso
Joe plans to receive 1,000,000 pesos ($100,000/$0.10)
Foreign Currency Transactions (3)
Joe has foreign exchange risk exposure because he may
receive less than $100,000.
Suppose the peso decreases such that in 30 days the exchange
rate is $0.09 per 1 peso.
Joe will receive 1,000,000 pesos which will be worth $90,000
(1,000,000 x $0.09) and Joe receives $10,000 less due to
exchange rate fluctuation.
Accounting for Foreign Currency Transactions
One transaction perspective
Treats sale and collection as one transaction
Transaction complete when
Foreign currency received and converted
Sale is measured at converted amount
Not allowed under IFRS or U.S. GAAP
Two transaction perspective
Two transactions
Sale
Collection
Sale based on current exchange rate
Exchange rate changes
Collection for different amount
Difference considered
Foreign exchange gain
Foreign exchange loss
Concepts are identical for purchase transaction
(IAS) 21 and FASB ASC 830 require two-transaction
perspective
Transaction types, exposure type and gain or loss – export sales
Export sale asset exposure--if foreign currency appreciates
foreign exchange gain
Export sale asset exposure--if foreign currency depreciates
foreign exchange loss
Transaction types, exposure type and gain or loss – import
purchases
Import purchase liability exposure -- if foreign currency
appreciates foreign exchange loss
Import purchase liability exposure -- if foreign currency
depreciates foreign exchange gain
Export sale – example 1
February 1, 2018, Eximco a U.S. company, makes a sale and
ships goods to Jose Spanish customer.
Sales price is $1,500,000
Jose agrees to pay in Euros on March 2, 2018.
Assume spot rate as of February 1, 2018 is $1.50 = 1Euro
Joe, Inc. records the sale (in U.S. $) on February 1, 2018 as
follows:
Accounts Receivable $1,500,000
Sales $1,500,000
On March 2, 2018, the spot rate is 1Euro = $1.48
Joe Inc. will receive 1,000,000 Euros which are now worth
$1,480,000 Joe makes the following journal entries:
Dr. Foreign exchange loss 20,000
Cr. Accounts receivable 20,000
Dr. Cash 1,480,000
Cr. Accounts Receivable 1,480,000
Balance Sheet Date before Date of Payment
Revalue foreign currency receivable or payable to spot rate on
balance sheet date
Accrual Approach: show gain or loss for change in value of
receivable or payable
Export sale – example 2
Assume the following facts are added or changed:
Joe Inc., makes sale and ships goods on December 1, 2017
rather than February 1, 2018.
Spot rate as of December 1, 2017 is $1.50 per Euro.
Spot rate as of December 31, 2017 is $1.51 per Euro
Joe Inc. has a December 31 year end.
Joe, Inc. records the sale (in U.S. $) on December 1, 2017 and
the foreign exchange gain on December 31, 2017 as follows:
1\12 Accounts Receivable 1,500,000
Sales 1,500,000
31\12 Accounts Receivable(1000000*(1.51-1.50) 10,000
foreign currency gain 10,000
Joe, Inc. records the receivable collection and a foreign
exchange loss on March 2, 2018: 1Euro = $1.48
Dr. Foreign Exchange Loss (1000000*(1.51-1.48)) 30,000
Cr. Accounts Receivable 30,000
Dr. Cash 1,480,000
Cr. Accounts Receivable 1,480,000
Or the journal entries recorded at march 2 could have been
combined into one single entry:
Dr. Foreign Exchange Loss 30,000
Dr. Cash 1,480,000
Cr. Accounts Receivable 1,510,000
•
12. El Primero Company – Foreign Currency Purchase/Payable
12/1/Y1 Inventory $34,800
Accounts payable (coronas) [40,000 x $.87] $34,800
12/31/Y1 Accounts payable (coronas) [40,000 x ($.82-$.87)] $2,000
Foreign exchange gain $2,000
1/28/Y1 Foreign exchange loss $3,600
Accounts payable (coronas) [40,000 x ($.91-$.82)] $3,600
Accounts payable (coronas) (40000*0.91) $36,400
Cash $36,400
