Accounting and Reporting for Foreign Currencies.ppt
SewaleAbate1
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About This Presentation
Accounting and reporting
Slide Content
Advanced Financial Accounting
ADDIS ABABA UNIVERSITY
COLLAGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING & FINANCE
Prepared and Presented By:
1.Tamirat Assefa GSE/8374/14
2.Tariku Kifle GSE/2835/14
3.Temesgen Bireda GSE/5168/14
4.Wube Tsige GSE/7295/14
5.Wubeshet Kifle GSE/8628/14
Submitted to: Sewale Abate (PhD)
Submission/presentation Date: 09 January, 2022
1
ADDIS ABABA UNIVERSITY
COLLAGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING & FINANCE
Prepared and Presented By:
1.Tamirat Assefa GSE/8374/14
2.Tariku Kifle GSE/2835/14
3.Temesgen Bireda GSE/5168/14
4.Wube Tsige GSE/7295/14
5.Wubeshet Kifle GSE/8628/14
Submitted to: Sewale Abate (PhD)
Submission/presentation Date: 09 January, 2022
1
Chapter Two
Accounting and Reporting for
Foreign Currencies
2.1. Accounting and Reporting for
Foreign Currencies
2
Accounting and Reporting for
Foreign Currencies
2.1. Accounting and Reporting for
Foreign Currencies
2
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
Understand concepts related to foreign currency, exchange rates,
and foreign exchange risk.
Account for foreign currency transactions using the two-transaction
perspective, accrual approach.
Understand how foreign currency forward contracts and foreign
currency options can be used to hedge foreign exchange risk.
Account for forward contracts and options used as hedges of
foreign currency denominated assets and liabilities, firm
commitments and forecasted foreign currency transactions.
How to prepare journal entries to account for foreign currency,
borrowings and loans.
3
After studying this chapter, you should be able to:
Understand concepts related to foreign currency, exchange rates,
and foreign exchange risk.
Account for foreign currency transactions using the two-transaction
perspective, accrual approach.
Understand how foreign currency forward contracts and foreign
currency options can be used to hedge foreign exchange risk.
Account for forward contracts and options used as hedges of
foreign currency denominated assets and liabilities, firm
commitments and forecasted foreign currency transactions.
How to prepare journal entries to account for foreign currency,
borrowings and loans.
3
Accounting and Reporting for
Foreign Currencies
Why is there a need?
Many companies engage in international
transactions such as:
1.Importing and exporting goods,
2.Establishing branches in another countries,
3.Holding investment in foreign companies.
4
Foreign Currencies
Why is there a need?
Many companies engage in international
transactions such as:
1.Importing and exporting goods,
2.Establishing branches in another countries,
3.Holding investment in foreign companies.
4
Each country uses its own currency as the unit of value for the purchase
and sale of goods and services.
The foreign exchange rate is the price at which the foreign currency can
be acquired.
A variety of factors determine the exchange rate between two currencies,
unfortunately for those engaged in international business the exchange
rate can fluctuate over time
Between 1945 and 1973, countries fixed the par value of their currency in
terms of the U.S. dollar.
Since 1973, exchange rates have been allowed to float in value.
Several currency arrangements exist.
Foreign Exchange Market Foreign Exchange Market
and sale of goods and services.
The foreign exchange rate is the price at which the foreign currency can
be acquired.
A variety of factors determine the exchange rate between two currencies,
unfortunately for those engaged in international business the exchange
rate can fluctuate over time
Between 1945 and 1973, countries fixed the par value of their currency in
terms of the U.S. dollar.
Since 1973, exchange rates have been allowed to float in value.
Several currency arrangements exist.
Foreign Exchange Market Foreign Exchange Market
Different Currency Mechanisms
Three Different Currency Mechanisms :-
Independent float: the currency is allowed to fluctuate
according to market forces.
A fixed exchange-rate system(Pegged to another
currency):- the currency’s value is fixed in terms of a
particular foreign currency and the central bank intervenes
to maintain the fixed value.
European Monetary System:- common currency (the euro)
is used in multiple countries.
6
Three Different Currency Mechanisms :-
Independent float: the currency is allowed to fluctuate
according to market forces.
A fixed exchange-rate system(Pegged to another
currency):- the currency’s value is fixed in terms of a
particular foreign currency and the central bank intervenes
to maintain the fixed value.
European Monetary System:- common currency (the euro)
is used in multiple countries.
6
What is a Foreign Currency Transaction
•It is a transaction to be settled in a currency other than the
local currency
•A foreign transaction must be expressed in terms of our local
currency before they can be recorded in the books.
7
•It is a transaction to be settled in a currency other than the
local currency
•A foreign transaction must be expressed in terms of our local
currency before they can be recorded in the books.
7
Exchange Rate
It is the price of one currency in terms of another currency.
An exchange rate is the cost of one currency in terms of
another,
The difference between the rates at which a bank is willing
to buy and sell currency is known as the “spread.”
Foreign Currency Quotes :
Direct quotation - indicate the number of domestic
currency needed to purchase one unit of foreign currency.
- How much is 1 foreign currency unit(FCU) in terms of
local currency unit(LCU)
Example : $1 = ETB 48.15
8
It is the price of one currency in terms of another currency.
An exchange rate is the cost of one currency in terms of
another,
The difference between the rates at which a bank is willing
to buy and sell currency is known as the “spread.”
Foreign Currency Quotes :
Direct quotation - indicate the number of domestic
currency needed to purchase one unit of foreign currency.
- How much is 1 foreign currency unit(FCU) in terms of
local currency unit(LCU)
Example : $1 = ETB 48.15
8
Presentation of exchange…cont’d
Indirect quotation - indicate the number of foreign
currency units that could be purchased with one
unit of domestic currency.
- How much is 1 LCU in terms of FCU?
Example : ETB 1 = $ 0.02
Accounting Principle
1.What kind of exchange rate(s) to use?
2. How to report the effects of change in exchange rates in the
financial statements?
9
Indirect quotation - indicate the number of foreign
currency units that could be purchased with one
unit of domestic currency.
- How much is 1 LCU in terms of FCU?
Example : ETB 1 = $ 0.02
Accounting Principle
1.What kind of exchange rate(s) to use?
2. How to report the effects of change in exchange rates in the
financial statements?
9
Foreign Currency Trades
Foreign currency trades can be executed on a spot or forward
basis.
I. Spot rate
Is the price at which a foreign currency can be purchased or
sold today.
The exchange rate for immediate delivery.
II. Forward (or Future ) rate
Is the price available today at which foreign currency can be
purchased or sold in the future.
The exchange rate at which the currency can be exchanged at
a future date.
10
Foreign currency trades can be executed on a spot or forward
basis.
I. Spot rate
Is the price at which a foreign currency can be purchased or
sold today.
The exchange rate for immediate delivery.
II. Forward (or Future ) rate
Is the price available today at which foreign currency can be
purchased or sold in the future.
The exchange rate at which the currency can be exchanged at
a future date.
10
Foreign Currency Trades cont’d
If forward rates exceed spot rates on any given date, the
foreign currency is said to be selling at a premium in the
forward market.
If forward rates are less than spot rates, the currency is
said to be selling at a discount.
Initial Recognition
A foreign currency is initially recognized by translating the
foreign currency amount into local currency using the spot
exchange rate at the date of transaction.
11
If forward rates exceed spot rates on any given date, the
foreign currency is said to be selling at a premium in the
forward market.
If forward rates are less than spot rates, the currency is
said to be selling at a discount.
Initial Recognition
A foreign currency is initially recognized by translating the
foreign currency amount into local currency using the spot
exchange rate at the date of transaction.
11
Option Contracts Foreign Exchange
Foreign currency options give the holder of an option the right
but not the obligation to trade foreign currency in the future.
Put options allow for the sale of foreign currency by the
option holder.
Call options allow for the purchase of foreign currency by
the option holder.
A strike price is the exchange rate at which options will be
executed if option holders decide to exercise options.
Foreign currency options give the holder of an option the right
but not the obligation to trade foreign currency in the future.
Put options allow for the sale of foreign currency by the
option holder.
Call options allow for the purchase of foreign currency by
the option holder.
A strike price is the exchange rate at which options will be
executed if option holders decide to exercise options.
Accounting for foreign currency transactions
Export sales and import purchases are international
transactions; they are components of what is called
trade.
The companies involved must decide which currency will
be used to settle the transaction, and whether the transaction
will be denominated (payment will be made) in domestic or
foreign currency.
If a company receives foreign currency to settle the
transaction, it must restate the amount of foreign currency
received into domestic currency.
Export sales and import purchases are international
transactions; they are components of what is called
trade.
The companies involved must decide which currency will
be used to settle the transaction, and whether the transaction
will be denominated (payment will be made) in domestic or
foreign currency.
If a company receives foreign currency to settle the
transaction, it must restate the amount of foreign currency
received into domestic currency.
Transaction Exposure
Transaction Exposure
Export sale:
Exposure exists when an exporter allows a buyer to pay in
a foreign currency after the sale has been made.
The exporter is exposed to the risk that the foreign
currency might depreciate between the sale and payment
dates.
Import purchase:
Exposure exists when the importer is required to pay in foreign
currency sometime after the purchase.
The importer is exposed to the risk that the foreign currency
might appreciate between the purchase and payment dates,
increasing the domestic currency paid.
Transaction Exposure
Export sale:
Exposure exists when an exporter allows a buyer to pay in
a foreign currency after the sale has been made.
The exporter is exposed to the risk that the foreign
currency might depreciate between the sale and payment
dates.
Import purchase:
Exposure exists when the importer is required to pay in foreign
currency sometime after the purchase.
The importer is exposed to the risk that the foreign currency
might appreciate between the purchase and payment dates,
increasing the domestic currency paid.
A major issue in accounting for foreign currency
Transactions are how to account for the:
Change in the domestic currency value of the sales
revenue and account receivable resulting from the
export when the foreign currency changes in value.
Change in the domestic currency value of the
account payable and goods being acquired in an
import purchase.
Exchange difference (or exchange gains and
losses) are recognized in profit or loss.
Transactions are how to account for the:
Change in the domestic currency value of the sales
revenue and account receivable resulting from the
export when the foreign currency changes in value.
Change in the domestic currency value of the
account payable and goods being acquired in an
import purchase.
Exchange difference (or exchange gains and
losses) are recognized in profit or loss.
Accounting Alternatives
Conceptually, the two methods of accounting for changes
in the value of a foreign currency transaction are the one-
transaction perspective and the two-transaction
perspective.
The one transaction perspective assumes that an export
sale is not complete until the foreign currency receivable
has been collected and converted.
16
Conceptually, the two methods of accounting for changes
in the value of a foreign currency transaction are the one-
transaction perspective and the two-transaction
perspective.
The one transaction perspective assumes that an export
sale is not complete until the foreign currency receivable
has been collected and converted.
16
Cont’d Accounting Alternatives
Instead, U.S. GAAP requires companies to use a two-
transaction perspective in accounting for foreign currency
transactions.
This perspective treats the export sale and the subsequent
collection of cash as two separate transactions.
Because management has made two decisions:-
1.to make the export sale and
2.to extend credit in foreign currency to the customer—the
company should report the income effect from each of
these decisions separately
17
Instead, U.S. GAAP requires companies to use a two-
transaction perspective in accounting for foreign currency
transactions.
This perspective treats the export sale and the subsequent
collection of cash as two separate transactions.
Because management has made two decisions:-
1.to make the export sale and
2.to extend credit in foreign currency to the customer—the
company should report the income effect from each of
these decisions separately
17
Accounting standard
IAS 21 the effects of change in foreign exchange rates
Similar to U.S. GAAP, IAS 21, “The Effects of
Changes in Foreign Exchange Rates ” requires the
use of a two-transaction perspective to account for
foreign currency transactions with unrealized foreign
exchange gains and losses accrued in net income in
the period of exchange rate change.
There are no substantive differences between U.S.
GAAP and IFRS in accounting for foreign currency
transactions.
18
IAS 21 the effects of change in foreign exchange rates
Similar to U.S. GAAP, IAS 21, “The Effects of
Changes in Foreign Exchange Rates ” requires the
use of a two-transaction perspective to account for
foreign currency transactions with unrealized foreign
exchange gains and losses accrued in net income in
the period of exchange rate change.
There are no substantive differences between U.S.
GAAP and IFRS in accounting for foreign currency
transactions.
18
Accounting for Foreign Currency - import
Import purchases denominated in a foreign currency
and the subsequent cash payment must be accounted
for separately.
The goods purchased is recorded at the date of
purchase, with no subsequent adjustments to the cost of
the goods.
Any difference between the exchange rate have been
purchased date and the actual amount paid on the
payment date due to a change in the exchange rate is
treated as a foreign exchange gain or loss.
19
Import purchases denominated in a foreign currency
and the subsequent cash payment must be accounted
for separately.
The goods purchased is recorded at the date of
purchase, with no subsequent adjustments to the cost of
the goods.
Any difference between the exchange rate have been
purchased date and the actual amount paid on the
payment date due to a change in the exchange rate is
treated as a foreign exchange gain or loss.
19
Guidelines
1. Inventory: at the spot rate at the date the inventory was
purchased,
2.Cost of Goods Sold: at the spot rate at the date the
inventory was purchased,
3.Sales: at the spot rate at the date of sale,
4.Account Receivable: at the spot rate at the balance sheet
date,
5.Account Payable: at the spot rate at the balance sheet date
and
6.Cash: at the spot rate when collected and the spot rate
when paid.
20
1. Inventory: at the spot rate at the date the inventory was
purchased,
2.Cost of Goods Sold: at the spot rate at the date the
inventory was purchased,
3.Sales: at the spot rate at the date of sale,
4.Account Receivable: at the spot rate at the balance sheet
date,
5.Account Payable: at the spot rate at the balance sheet date
and
6.Cash: at the spot rate when collected and the spot rate
when paid.
20
Other Considerations
FOB shipping terms are also considered
FOB shipping point:
transaction date - the date of shipment
FOB destination
transaction date - the date of receiving the goods
21
FOB shipping terms are also considered
FOB shipping point:
transaction date - the date of shipment
FOB destination
transaction date - the date of receiving the goods
21
Treatment of Exchange Differences
Example for Importing transaction
Problem 2.1
On November 01, 2020 Abba Buna, an Ethiopian
Company, order goods from China’s Supplier for
$400,000. The inventory was shipped and invoiced
on December 01, 2020, to be paid in US dollars on
March 31, 2021.
22
Example for Importing transaction
Problem 2.1
On November 01, 2020 Abba Buna, an Ethiopian
Company, order goods from China’s Supplier for
$400,000. The inventory was shipped and invoiced
on December 01, 2020, to be paid in US dollars on
March 31, 2021.
22
Cont’d import transaction
Please prepare the
journal entries to
record the above
transaction in the
books of Abba Buna
Company.
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
23
Please prepare the
journal entries to
record the above
transaction in the
books of Abba Buna
Company.
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
23
Cont’d import transaction
A . On November 01, 2020 - No entry
recorded
B . On December 01, 2020
Purchase………………19,120,000.00
Account payable…………..19,120,000.00
To record 400,000*47.80
C . Selling spot rate Dec 31, 2020 48.60
Selling spot rate Dec 01, 2020
47.80
Increase in selling spot rate 0.80
Foreign currency units 400,000
Foreign exchange loss (400,000*0.80)
…………….320,000.00
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
24
A . On November 01, 2020 - No entry
recorded
B . On December 01, 2020
Purchase………………19,120,000.00
Account payable…………..19,120,000.00
To record 400,000*47.80
C . Selling spot rate Dec 31, 2020 48.60
Selling spot rate Dec 01, 2020
47.80
Increase in selling spot rate 0.80
Foreign currency units 400,000
Foreign exchange loss (400,000*0.80)
…………….320,000.00
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
24
Cont’d import transaction
December 31, 2020 entry
Foreign exchange loss………. 320, 000.00
Account Payable………… 320, 000.00
D. Selling spot on March 31, 2021….……...47.90
Selling spot on December 31, 2020……..48.60
Decrease in selling spot rate …………….0.700.70
Foreign currency units . ………..400,000
Foreign exchange gain(400,000*0.70)……..….280,000.00
March 31, 2021 entry
Account payable…………………280,000.00
Foreign exchange gain………. 280,000.00
A/Payable($400,000*47.90)….19,160,000.00
.
Cash……………………….19,160,000.00
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
25
December 31, 2020 entry
Foreign exchange loss………. 320, 000.00
Account Payable………… 320, 000.00
D. Selling spot on March 31, 2021….……...47.90
Selling spot on December 31, 2020……..48.60
Decrease in selling spot rate …………….0.700.70
Foreign currency units . ………..400,000
Foreign exchange gain(400,000*0.70)……..….280,000.00
March 31, 2021 entry
Account payable…………………280,000.00
Foreign exchange gain………. 280,000.00
A/Payable($400,000*47.90)….19,160,000.00
.
Cash……………………….19,160,000.00
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
25
Cont’d import transaction
Summary
The cost of delaying the payment
is ETB 40,000.00 ($400,000.00
x(47.90-47.80) reported in the
following manner:
ETB 320,000.00 F. exch. Loss in
2020
ETB 280,000.00 F. exch. Gain in
2021
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
26
Summary
The cost of delaying the payment
is ETB 40,000.00 ($400,000.00
x(47.90-47.80) reported in the
following manner:
ETB 320,000.00 F. exch. Loss in
2020
ETB 280,000.00 F. exch. Gain in
2021
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
26
Possible questions may arises:
1.At what amount the merchandise
purchased be reported in 2020?
2.What amount should be reported as a
liability to the supplier (A/P) on
December 31, 2020
3.What amount of foreign exchange
gain or loss should be recorded on
December 31, 2020?
4. What amount of foreign exchange
gain or loss should be recorded on
March 31, 2021?
5. How much ETB will it cost Abba
Buna Company to finally pay the
account on March 31, 2021?
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
27
1.At what amount the merchandise
purchased be reported in 2020?
2.What amount should be reported as a
liability to the supplier (A/P) on
December 31, 2020
3.What amount of foreign exchange
gain or loss should be recorded on
December 31, 2020?
4. What amount of foreign exchange
gain or loss should be recorded on
March 31, 2021?
5. How much ETB will it cost Abba
Buna Company to finally pay the
account on March 31, 2021?
Selling Spot Buying Spot
Rates Rates
Nov 01, 2020 46.50 45.50
Dec 01, 2020 47.80 47.20
Dec 31, 2020 48.60 48.10
Mar 31, 2021 47.90 47.00
27
Possible questions – Answer
1.Answer for Qs # 1. ETB
19,120,000.00 ($400,000.00 x ETB
47.80)
2.Answer for Qs # 2. ETB
19,440,000.00 ($400,000.00 x ETB
48.60)
3.Answer for Qs # 3. ETB
320,000.00 foreign exchange loss
4.Answer for Qs # 4. ETB 40,000.00
foreign exchange loss
5.Answer for Qs # 5. ETB
19,160,000.0($400,000.00 x 47.90)
1.At what amount the merchandise
purchased be reported in 2020
2.What amount should be reported
as a liability to the supplier (A/P)
on December 31, 2020
3.What amount of foreign exchange
gain or loss should be recorded on
December 31, 2020?
4. What amount of foreign exchange
gain or loss should be recorded on
March 31, 2021?
5. How much ETB will it cost Abba
Buna Company to finally pay the
account on March 31, 2021?
28
1.Answer for Qs # 1. ETB
19,120,000.00 ($400,000.00 x ETB
47.80)
2.Answer for Qs # 2. ETB
19,440,000.00 ($400,000.00 x ETB
48.60)
3.Answer for Qs # 3. ETB
320,000.00 foreign exchange loss
4.Answer for Qs # 4. ETB 40,000.00
foreign exchange loss
5.Answer for Qs # 5. ETB
19,160,000.0($400,000.00 x 47.90)
1.At what amount the merchandise
purchased be reported in 2020
2.What amount should be reported
as a liability to the supplier (A/P)
on December 31, 2020
3.What amount of foreign exchange
gain or loss should be recorded on
December 31, 2020?
4. What amount of foreign exchange
gain or loss should be recorded on
March 31, 2021?
5. How much ETB will it cost Abba
Buna Company to finally pay the
account on March 31, 2021?
28
Accounting for Foreign Currency-Sales
Foreign Currency Transactions requires the two
transaction perspective and treats the sale and
collection of cash as two separate transactions.
Account for the original sale at the date of sale. No
subsequent adjustments are required.
Changes in currency are accounted for as
gains/losses from exchange rate fluctuations
reported separately from sales in the income
statement
29
Foreign Currency Transactions requires the two
transaction perspective and treats the sale and
collection of cash as two separate transactions.
Account for the original sale at the date of sale. No
subsequent adjustments are required.
Changes in currency are accounted for as
gains/losses from exchange rate fluctuations
reported separately from sales in the income
statement
29
Example for Exporting transaction
Problem 2.2
On November 01, 2020 Abba Buna, an Ethiopian Company,
received an order goods from Chinese supplier for $400,000.
Abba Buna company shipped inventory and billed the
Chinese company on December 01, 2020.The foreign
company in this case Chinese company will settle its account
on march 31, 2021 by remitting its payments in US Dollars.
The spot rates for US dollars are the same used in problem
2.1 above.
30
Problem 2.2
On November 01, 2020 Abba Buna, an Ethiopian Company,
received an order goods from Chinese supplier for $400,000.
Abba Buna company shipped inventory and billed the
Chinese company on December 01, 2020.The foreign
company in this case Chinese company will settle its account
on march 31, 2021 by remitting its payments in US Dollars.
The spot rates for US dollars are the same used in problem
2.1 above.
30
Example for Exporting transaction
Please prepare the
journal entries to record
the above transaction in
the books of Abba Buna
Company.
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
31
Please prepare the
journal entries to record
the above transaction in
the books of Abba Buna
Company.
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
31
Example for Exporting transaction
A . On November 01, 2020
No entry recorded
B . On December 01, 2020
A/Rec.…... 18,880,000.00
Sales ……....…18,880,000.00
($400,000 x 47.20)
Buying spot rate Dec 31, 2020 48.10
Buying spot rate Dec 01, 2020 47.20
Incr. in Buying spot rate 0.90
Foreign currency units 400,000
Foreign exchange gain (400,000*0.90)
…………….360,000.00
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
32
A . On November 01, 2020
No entry recorded
B . On December 01, 2020
A/Rec.…... 18,880,000.00
Sales ……....…18,880,000.00
($400,000 x 47.20)
Buying spot rate Dec 31, 2020 48.10
Buying spot rate Dec 01, 2020 47.20
Incr. in Buying spot rate 0.90
Foreign currency units 400,000
Foreign exchange gain (400,000*0.90)
…………….360,000.00
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
32
Example for Exporting transaction
On December 31, 2020
A/receivable …………360,000.00
For. Exchange gain……360,000.00
March 31, 2021
Buying spot on Mar 31, 2021……... 47.00
Buying spot on Dec 31, 2020…..….. 48.10
Decr. in buying spot rate ……...…….1.10
Foreign currency units 400,000
Foreign exchange loss (400,000*1.10)……….
….440,000.00
The spot rates for US dollars are
as follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
33
On December 31, 2020
A/receivable …………360,000.00
For. Exchange gain……360,000.00
March 31, 2021
Buying spot on Mar 31, 2021……... 47.00
Buying spot on Dec 31, 2020…..….. 48.10
Decr. in buying spot rate ……...…….1.10
Foreign currency units 400,000
Foreign exchange loss (400,000*1.10)……….
….440,000.00
The spot rates for US dollars are
as follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
33
Example for Exporting transaction
Entry on March 31, 2021 would be:
For. exchange loss………. 440,000.00
A/Receivable ……..……..440,000.00
Cash foreign currency...18,800.000.00
A/receivable…..……18,800.000.00
($400,000 x 47.00)
Cash………………….18,800,000.00
Cash foreign currency..18,800.000.00
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
34
Entry on March 31, 2021 would be:
For. exchange loss………. 440,000.00
A/Receivable ……..……..440,000.00
Cash foreign currency...18,800.000.00
A/receivable…..……18,800.000.00
($400,000 x 47.00)
Cash………………….18,800,000.00
Cash foreign currency..18,800.000.00
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
34
Summary Exporting transaction
The benefit of delaying the collection is ETB 80,000.00
(400,000.00*{47-47.20}) reported in the following
manner
ETB 360,000.00 foreign exchange gain in 2020
ETB 440,000.00 foreign exchange loss in 2021
35
The benefit of delaying the collection is ETB 80,000.00
(400,000.00*{47-47.20}) reported in the following
manner
ETB 360,000.00 foreign exchange gain in 2020
ETB 440,000.00 foreign exchange loss in 2021
35
Example for Exporting transaction
Entry on March 31, 2021 would be:
For. exchange loss………. 440,000.00
A/Receivable ……..……..440,000.00
Cash foreign currency...18,800.000.00
A/receivable…..……18,800.000.00
($400,000 x 47.00)
Cash………………….18,800,000.00
Cash foreign currency..18,800.000.00
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
36
Entry on March 31, 2021 would be:
For. exchange loss………. 440,000.00
A/Receivable ……..……..440,000.00
Cash foreign currency...18,800.000.00
A/receivable…..……18,800.000.00
($400,000 x 47.00)
Cash………………….18,800,000.00
Cash foreign currency..18,800.000.00
The spot rates for US dollars are as
follow:
Selling Spot Buying Spot
Rates Rates
November 01, 2020 46.50 45.50
December 01, 2020 47.80 47.20
December 31, 2020 48.60 48.10
March 31, 2021 47.90 47.00
36
Possible questions may arises on
Exporting Transaction
1.What amount of sales should be reported in 2020?
2.What amount should be reported as receivable from
foreign customer(A/R) on December 31, 2020
3.What amount of foreign exchange gain or loss should
be recorded on December 31, 2020?
4.What amount of foreign exchange gain or loss should
be recorded on March 31, 2021?
5. How much ETB will did Abba Buna Company
received on March 31, 2021?
37
Exporting Transaction
1.What amount of sales should be reported in 2020?
2.What amount should be reported as receivable from
foreign customer(A/R) on December 31, 2020
3.What amount of foreign exchange gain or loss should
be recorded on December 31, 2020?
4.What amount of foreign exchange gain or loss should
be recorded on March 31, 2021?
5. How much ETB will did Abba Buna Company
received on March 31, 2021?
37
Answers for Possible questions on
Exporting Transaction
1.What amount of sales should be
reported in 2020?
2.What amount should be reported
as receivable from foreign
customer(A/R) on December 31,
2020
3.What amount of foreign
exchange gain or loss should be
recorded on December 31, 2020?
4.What amount of foreign
exchange gain or loss should be
recorded on March 31, 2021?
5. How much ETB will did Abba
Buna Company received on
March 31, 2021?
Qs # 1. ETB 18,880,000.00 ($400,000.00
x ETB 47.20)
Qs # 2. ETB 19,240,000.00 ($400,000.00
x ETB 48.10)
Qs # 3. ETB 360,000.00 foreign
exchange gain
Qs # 4. ETB 40,000.00 foreign exchange
loss
Qs # 5. ETB 18,880,000.0($400,000.00 x
47.00)
Other consideration are the same as
import foreign transaction
38
Exporting Transaction
1.What amount of sales should be
reported in 2020?
2.What amount should be reported
as receivable from foreign
customer(A/R) on December 31,
2020
3.What amount of foreign
exchange gain or loss should be
recorded on December 31, 2020?
4.What amount of foreign
exchange gain or loss should be
recorded on March 31, 2021?
5. How much ETB will did Abba
Buna Company received on
March 31, 2021?
Qs # 1. ETB 18,880,000.00 ($400,000.00
x ETB 47.20)
Qs # 2. ETB 19,240,000.00 ($400,000.00
x ETB 48.10)
Qs # 3. ETB 360,000.00 foreign
exchange gain
Qs # 4. ETB 40,000.00 foreign exchange
loss
Qs # 5. ETB 18,880,000.0($400,000.00 x
47.00)
Other consideration are the same as
import foreign transaction
38
Summary of Exchange Rates and Foreign
Exchange Gains and Losses
Summary of the relationship between fluctuations
in exchange rates and foreign exchange gains and
losses:
Foreign currency receivables from an export sale
create an asset exposure to foreign exchange risk.
Foreign currency payables from an import
purchase create a liability exposure to foreign
exchange risk.
39
Exchange Gains and Losses
Summary of the relationship between fluctuations
in exchange rates and foreign exchange gains and
losses:
Foreign currency receivables from an export sale
create an asset exposure to foreign exchange risk.
Foreign currency payables from an import
purchase create a liability exposure to foreign
exchange risk.
39
Closing Summary
Transaction Type of exchange rateExchange rate Exchange rate
Importing Selling spot rate FX loss FX gain
Exporting Buying spot rate FX gain FX loss
40
Transaction Type of exchange rateExchange rate Exchange rate
Importing Selling spot rate FX loss FX gain
Exporting Buying spot rate FX gain FX loss
40
Balance Sheet Date before Date of Payment
Authoritative accounting literature requires foreign
currency balances foreign currency receivables or
foreign currency payables to be revalued at the
balance sheet date to account for change in exchange
rates.
Consistent with accrual accounting, under the two
transaction perspective, a foreign exchange gain or
loss arises at the balance sheet date.
41
Authoritative accounting literature requires foreign
currency balances foreign currency receivables or
foreign currency payables to be revalued at the
balance sheet date to account for change in exchange
rates.
Consistent with accrual accounting, under the two
transaction perspective, a foreign exchange gain or
loss arises at the balance sheet date.
41
Foreign Currency Borrowings
Companies often must account for foreign currency
borrowings, another type of foreign currency transaction.
Companies borrow foreign currency from foreign lenders to
finance foreign operations or to take advantage of more
favorable interest rates.
The principal and interest are denominated in foreign currency
and create an exposure to foreign exchange risk which
complicate accounting for a foreign currency borrowing
Companies often must account for foreign currency
borrowings, another type of foreign currency transaction.
Companies borrow foreign currency from foreign lenders to
finance foreign operations or to take advantage of more
favorable interest rates.
The principal and interest are denominated in foreign currency
and create an exposure to foreign exchange risk which
complicate accounting for a foreign currency borrowing
Foreign Currency Loans
Companies lend foreign currency to related parties,
creating the opposite situation from a foreign currency
borrowing.
The company must keep track of a note receivable and
interest receivable, both of which are denominated in
foreign currency.
Exchange gains and losses that would be included in
income.
43
Companies lend foreign currency to related parties,
creating the opposite situation from a foreign currency
borrowing.
The company must keep track of a note receivable and
interest receivable, both of which are denominated in
foreign currency.
Exchange gains and losses that would be included in
income.
43
Problem 2.3
Abba Bunna Company borrowed 300,000 Dollars on May
1, 2020 for one year at an interest rate of 5% per annum.
Abba Bunna must make its first interest payment on the
loan on November 1, 2020, and will make a second interest
payment on April 30, 2021, when the loan is repaid.
December is 31, 2020 year-end .
Prepare all journal entries related to this foreign currency
borrowing.
Assuming the following exchange rates for 1 Dollars:
May 1, 2020 ETB 51.20
November 1, 2020 ETB 51.24
December 31, 2020 ETB 51.26
April 30, 2021 ETB 51.28
Abba Bunna Company borrowed 300,000 Dollars on May
1, 2020 for one year at an interest rate of 5% per annum.
Abba Bunna must make its first interest payment on the
loan on November 1, 2020, and will make a second interest
payment on April 30, 2021, when the loan is repaid.
December is 31, 2020 year-end .
Prepare all journal entries related to this foreign currency
borrowing.
Assuming the following exchange rates for 1 Dollars:
May 1, 2020 ETB 51.20
November 1, 2020 ETB 51.24
December 31, 2020 ETB 51.26
April 30, 2021 ETB 51.28
Cont’d - Problem 2.3
Prepare journal entries for a foreign currency borrowing Solution
5/1/20
Cash 15,360,000
Note Payable 15,360,000
[300,000 @ 51.10]
11/1/20Interest Expense
384,300
Cash 384,300
[300,000 x 5% x 6/12 x ETB51.24] 384,300
12/31/20
Interest Expense 128,150
Interest
Payable
128,150
{300,000 x 5% x 2/12 x $51.26] 12,815
Foreign Exchange Loss
18,000.00
Note Payable (euro)
18,800.00
[300,000 x (ETB51.26 – ETB51.20)] 18,000 45
Prepare journal entries for a foreign currency borrowing Solution
5/1/20
Cash 15,360,000
Note Payable 15,360,000
[300,000 @ 51.10]
11/1/20Interest Expense
384,300
Cash 384,300
[300,000 x 5% x 6/12 x ETB51.24] 384,300
12/31/20
Interest Expense 128,150
Interest
Payable
128,150
{300,000 x 5% x 2/12 x $51.26] 12,815
Foreign Exchange Loss
18,000.00
Note Payable (euro)
18,800.00
[300,000 x (ETB51.26 – ETB51.20)] 18,000 45
Cont’d - Problem 2.3
April 30, 2021
Interest Expense
256,400.00
Interest Payable (euro)
128,150
Foreign Exchange Loss
50
Cash 384,600
[300,000 x 5% x 4/12 x ETB 51.28] 256,400
[300,000 x 5% x 2/12 x (ETB51.28 – $51.26)] 50
[300,000 x 5% x 6/12 x ETB51.28] 384,600
Note Payable
378,000
Foreign Exchange Loss 6,000
Cash 384,000
[300,000 x ($1.28 - $1.26)] 6,000
46
April 30, 2021
Interest Expense
256,400.00
Interest Payable (euro)
128,150
Foreign Exchange Loss
50
Cash 384,600
[300,000 x 5% x 4/12 x ETB 51.28] 256,400
[300,000 x 5% x 2/12 x (ETB51.28 – $51.26)] 50
[300,000 x 5% x 6/12 x ETB51.28] 384,600
Note Payable
378,000
Foreign Exchange Loss 6,000
Cash 384,000
[300,000 x ($1.28 - $1.26)] 6,000
46
Derivatives and Hedging Transactions
A financial instrument or other contract that drives its value from changes
in value of some underlying.
It is used to Manage Risk
Type of Derivatives
1.Forward (or Futures) contract
A contract that gives the holder the obligation to buy or sell an asset at a set price at a future
date.
2.Option contract
A contract that gives the holder the right, but not the obligation, to buy or sell an asset at a set
price at a future date.
3.Swap Agreement
A contract between two parties to exchange in the future.
47
A financial instrument or other contract that drives its value from changes
in value of some underlying.
It is used to Manage Risk
Type of Derivatives
1.Forward (or Futures) contract
A contract that gives the holder the obligation to buy or sell an asset at a set price at a future
date.
2.Option contract
A contract that gives the holder the right, but not the obligation, to buy or sell an asset at a set
price at a future date.
3.Swap Agreement
A contract between two parties to exchange in the future.
47
HEDGE ACCOUNTING
Companies enter into hedging relationships to minimize the adverse effect that changes in
exchange rates have on cash flows and net income.
As such, companies would like to account for hedges in such a way to recognize the gain or
loss from the hedge in net income in the same period as the loss or gain on the risk being
hedged. This approach is known as hedge accounting.
IFRS 9, “Financial Instruments,” provides guidance on the accounting for hedging
instruments including those used to hedge foreign exchange risk. IFRS 9 rules and
procedures related to foreign currency hedge accounting generally are consistent with
GAAP.
U.S.GAAP allows hedge accounting for foreign currency derivatives only if three conditions
are satisfied:
The derivative is used to hedge either a fair-value exposure or cash flow exposure to
foreign exchange risk.
The derivative is highly effective in offsetting changes in the fair value or cash flows
related to the hedged item.
The derivative is properly documented as a hedge
48
Companies enter into hedging relationships to minimize the adverse effect that changes in
exchange rates have on cash flows and net income.
As such, companies would like to account for hedges in such a way to recognize the gain or
loss from the hedge in net income in the same period as the loss or gain on the risk being
hedged. This approach is known as hedge accounting.
IFRS 9, “Financial Instruments,” provides guidance on the accounting for hedging
instruments including those used to hedge foreign exchange risk. IFRS 9 rules and
procedures related to foreign currency hedge accounting generally are consistent with
GAAP.
U.S.GAAP allows hedge accounting for foreign currency derivatives only if three conditions
are satisfied:
The derivative is used to hedge either a fair-value exposure or cash flow exposure to
foreign exchange risk.
The derivative is highly effective in offsetting changes in the fair value or cash flows
related to the hedged item.
The derivative is properly documented as a hedge
48
Cont’d Type of Derivatives
Measurement of Derivatives - all derivatives are measured at fair value.
Use of Derivatives
For Speculation
For hedging
Speculation involves trying to make a profit from a security's price
change, whereas hedging attempts to reduce the amount of risk, or
volatility, associated with a security's price change.
Hedging – is a risk management strategy to minimize or offset the risk of any
adverse price movements.
Its objective is to reduce potential loss arising from transaction exposure
Components of Hedging Relationship
1.Hedged item
2.Hedging instrument
49
Measurement of Derivatives - all derivatives are measured at fair value.
Use of Derivatives
For Speculation
For hedging
Speculation involves trying to make a profit from a security's price
change, whereas hedging attempts to reduce the amount of risk, or
volatility, associated with a security's price change.
Hedging – is a risk management strategy to minimize or offset the risk of any
adverse price movements.
Its objective is to reduce potential loss arising from transaction exposure
Components of Hedging Relationship
1.Hedged item
2.Hedging instrument
49
Hedged Item
Defined as:
Recognized asset or liability
Firm commitment
Highly probable forecasted transaction
Net investment in a foreign transaction
The exposes the entity to risk of exchange in fair value or
future cash flows and is designated as being hedged.
Hedging Instruments
A designated derivative or non-derivative financial asset or liability whose
fair value or cash flows are expected to offset changes in fair value or cash
flows of a designated hedge item. Examples: Forward contracts, Option
contracts and Swap agreements.
50
Defined as:
Recognized asset or liability
Firm commitment
Highly probable forecasted transaction
Net investment in a foreign transaction
The exposes the entity to risk of exchange in fair value or
future cash flows and is designated as being hedged.
Hedging Instruments
A designated derivative or non-derivative financial asset or liability whose
fair value or cash flows are expected to offset changes in fair value or cash
flows of a designated hedge item. Examples: Forward contracts, Option
contracts and Swap agreements.
50
Types of Hedge
Fair value hedge
Hedge of the exposure to changes in fair value of a recognized asset or liability or
of unrecognized commitment.
Cash flow hedge
Hedge of the exposure to variability in future cash flows.
Qualifications of Hedged Items
51
Fair Value Hedge Cash Flow Hedge
Hedged item Change in P/L
Normal accounting
procedures
Hedging instrument Change in P/L Change in OCI
Fair value hedge
Hedge of the exposure to changes in fair value of a recognized asset or liability or
of unrecognized commitment.
Cash flow hedge
Hedge of the exposure to variability in future cash flows.
Qualifications of Hedged Items
51
Fair Value Hedge Cash Flow Hedge
Hedged item Change in P/L
Normal accounting
procedures
Hedging instrument Change in P/L Change in OCI
Problem 2.4. – Hedging an exposed
liability Position
AZ Coffee Exporter Corporation purchased goods from MK
General Inc.(Foreign Company). for ETB 600,000.00. The
merchandise was received on November 01, 2021, with
payment due in ETB on January 30, 2022. Also on November
01, 2021 AZ Coffee exporter Corporation entered into a
forward contract with CBE to purchase the necessary
600,000.00 ETB for delivery of January 30, 2022 to hedge the
purchase transaction. The hedge is accounted for as fair value
hedge. The following direct exchange rates were provided:
liability Position
AZ Coffee Exporter Corporation purchased goods from MK
General Inc.(Foreign Company). for ETB 600,000.00. The
merchandise was received on November 01, 2021, with
payment due in ETB on January 30, 2022. Also on November
01, 2021 AZ Coffee exporter Corporation entered into a
forward contract with CBE to purchase the necessary
600,000.00 ETB for delivery of January 30, 2022 to hedge the
purchase transaction. The hedge is accounted for as fair value
hedge. The following direct exchange rates were provided:
Cont’d Problem 2.4 – Hedging an
exposed liability Position
Nov 1, 2021 Dec 31, 2021 Jan 31, 2022
Spot rate – selling 48.15 49.15 50.05
Spot rate – buying 47.50 48.50 48.50
90-date forward –buying 48.50 49.50 49.55
90-date forward –selling 48.80 49.50 49.55
60-date forward –buying 48.90 49.80 49.81
60-date forward –selling 48.93 48.95 48.94
30-date forward –buying 48.83 48.831 48.832
30-date forward –selling 48.93 48.90 48.846
exposed liability Position
Nov 1, 2021 Dec 31, 2021 Jan 31, 2022
Spot rate – selling 48.15 49.15 50.05
Spot rate – buying 47.50 48.50 48.50
90-date forward –buying 48.50 49.50 49.55
90-date forward –selling 48.80 49.50 49.55
60-date forward –buying 48.90 49.80 49.81
60-date forward –selling 48.93 48.95 48.94
30-date forward –buying 48.83 48.831 48.832
30-date forward –selling 48.93 48.90 48.846
Cont’d Problem – Hedging an
exposed liability Position
Required:
Please prepare all the necessary journal entries to record the
foregoing transactions, based on the above givens.
exposed liability Position
Required:
Please prepare all the necessary journal entries to record the
foregoing transactions, based on the above givens.
Solution for Problem 2.4.
Hedged Item
1 Nov 2021 Purchase)……….
28,890,000.00
Account payable…….…
28,890,000.00
To record purchase of
(600,[email protected])
31 Dec 2021Spot rate - selling
49.15
1 Nov 2021Spot rate - selling
48.15
Incr. in selling price spot
rate
1.00
X:FC unites 600,000.00
Foreign exchange loss 600,000.00
31 Dec 2021 Foreign exchange loss 600,000.00
Accounts payable
600,000.00
Hedging instrument
1 Nov 21
Foreign currency
receivable……
29,280,000.0
0
ETB Payable…………
29,280,000.0
0
FC Units………….
600,000.00
X:forward rate-
selling (90 days)
48.80
Nocked price
29,280,000.
00
Forward rate - selling
(30-days),
12/31/2021
48.90
Forward rate - selling
(90-days),
11/01/2021
48.80
Increase in selling
price forward rate
0.10
FC Units………….
600,000.00
Gain on forward
contract
60,000.00 55
Hedged Item
1 Nov 2021 Purchase)……….
28,890,000.00
Account payable…….…
28,890,000.00
To record purchase of
(600,[email protected])
31 Dec 2021Spot rate - selling
49.15
1 Nov 2021Spot rate - selling
48.15
Incr. in selling price spot
rate
1.00
X:FC unites 600,000.00
Foreign exchange loss 600,000.00
31 Dec 2021 Foreign exchange loss 600,000.00
Accounts payable
600,000.00
Hedging instrument
1 Nov 21
Foreign currency
receivable……
29,280,000.0
0
ETB Payable…………
29,280,000.0
0
FC Units………….
600,000.00
X:forward rate-
selling (90 days)
48.80
Nocked price
29,280,000.
00
Forward rate - selling
(30-days),
12/31/2021
48.90
Forward rate - selling
(90-days),
11/01/2021
48.80
Increase in selling
price forward rate
0.10
FC Units………….
600,000.00
Gain on forward
contract
60,000.00 55
Cont’d Solution for Problem 2.4.
Hedged Item Hedging instrument
31 December 2021Foreign currency receivable……….
60,000.00
Gain on forward contract………
60,000.00
56
Hedged Item Hedging instrument
31 December 2021Foreign currency receivable……….
60,000.00
Gain on forward contract………
60,000.00
56
Cont’d Solution for Problem 2.4.
Hedged Item
31 Jan 22 Spot rate - selling 50.05
31 Dec 21 Spot rate - selling 49.15
Increase in selling
price spot rate 0.90
X:FC units 600,000.00
Foreign exchange
loss 540,000.00
31 Jan 22
Foreign exchange
loss 540,000.00
Accounts payable
540,000.00
Account payable 30,030,000.00
Cash -foreign
currency
30,030,000.00
Hedging instrument
31 Jan 2022 Spot rate selling
50.05
Forward rate - selling
(30-days), 12/31/2021
48.90
Increase in exchange rate
1.15
FC Units………….
600,000.00
Gain on forward contract
690,000.00
31 Jan 2022
Foreign currency
receivable……….
690,000.00
Gain on forward contract……….
690,000.00
Cash -foreign
currency(600000*50.05)
30,030,000.00
Foreign currency receivable
30,030,000.00
57
Hedged Item
31 Jan 22 Spot rate - selling 50.05
31 Dec 21 Spot rate - selling 49.15
Increase in selling
price spot rate 0.90
X:FC units 600,000.00
Foreign exchange
loss 540,000.00
31 Jan 22
Foreign exchange
loss 540,000.00
Accounts payable
540,000.00
Account payable 30,030,000.00
Cash -foreign
currency
30,030,000.00
Hedging instrument
31 Jan 2022 Spot rate selling
50.05
Forward rate - selling
(30-days), 12/31/2021
48.90
Increase in exchange rate
1.15
FC Units………….
600,000.00
Gain on forward contract
690,000.00
31 Jan 2022
Foreign currency
receivable……….
690,000.00
Gain on forward contract……….
690,000.00
Cash -foreign
currency(600000*50.05)
30,030,000.00
Foreign currency receivable
30,030,000.00
57
Cont’d Solution for Problem 2.4.
Hedged Item
Hedging instrument
31 Jan 2022ETB payable 28,890,000.00
Cash 28,890,000.00
600,[email protected]
58
Hedged Item
Hedging instrument
31 Jan 2022ETB payable 28,890,000.00
Cash 28,890,000.00
600,[email protected]
58
Possible Questions
1. What is the fair value of the forward contract on November 1,
2021?
2.How much is the gain or loss to be recognized with resect to the
hedged item on December 31, 2021?
3. How much is the gain or loss to be recognized with resect to the
hedged instrument on December 31, 2021?
4.How much is the gain or loss to be recognized with resect to the
hedged item on January 31, 2022?
5.How much is the gain or loss to be recognized with resect to the
hedged instrument on January 31, 2022?
6.What is the fair value of the forward contract on January 31, 2022?
7.What is the net impact on the company’s income in 2022 as a result
of this hedge?
1. What is the fair value of the forward contract on November 1,
2021?
2.How much is the gain or loss to be recognized with resect to the
hedged item on December 31, 2021?
3. How much is the gain or loss to be recognized with resect to the
hedged instrument on December 31, 2021?
4.How much is the gain or loss to be recognized with resect to the
hedged item on January 31, 2022?
5.How much is the gain or loss to be recognized with resect to the
hedged instrument on January 31, 2022?
6.What is the fair value of the forward contract on January 31, 2022?
7.What is the net impact on the company’s income in 2022 as a result
of this hedge?
Problem 2.5. – Hedging an
exposed Asset Position
ABC Exporter sold Merchandise to XYZ Corporation for on December
01, 2021 for $50,000.00. Payment will be received on March 01, 2022.
ABC Exporter entered into forward exchange contracts to hedge the
transaction on December 01, 2021. The following rates available on
various dates are as follows:
Dec 1, 2021 Dec 31, 2021 March 01, 2022
Spot rate – selling ETB 50.75 51.00 51.25
Spot rate – buying 50.00 50.25 50.50
30-date forward –selling 50.35 50.70 51.40
30-date forward –buying 50.10 50.35 50.55
60-date forward –selling 50.90 51.10 51.25
60-date forward –Buying 50.20 50.40 50.65
90-date forward –selling 50.85 50.75 51.00
90-date forward –buying 50.30 50.45 50.60
exposed Asset Position
ABC Exporter sold Merchandise to XYZ Corporation for on December
01, 2021 for $50,000.00. Payment will be received on March 01, 2022.
ABC Exporter entered into forward exchange contracts to hedge the
transaction on December 01, 2021. The following rates available on
various dates are as follows:
Dec 1, 2021 Dec 31, 2021 March 01, 2022
Spot rate – selling ETB 50.75 51.00 51.25
Spot rate – buying 50.00 50.25 50.50
30-date forward –selling 50.35 50.70 51.40
30-date forward –buying 50.10 50.35 50.55
60-date forward –selling 50.90 51.10 51.25
60-date forward –Buying 50.20 50.40 50.65
90-date forward –selling 50.85 50.75 51.00
90-date forward –buying 50.30 50.45 50.60
Cont’d Problem 2.5 – Hedging an
exposed Asset Position
Required:
Please prepare all the necessary journal entries to record
the foregoing transactions, based on the following
givens.
exposed Asset Position
Required:
Please prepare all the necessary journal entries to record
the foregoing transactions, based on the following
givens.
To record Problem 2.5 – Hedging
Hedged Item Hedging instrument
62
1 Dec 2021Account payable($50,000 * 50)…
2,500,000.00
Sales
2,500,000.00
1 Dec 2021ETB Receivable………
2,515,000.00
ETB Payable…
2,515,000.00
FC Units………….
50,000.00
X:forward rate-buying
(90 days), Dec1, 2021
50.30
Nocked price 2,515,000.00
Hedged Item Hedging instrument
62
1 Dec 2021Account payable($50,000 * 50)…
2,500,000.00
Sales
2,500,000.00
1 Dec 2021ETB Receivable………
2,515,000.00
ETB Payable…
2,515,000.00
FC Units………….
50,000.00
X:forward rate-buying
(90 days), Dec1, 2021
50.30
Nocked price 2,515,000.00
Cont’d Problem 2.5 – Hedging
Hedged Item Hedging instrument
63
31 Dec 2021Spot rate - Buying
50.25
1 Dec 2021
Spot rate - Buying
50.00
Increase in selling price spot rate
0.25
X:FC unites
50,000.00
Foreign exchange loss
12,500.00
31 Dec 2021Account receivable
12,500.00
Foreign exchange gain
12,500.00
Forward rate - Buying
(60-
days), Dec 31, 2021
50.40
Forward rate - Buying
(90-days), Dec 01,
2021
50.30
Increase in forward rate
0.10
FC Units………….
50,000.00
Loss on forward contract
5,000.00
31 Dec 2021Loss on forward contract …
5,000.00
Foreign currency
payable……….
5,000.00
Hedged Item Hedging instrument
63
31 Dec 2021Spot rate - Buying
50.25
1 Dec 2021
Spot rate - Buying
50.00
Increase in selling price spot rate
0.25
X:FC unites
50,000.00
Foreign exchange loss
12,500.00
31 Dec 2021Account receivable
12,500.00
Foreign exchange gain
12,500.00
Forward rate - Buying
(60-
days), Dec 31, 2021
50.40
Forward rate - Buying
(90-days), Dec 01,
2021
50.30
Increase in forward rate
0.10
FC Units………….
50,000.00
Loss on forward contract
5,000.00
31 Dec 2021Loss on forward contract …
5,000.00
Foreign currency
payable……….
5,000.00
Cont’d Problem 2.5 – Hedging
Hedged Item Hedging instrument
64
1 March 2022Foreign currency payable 2,525,000.00
Cash -foreign currency(50,000*50.50) 2,525,000.00
Cash 2,515,000.00
ETB Receivable 2,515,000.00
Hedged Item Hedging instrument
64
1 March 2022Foreign currency payable 2,525,000.00
Cash -foreign currency(50,000*50.50) 2,525,000.00
Cash 2,515,000.00
ETB Receivable 2,515,000.00
Possible Questions
1.What is the fair value of the forward contract on December
1, 2021? Answer: Zero
2.How much is the gain or loss to be recognized with resect to
the hedged item on December 31, 2021? Answer: 12,500.00
FX Loss
3.How much is the gain or loss to be recognized with resect to
the hedged instrument on December 31, 2021? Ans: 5000.00
Loss
4.How much is the gain or loss to be recognized with resect to
the hedged item on March 01, 2022? Answer: 12,500.00 FX
gain
5.How much is the gain or loss to be recognized with resect to the
hedged instrument on March 01, 2022? Ans: 5000.00 Loss
1.What is the fair value of the forward contract on December
1, 2021? Answer: Zero
2.How much is the gain or loss to be recognized with resect to
the hedged item on December 31, 2021? Answer: 12,500.00
FX Loss
3.How much is the gain or loss to be recognized with resect to
the hedged instrument on December 31, 2021? Ans: 5000.00
Loss
4.How much is the gain or loss to be recognized with resect to
the hedged item on March 01, 2022? Answer: 12,500.00 FX
gain
5.How much is the gain or loss to be recognized with resect to the
hedged instrument on March 01, 2022? Ans: 5000.00 Loss
Cont’d: Possible Questions
6. What is the fair value of the forward contract on March
01, 2022? Answer: 10,0000.000 liability
7. What is the net impact on the company’s income in
2022 as a result of this hedge? Answer: 7,500.00 gain
8. How much ETB did the company ultimately realized
from the exporting transaction? Answer 2,515,000.00
6. What is the fair value of the forward contract on March
01, 2022? Answer: 10,0000.000 liability
7. What is the net impact on the company’s income in
2022 as a result of this hedge? Answer: 7,500.00 gain
8. How much ETB did the company ultimately realized
from the exporting transaction? Answer 2,515,000.00
Firm Commitment
A binding agreement to purchase or sell an asset at a set
price on a future date.
When an unrecognized firm commitment is designed as a
hedger item, the subsequent cumulative change in the fair
value of the firm commitment is recognized as an asset or
liability with a corresponding gain or loss recognized in
profit or loss.
The initial carrying amount of the asset or liability that
arises from a firm commitment is a adjusted to include the
cumulative change in the fair value of the firm
commitment.
A binding agreement to purchase or sell an asset at a set
price on a future date.
When an unrecognized firm commitment is designed as a
hedger item, the subsequent cumulative change in the fair
value of the firm commitment is recognized as an asset or
liability with a corresponding gain or loss recognized in
profit or loss.
The initial carrying amount of the asset or liability that
arises from a firm commitment is a adjusted to include the
cumulative change in the fair value of the firm
commitment.
Problem 2.6
On December 15, 2021, Parrot Company committed to
purchase goods from a foreign company for $20,000. The
company was concerned about the fluctuation in the US
Dollars, so this date, the company entered into a 30-day
forward contract to purchase $20,000.
Relevant rates as follows:
Dec 15, 21 Dec 31, 21 Jan 14, 22
Spot rate 48.40 48.52 48.60
Forward rate 48.48 48.54 48.60
Required: Please prepare all the necessary journal entries to
record the foreign transaction.
On December 15, 2021, Parrot Company committed to
purchase goods from a foreign company for $20,000. The
company was concerned about the fluctuation in the US
Dollars, so this date, the company entered into a 30-day
forward contract to purchase $20,000.
Relevant rates as follows:
Dec 15, 21 Dec 31, 21 Jan 14, 22
Spot rate 48.40 48.52 48.60
Forward rate 48.48 48.54 48.60
Required: Please prepare all the necessary journal entries to
record the foreign transaction.
Problem 2.6 solution
Hedged Item Hedging Instrument
Dec 15, 2021Foreign Currency
receivable($20,000*48.48
969,600
ETB Payable 969,600
Forward rate 12/31/2021 48.54
Forward rate 12/15/2021 48.48
Incr. in forward rate 0.06
X:FC units 20,000
Gain on forward contract 1,200
12/31/21 Foreign Currency receivable 1,200
Gain on forward contract 1,200
Cash-foreign currency 972,000
Foreign currency receivable 972,000
ETB- Payable 969,600
12/31/21 Cash 969,600
69
12/15/20221No entry
12/31/21 Loss for firm
commitment
1,200
firm commitment 1,200
Purchase(20000X
48.60)
972,000
Cash-foreign
currency
972,000
Firm
Commitment
2,4000
Purchase 2,400
Hedged Item Hedging Instrument
Dec 15, 2021Foreign Currency
receivable($20,000*48.48
969,600
ETB Payable 969,600
Forward rate 12/31/2021 48.54
Forward rate 12/15/2021 48.48
Incr. in forward rate 0.06
X:FC units 20,000
Gain on forward contract 1,200
12/31/21 Foreign Currency receivable 1,200
Gain on forward contract 1,200
Cash-foreign currency 972,000
Foreign currency receivable 972,000
ETB- Payable 969,600
12/31/21 Cash 969,600
69
12/15/20221No entry
12/31/21 Loss for firm
commitment
1,200
firm commitment 1,200
Purchase(20000X
48.60)
972,000
Cash-foreign
currency
972,000
Firm
Commitment
2,4000
Purchase 2,400
Reference
References:
1.HOYLE Advanced Accounting 10ed
2.YouTube: https://www.youtube.com/watch?v=s93Nc81Rc5c&t=682s
https://www.youtube.com/watch?v=McschhMMS3E&t=521s
70
References:
1.HOYLE Advanced Accounting 10ed
2.YouTube: https://www.youtube.com/watch?v=s93Nc81Rc5c&t=682s
https://www.youtube.com/watch?v=McschhMMS3E&t=521s
70
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71
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