Chapter Nine
Foreign
Currency
Transactions and
Hedging Foreign
Exchange Risk
McGraw-Hill/Irwin
LO 1
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Foreign Exchange Rates
Ø An Exchange Rate is the cost of one currency in
terms of another.
Ø Rates published daily in the Wall Street Journal
are as of 4:00pm Eastern time on the day prior to
publication.
Ø Rates change constantly!
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Foreign Exchange Rates
Spot Rate
Ø The exchange rate that is available today.
Forward Rate
Ø The exchange rate that can be locked in
today for an expected future exchange
transaction.
Ø The actual spot rate at the future date may
differ from today’s forward rate.
9-3
Foreign Exchange Forward Contracts
A forward contract requires the purchase (or
sale) of currency units at a future date at the
contracted exchange rate.
This forward contract
allows us to purchase
1,000,000 ¥ at a price of
$.0080 US in 30 days.
But if the spot rate is
$.0069 US in 30 days,
we still have to pay
$.0080 US and we lose
$1,100!!
9-4
Foreign Exchange –
Option Contracts
An options contract gives the holder the option
of buying (or selling) currency units at a future
date at the contracted “strike” price.
An options contract
gives the holder the
option of buying (or
selling) currency
units at a future date
at the contracted
“strike” price.
That way, if the spot
rate is $.0069 in 30
days, we only lose
the $20 cost of the
option contract!
9-5
LO 2
Foreign Currency Transactions
ØA U.S. company buys or sells goods or
services to a party in another country.
This is often called foreign trade.
ØThe transaction is often denominated
in the currency of the foreign party.
ØHow do we account for the changes in
the value of the foreign currency?
9-6
Foreign Currency Transactions
GAAP requires a two-transaction
perspective.
(1)Account for the original sale in
US Dollars.
(2)Account for gains/losses from
exchange rate fluctuations.
9-7
Foreign Exchange Transaction Example
On 12/1/13, Amerco sells inventory to a German
corporation for 1 million euros on credit. Amerco
expects to be paid in euros in 90 days.
The current exchange rate is 1 € = $1.32.
Amerco would first record the sale:
Note that Amerco’s ledger is in US Dollars, but has a
separate account for receivables expected to be
collected in a foreign currency.
9-8
Foreign Exchange Transaction Example
On 12/31/13, the exchange rate is $1 = 1.33 €.
At the balance sheet date we have to remeasure the
original A/R to the current exchange rate.
When we increase A/R to the new value in
US Dollars, we recognize a gain from foreign
currency exchange.
9-9
Foreign Exchange Transaction Example
On 3/1/14, Amerco is paid the 1 million euros.
The exchange rate on 3/1/14, was $1 = 1.30 €.
Amerco records this transaction in two steps.
First, Amerco remeasures the A/R balance at the
current exchange rate. Then, they can record the
collection of cash and clear the A/R balance.
9-10
Chapter 9—Foreign Currency
Transactions
Problems 9-24, 9-25
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
9-11
Problem 9-24
¡ On December 20, 2015, Butanta Company (a U.S. company
headquartered in Miami, Florida) sold parts to a foreign
customer at a price of 50,000 ostras. Payment is received on
January 10, 2016. Currency exchange rates for 1 ostra are
as follows:
Chart 924
a) How does the fluctuation in exchange rates affect
Butanta's 2015 income statement?
b) How does the fluctuation in exchange rates affect
Butanta's 2016 income statement?
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
9-12
P9-24 - Journal Entry – Day of
Sale
! “On$December$20,$2015,$Butanta Company$(a$U.S.$company$headquartered$in$Miami,$Florida)$sold$
parts$to$a$foreign$customer$at$a$price$of$50,000$ostras.”
Chart 9-24
! 12/20/2015&''' 50,000&x&1.05&=&52,500
Accounts Receivable (ostras)
Sales
12/20/2015
McGraw-Hill/Irwin
52,500
52,500
Accounts Receivable
52,500
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
9-13
P9-24 - Journal Entry – Balance
Sheet Date
• “On December 20, 2015, Butanta Company (a U.S. company
headquartered in Miami, Florida) sold parts to a foreign
customer at a price of 50,000 ostras.”
Chart 9-24
• 12/31/2015 --- 50,000 x 1.02 = 51,000
Foreign Exchange Loss
Accounts Receivable (ostras)
Accounts Receivable
12/20/2015 52,500
?
12/31/2015
51,000
McGraw-Hill/Irwin
1,500
12/20/2015
1,500
Accounts Receivable
52,500
1,500
12/31/2015
51,000
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
9-14
P9-24 - Journal Entry –
Collection Date
¡
“On December 20, 2015, Butanta Company (a U.S. company headquartered in Miami,
Florida) sold parts to a foreign customer at a price of 50,000 ostras … Payment is
received on January 10, 2016.”
Chart 9-24
¡
1/10/2016 --- 50,000 x 0.98 = 49,000
Foreign Exchange Loss
Accounts Receivable (ostras)
Cash
Accounts Receivable (ostras)
2,000
2,000
49,000
49,000
Accounts Receivable
Accounts Receivable
12/31/2015
12/31/2015
51,000
51,000
2,000
?
1/10/2016
1/10/2016
49,000
49,000
McGraw-Hill/Irwin
9-15
P9-24 – Solution Summary
12/20/2015 - Day of Sale
Accounts Receivable
(ostras)
Sales
Accounts Receivable
12/20/2015
1,500
52,500
52,500
1,500
1/10/16 Settlement Date (Collection)
Foreign Exchange Loss
2,000
Accounts Receivable (ostras)
2,000
Cash
49,000
Accounts Receivable (ostras)
12/31/2015
51,000
2,000
12/31/15 Balance Sheet Date
Foreign Exchange Loss
1,500
Accounts Receivable (ostras)
McGraw-Hill/Irwin
52,500
1/10/2016
49,000
49,000
How does the fluctuation in exchange rates
affect (a) Butanta's 2015 and (b) 2016 income
statements?
•
(a) The ostra receivable decreases in dollar
value from (50,000 × $1.05) $52,500 at
December 20 to $51,000 (50,000 × $1.02) at
December 31, resulting in a foreign
exchange loss of $1,500 in 2015.
•
(b) The further decrease in dollar value of
the ostra receivable from $51,000 at
December 31 to $49,000 (50,000 × $.98) at
January 10 results in an additional $2,000
foreign exchange loss in 2016.
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
9-16