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Foreign Transactions and
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles
(We recommend this as work of authority.)
transactions are undertaken abroad, accounting for these transactions
by a U.S. company is done in U.S. dollars - the unit of measurement in
the United States. The accountant
normally becomes involved in foreign transactions and operations in one
of two ways:
currency transactions - transactions that require settlement in a
foreign currency, including buying and selling, borrowing or lending,
of financial statements of a foreign subsidiary or branch office whose
statements are denominated in foreign currency.
currency transactions are accounted for as follows according FASB No.
payable, revenues, and expenses are translated and recorded in dollars
at the spot rate existing on the transaction date.
An exchange rate that indicates the price of foreign currencies
on a particular date for immediate delivery is called a spot rate.
the balance-sheet date, receivables and payable are adjusted to the
gains and losses resulting from changes in the spot rate from one
point in time to another are usually recognized in the current period's
required for forward exchange contracts depends upon management's intent
when entering into the contract.
A summary of accounting for forward exchange contracts is shown
of forward contract
|Accounting for exchange
gain or loss
|Accounting for forward
contract premium or discount
Hedge of an exposed
no net exchange gain or loss
against operating income over term of contract
Hedge of an identifiable
to transaction date; then adjustment of dollar basis of
be deferred to transaction date as with exchange gain or loss
currently in income statement
separate accounting recognition
principles for purposes of consolidation, combination, or reporting on
the equity method for foreign operations (branches, subsidiaries) can
be summarized in broad terms as follows:
currency financial statements must be in conformity with generally
accepted accounting principles before they are translated.
FUNCTIONAL CURRENCY of an entity is the currency of the primary economic
environment in which the foreign entity operates.
The functional currency may be the currency of the country
in which the foreign entity is located, the U.S. dollar, or the currency
of another foreign country. If the foreign entity's operations are self-contained and integrated
in a particular country and are not dependent on the economic environment
of the parent company, the functional currency is the foreign currency.
The functional currency of a foreign company would be the U.S.
dollar if the foreign operation is an integral component or extension
of the parent company's operations.
The daily operations and cash flows of the foreign operation
of the foreign entity are dependent on the economic environment of
the parent company.
the functional currency is the local currency of the foreign entity,
the current rate method is used to translate foreign currency financial
statements into U.S. dollars.
All assets and liabilities are translated by using the current
exchange rate at the balance sheet dates.
This method provides that all financial relationship remain
the same in both local currency and U.S. dollars.
Owners' equity is translated by using historical rates; revenues
and gains and expenses and losses are translated at the rates in existence
during the period when the transactions occurred.
The translation adjustment which result from the application
of these rules are reported as a separate component in owners' equity
of the U.S. company's consolidated balance sheet (or parent-only balance
sheet if consolidation was not deemed appropriate.)
the functional currency is the reporting currency (the U.S. dollar),
the foreign currency financial statements are re-measured into U.S.
dollars using the temporal method.
All foreign currency balances are restated to U.S. dollars
using both historical and current exchange rates.
Foreign currency balances which show prices from past transactions
are translated by using historical rates; foreign currency balances
which show prices from current transactions are translated by using
the current exchange rate. Translation
gains or losses that result from the re-measurement process are reported
on the U.S. company's consolidated income statement.
of the current rate method maintain that the use of this method will reflect
most clearly the true economic facts since presenting all revenue and
expense items at current rates reflects the actual earnings (those that
can be remitted to the home country) of a foreign operation at that time.
Also, stating all items at the current rate retains the operating
relationships after the translating intact with those that existed before
the translation. Critics
of the current rate method claim that since fixed assets are translated
at the current rate and not at the rate that existed when they were acquired,
the translated amounts do not represent historical costs and are not consistent
with generally accepted accounting principles.
the temporal method states monetary assets at the current rate, proponents
of this method claim that this reflects the foreign currency's ability
to obtain U.S. dollars. Since
historical rates are used for long-term assets and liabilities, the historical
cost principle is maintained. However,
the use of the temporal method distorts financial statement relationships
that exist before and after re-measurement.
appended exhibits illustrate the temporal method and the current rate
method. The temporal method
illustration assumes that the functional currency of a Canadian subsidiary
is the U.S. dollar. The current
rate method assumes that the functional currency of the Canadian subsidiary
is the Canadian dollar. The
Canadian subsidiary was established at the beginning of the year.
The current rate of exchange is $.80; the historical rate used
for the building and common stock is $.90; the average rate for the year
is $.85. The computation of the exchange loss for the year is shown
in an accompanying schedule. The
temporal method's $10,406 exchange loss occurred because the subsidiary
held net monetary assets denominated in Canadian dollars when the Canadian
dollar decreased in value relative to the U.S. dollar. The current rate method's translation adjustment for the year
which results from the impact of rate changes on the net monetary position
during the year is also shown in a separate schedule.
exposure to exchange translation losses is not usually the same as the
economic exposure to exchange losses.
Economic exposure is due to many factors including rates of inflation,
regulation, interest rate changes, and other factors.
Translation exposure is related to what accounts have to be translated
at current exchange rates. A
company's exposed position represent the net balance of all accounts translated
at current exchange rates. Accounts
translated at historical rates are not exposed to translation adjustments
because the same conversion rate is used each year.
The net translation exposure position of a firm can be explained
contributing to exposure:
assets (not including prepaid expenses).
denominated in fixed amounts of local currency (German marks; English
receivables (net of allowances).
dollar assets included in a, b, and c above.
algebraic sum of the items listed represents the company's net exposure
to risk of loss (or exposure to gain) through exchange fluctuations. An exposed position can usually be managed by controlling the
company's position in listed securities and by the use of forward exchange
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