I Introduction A Overview Transactions can occur in

I. Introduction A. Overview Transactions can occur in a variety of ways as follows: US Transaction $$ (US <---> US) Foreign Transaction $$ (US <---> Foreign) Foreign Operation of U. S. Company $$ US <---- (Foreign <---> Foreign) Foreign Financial Statement FC (Foreign <---> Foreign)

I. Introduction (cont. ) B. Accounting for transactions denominated in a foreign currency C. Accounting foreign operations D. Overview of International Accounting Standards Committee Pronouncements E. Overview of Accounting Standards in Foreign Countries F. The Future of International Accounting Standards

II. Accounting for Transactions Denominated in a Foreign Currency A. Exposed Foreign Asset or Liability The collection of a receivable or payment of a liability is a separate event from the related sale or purchase. At the transaction date, all elements of the transaction are translated into dollars and recorded using the current exchange rate. At subsequent balance sheet dates, and at settlement date, any unsettled receivables or payables are adjusted to reflect the current rate. The resulting gain or loss is an element of current income.

EXAMPLE 1 On October 15, 20 X 1, U. S. Company purchases 10, 000 wrenches from a Foreign Company at a price of 8 FCs each. Payments is denominated in FCs and is to be made on March 15, 20 X 2. Exchange rates are as follows: October 15, 20 X 1 $1 = 5 FCS 1 FC = $. 20 December 31, 20 X 1$1 = 3 FCS 1 FC = $. 333 March 15, 20 X 2 $1 = 4 FCS 1 FC = $. 25

EXAMPLE 1 SOLUTION - October 15, 20 X 2 Inventory 8 FC X 10, 000 X $. 20 = $16, 000 Accounts Payable $16, 000 SOLUTION - December 31, 20 X 2 Accounts Payable 8 FC X 10, 000 X $. 333 = $26, 667 Exchange Loss $26, 667 - $16, 000 = $10, 667 SOLUTION - March 15, 20 X 2 Amount Paid 8 FC X 10, 000 X $. 25 = $20, 000 Exchange Gain $26, 667 - $20, 000 = $ 6, 667

II. Accounting for Transactions Denominated in a Foreign Currency (cont. ) B. Hedged Foreign Asset or Liability When an existing net asset position (where receivables denominated in a foreign currency exceed the payables) or net liability position (where payables exceed receivables) is hedged, offsetting receivables and payables are created. The resulting gains and losses that are incurred cancel out.

EXAMPLE 2 U. S. Company buys inventory with a cost of 2, 500 FCs from Foreign Company on December 1, 20 X 2 payable on April 1, 20 X 3. Also on December 1, 20 X 2 U. S. Company bought a forward exchange contract to buy 2, 500 FCs at $2. 02. Spot exchange rates are as follows: December 1, 20 X 2 December 31, 20 X 2 April 1, 20 X 3 1 FC = $2. 00 1 FC = $2. 04 1 FC = $2. 10 $1 =. 50 FC $1 =. 49 FC $1 =. 486 FC

EXAMPLE 2 SOLUTION - December 1, 20 X 2 Inventory 2, 500 FC X $2. 00 = Accounts Payable FC Receivable 2, 500 FC X $2. 00 = Deferred Premium 2, 500 FC X. 02 = Due to Exchange Broker $5, 000 $ 50 $5, 050 SOLUTION - December 31, 20 X 2 Exchange Loss 2, 500 X (2. 04 - 2. 00) Accounts Payable 2, 500 FC X $2. 04 Exchange Gain 2, 500 X (2. 04 - 2. 00) Accounts Receivable 2, 500 FC X $2. 04 Forward Contract Expense $50 X 1/4 = $ 100 = $5, 100 = $ 12. 50

EXAMPLE 2 SOLUTION - April 1, 20 X 2 Exchange Loss 2, 500 X (2. 10 - 2. 04) Amount Paid 2, 500 FC X $2. 10 Exchange Gain 2, 500 X (2. 10 - 2. 04) Amount Received 2, 500 FC X $2. 10 Forward Contract Expense $50 X 3/4 = = = $ 150 $5, 250 $ 37. 50

II. Accounting for Transactions Denominated in a Foreign Currency (cont. ) C. Exposed Foreign Currency Commitment There is no transaction or accounting event until the product is delivered. When the product is delivered, the spot rate in effect at that date is used as the recorded cost of the asset. D. Hedged commitment Since a foreign currency commitment is not recorded until the product is delivered, the gain or loss on the forward exchange contract is deferred and closed to the cost of the product purchased.

EXAMPLE - 3 On October 10, 20 X 3, U. S. Company agrees to buy equipment from Foreign Company for 160, 000 FCs. The equipment is scheduled for delivery on February 15, 20 X 4 and payment is due on that date. On October 10, 20 X 3, U. S. Company enters into a forward exchange contract to purchase 160, 000 FCs at $1. 02 for delivery on February 15, 20 X 4. Spot exchange rates are as follows: October 10, 20 X 3 December 31, 20 X 3 February 15, 20 X 4 1 FC = $1. 00 1 FC = $1. 06 1 FC = $1. 10 $1 = 1. 00 FC $1 =. 94 FC $1 =. 91 FC

EXAMPLE - 3 SOLUTION - October 10, 20 X 3 FC Receivable 160, 000 FC X $1. 00 Deferred Premium 160, 000 FC X. 02 Due to Exchange Broker = = SOLUTION - December 31, 20 X 2 Def Exchange Gain 160, 000 X (1. 06 - 1. 00) = FC Receivable 160, 000 FC X $1. 06 = Deferred Premium 160, 000 FC X. 02 = Due to Exchange Broker $160, 000 $ 3, 200 $163, 200 $ 9, 600 $169, 600 $ 3, 200 $163, 200

EXAMPLE - 3 SOLUTION - February 15, 20 X 3 Def Exchange Gain 160, 000 X (1. 10 - 1. 06) = FC Receivable 160, 000 FC X $1. 10 = FC Received = FC Paid 160, 000 FC X $1. 10 = Equipment 160, 000 + 3, 200 = $ 6, 400 $176, 000 $163, 200

III. Accounting for Foreign Operations A. Financial Statements of Foreign Operation must conform to U. S. Generally Accepted Accounting Principles 1. Equity method investments 2. Consolidated financial statements

III. Accounting for Foreign Operations (cont. ) B. Determining the "Functional Currency" of the Foreign Operation The functional currency of an investee company is the currency in which it primarily generates and expends cash. If an entity's operations are self-contained and integrated within a particular country, the functional currency will be the currency of that country. If the entity is an integral component of the parent company, the functional currency would be that of the parent. If the foreign functional currency's cumulative three-year exchange rate is 100% or more, the currency is considered too unstable and its functional currency would be that of the parent.

III. Accounting for Foreign Operations (cont. ) C. Translation versus Remeasurement The approach to converting financial statement amounts denominated in foreign currencies depends upon the defined functional currency.

III. Accounting for Foreign Operations (cont. ) 1. Translation If the functional currency is the local currency, the financial statement amounts are "translated. " Translation produces a balance sheet that is the foreign balance sheet amounts converted to the parent's currency using the spot rate in effect at the balance sheet date. It produces an income statement that is the foreign income statement amounts converted to the parent's currency using the spot rate in effect at the transaction date. This is consistent with the idea that the foreign operation is a separate operation operating in the foreign country.

1. Translation Assets and Liabilities Revenues and Expenses Paid-in-Capital Current Rate Average Current Rate Historical Rate Gains and Losses - Separate Section of Owners' Equity

III. Accounting for Foreign Operations (cont. ) 2. Remeasurement If the functional currency is not the local currency, the financial statement amounts are "remeasured. " Remeasurement produces results similar to the translation of foreign transactions discussed previously. This is consistent with the idea that the foreign operation is merely an arm of the parent company conducting parent company transactions in the foreign country.

2. Remeasurement Monetary Assets and Liabilities Non-Monetary Assets and Liabilities Most Revenues and Expenses Current Rate Historical Rate Average Current Rate Cost of Goods Sold and Depreciation Paid-in-Capital Historical Rate Gains and Losses Income Statement