international accounting Chap 006
Transcript of international accounting Chap 006
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McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc !ll
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Chapter 6
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6-2
Foreign Currency Transactions and
Hedging Foreign Exchange Risk
Chapter Topics Foreign exchange markets
Foreign exchange risk Accounting for foreign currency transactions Hedging Foreign currency forward contracts and options Accounting for hedges
Cash flow hedges and fair value hedges
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Learning Objectives1. Provide an overview of the foreign exchange market.2. Explain how fluctuations in exchange rates give rise to foreign
exchange risk.3. emonstrate the accounting for foreign currency transactions.4. escri!e how foreign currency forward contracts and foreign
currency options can !e used to hedge foreign exchange risk.
Foreign Currency Transactions and
Hedging Foreign Exchange Risk
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Learning Objectives5. escri!e the concepts of cash flow hedges" fair value hedges" and
hedge accounting.6. emonstrate the accounting for forward contracts and options
used as cash flow hedges and fair value hedges to hedge foreigncurrency assets and lia!ilities" foreign currency firm commitments"and forecasted foreign currency transactions.
Foreign Currency Transactions and
Hedging Foreign Exchange Risk
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#earning $!%ective &
Foreign Exchange Markets
Foreign exchange rate Purchase price of a foreign currency'' e.g." in ecem!er ())* it
cost a!out ).)+ ,.-. dollars nine cents/ to purchase one 0exicanpeso.
From &+12 to &+*3 countries had exchange rates fixed to the ,.-.dollar.
,.-. dollar was fixed to gold at 432 per ounce. 5alance'of'payments deficits in the ,.-. during the &+6)s doomed
this system" so" !y 0arch &+*3 most currencies were allowed tofloat in value.
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Exchange Rate echanis!s Independent float7 currency value allowed to move freely with
little government intervention. Pegged to another currency7 currency value fixed pegged/ in
terms of a particular foreign currency e.g." ,.-. dollar/" andcentral !ank intervenes to maintain the exchange rate.
European Monetary System (Euro7 twelve countries use a
single currency" which floats against other currencies such as the,.-. dollar.
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Foreign Exchange Markets
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Foreign Exchange Rates Exchange rates" to the ,.-. dollar" are pu!lished in many places on the
internet and in newspapers. Exchange rates are reflected !oth as ,-4 e8uivalent direct 8uotes/
and currency per ,-4 indirect 8uotes/. For example" on Fe!ruary &2" ())9 the direct 8uote for a Euro was
4&.12+2 and the indirect 8uote was 4).692(. As a point of comparison"the direct 8uote when the Euro first appeared in &++9 was
approximately 4&.&* and the indirect 8uote was approximately 4).92. A direct 8uote is the reciprocal of an indirect 8uote and vice'versa.
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Foreign Exchange Markets
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"pot rates an# For$ar# rates Spot rate7 today:s price for purchasing or selling a foreign
currency. #or$ard rate7 today:s price for purchasing or selling a foreign
currency for some future date. Prem%um'' when the forward rate is greater than the spot rate for
a particular day.
&%scount'' when the forward rate is less than the spot rate for aparticular day.
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Foreign Exchange Markets
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Option contracts
#ore%gn currency opt%on7 gives the right" !ut not the o!ligation" totrade foreign currency for some period.Put opt%on7 the option to sell the foreign currency.Call opt%on7 the option to !uy the foreign currency.Str%e pr%ce7 the exchange rate at which currency will !e
exchanged when option is exercised.
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Foreign Exchange Markets
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Option contracts +pt%on prem%um7 cost of purchasing the option" which is a
function of the option:s intrinsic value and time value. Intr%ns%c ,alue7 is the gain that could !e made !y immediate
exercise of the option. %me ,alue7 the value that derives from the fact that the currency
value could increase during the remainder of the option period.
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Foreign Exchange Markets
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Exchange Rates and ForeignExchange Risk
Ter!ino%og& E.port sale7 a company sells to a foreign customer and later
receives payment in the customer:s currency. Import purchase7 a company purchases from a foreign supplier
and later pays in the supplier:s currency. #ore%gn e.change r%s7 the chance that the exporter will receive
less or that the importer will pay more than anticipated as a result
of a change in the exchange rate.
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Exa!p%e ;oe 4).&)/.
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Exchange Rates and Foreign
Exchange Risk
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;oe has foreign exchange risk exposure !ecause he may receiveless than 4&))"))).
-uppose the peso decreases such that in 3) days the exchangerate is 4).)+ per & peso.
;oe will receive &")))"))) pesos which will !e worth 4+)")))&")))"))) x 4).)+/ and ;oe receives 4&)"))) less due toexchange rate fluctuation.
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Exchange Rates and Foreign
Exchange Risk
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Accounting for ForeignCurrency Transactions
'cco(nting ) sa%e transaction
+ne transact%on perspect%,e =reats sale and collection as one transaction =ransaction is complete when foreign currency is received and
converted" and sale is measured at converted amount. =his approach is not allowed under
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$o transact%on perspect%,e =reats sale and collection as two transactions
-ale is one transaction and collection is a second transaction. -ale is !ased on current exchange rate.
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Transaction t&pes* expos(re t&pe an# gain or %oss )export sa%es
Export saleasset exposure''if foreign currency appreciates foreign exchange gain.
Export saleasset exposure''if foreign currency depreciates foreign exchange loss.
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Accounting for Foreign
Currency Transactions
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Transaction t&pes* expos(re t&pe an# gain or %oss )i!port p(rchases
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Export sa%e ) exa!p%e 1 Fe!ruary &" ())9" ;oe
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Export sa%e ) exa!p%e 1;oe"
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Export sa%e ) exa!p%e 1$n 0arch (" ())9" the spot rate is 4).)+ per peso.
;oe
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Export sa%e ) exa!p%e 2
/ssume the follo$%ng facts are added or changed0 ;oe
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Export sa%e ) exa!p%e 2;oe"
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Export sa%e ) exa!p%e 2;oe"
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Hedging Foreign Exchange Risk
1edg%ng'' protecting against losses from exchange ratefluctuations. Companies often use foreign currency forward
contracts and foreign currency options. #ore%gn currency for$ard contract7 an agreement to !uy or
sell foreign currency at a future date. #ore%gn currency opt%on7 the right to !uy or sell foreign
currency for a period of time.
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Hedging Foreign Exchange Risk
+e#ging ris, on an export sa%e ) exa!p%e 1 Previously" ;oe
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Hedging Foreign Exchange Risk
+e#ging ris, on an export sa%e ) exa!p%e 1 ,nder the contract" ;oe would have agreed to sell &")))")))
pesos for 4).&)2 on 0arch (" ())9.
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Hedging Foreign Exchange Risk
+e#ging ris, on an export sa%e ) exa!p%e 2 Previously" ;oe
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Hedging Foreign Exchange Risk
+e#ging ris, on an export sa%e ) exa!p%e 2 ;oe would now have the option sell &")))"))) pesos for 4).&& on
0arch (" ())9.
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Cash Flow Hedges, Fair ValueHedges, and Hedge Accounting
1edge account%ng7 an offsetting gain or loss from the hedge isrecogniBed in net income during the same period as the gain or
loss from the hedged item. Cash flo$ hedge7 an accounting designation for hedges that
offset varia!ility in cash flows of hedged items. #a%r ,alue hedge7 an accounting designation for hedges that
offset the varia!ility in fair value of hedged assets and lia!ilities.
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Hedge Accounting
+e#ge acco(nting exa!p%es&. FC asset>forward contract>cash flow hedge
(. FC asset>forward contract>fair value hedge3. FC asset>option>cash flow hedge1. FC firm commitment>forward contract>fair value hedge2. FC firm commitment>option>fair value hedge6. Forecasted FC transaction>option>cash flow hedge
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Hedge Accounting
'ss(!ptions -or exa!p%es 1 an# 2 ecem!er &" ())*" ;oe
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Hedge Accounting
;oe enters a foreign currency forward contract on ecem!er &"())*.
=he contract calls for ;oe to sell &")))"))) pesos at a forward rateof 4).&)2" on 0arch (" ())9.
=he forward rate on ecem!er 3&" ())* for 0arch (" ())9delivery is 4).)+6.
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Hedge Accounting
Exa!p%e 1* FC asset-or$ar#cash -%o$ he#ge
&(>)&>)*Accounts receiva!le &&)")))
-ales &&)")))
&(>3&>)*Foreign exchange loss &)")))
Accounts receiva!le &)")))
Accumulated $ther Comprehensive
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Hedge Accounting
Exa!p%e 1* FC asset-or$ar#cash -%o$ he#ge
&(>3&>)*Forward contract 9"+&&Accumulated $ther Comprehensive
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Hedge Accounting
Exa!p%e 1* FC asset-or$ar#cash -%o$ he#ge
3>)(>)9Foreign exchange loss 2")))Accounts receiva!le 2")))
Accumulated $ther Comprehensive
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Hedge Accounting
Exa!p%e 1* FC asset-or$ar#cash -%o$ he#ge
3>)(>)9iscount expense 3"333 Accumulated $ther Comprehensive
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Hedge Accounting
Exa!p%e 2* FC asset-or$ar#-air va%(e he#ge
&(>)&>)*Accounts receiva!le &&)")))-ales &&)")))
&(>3&>)*Foreign exchange loss &)")))
Accounts receiva!le &)")))
Forward contract 9"+&&?ain on forward contract 9"+&&
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Hedge Accounting
Exa!p%e 2* FC asset-or$ar#-air va%(e he#ge
3>)(>)9Foreign exchange loss 2")))
Accounts receiva!le 2")))
Forward contract &")9+?ain on forward contract &")9+
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Hedge Accounting
Exa!p%e 2* FC asset-or$ar#-air va%(e he#ge
3>)(>)9Foreign currency +2")))Accounts receiva!le +2")))
Cash &)2")))Foreign currency +2")))Forward contract &)")))
# i $!% ti 6