International Accounting, 6/e

Frederick D.S. Choi

Chapter 6: Foreign Currency

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Learning Objectives
 Why do firms translate from one currency to another?
 What is the difference between a spot, forward, and swap
transaction?
 What exchange rates are used in the currency translation
process and what are their financial statement effects?
 How does a translation gain or loss differ from a transactions
gain or loss?
 Is there more than one way of translating financial statements
from one currency to another? If so, what are they?
 How does the temporal method of currency translation differ from
the current rate method?
 What is the relationship between currency translation and
inflation?

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Why do Firms Translate?
 Facilitates the preparation of consolidated financial
statements that allow readers to see the performance
of a multinational company’s total operations both
domestic and foreign.
 Facilitates the measurement of a firm’s exposure to
foreign exchange risk.
 Facilitates the recording of foreign currency
transactions; i.e., foreign currency sales, purchases,
borrowing or lending in the consolidated entity’s
reporting currency.
 Facilitates reporting domestic accounts to foreign
audiences-of-interest.

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Types of Transaction Rates
 Spot transactions: the physical exchange of one currency for
another in which delivery takes place immediately.
 Direct quote: the exchange rate specifies the number of
domestic currency units needed to acquire a unit of foreign
currency.
 Indirect quote: the exchange rate specifies the price of a unit of
the domestic currency in terms of the foreign currency.
 Forward transaction: agreements to exchange a specified
amount of one currency for another at a future date.
 Swap transaction: involves the simultaneous spot purchase and
forward sale, or spot sale and forward purchase of a currency.

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Accounting for Spot
Transactions
 Spot transaction: occurs when an enterprise purchases or sells
goods for which payment is made in a foreign currency, or when it
borrows or lends foreign currency.
 At the transaction date, each asset, liability, revenue, and expense
denominated in a foreign currency is measured and recorded in the
functional currency of the reporting entity at the spot exchange rate
in effect on that date.
 Functional currency is the primary currency in which the
reporting entity transacts business and generates and
spends cash; e.g., dollars in the case of a U.S. reporting
entity.
 At each balance sheet date, recorded balances denominated
in a currency other than the functional currency of the
reporting entity is adjusted to reflect the current exchange
rate.

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Accounting for Spot
Transactions (contin)
 A foreign exchange gain or loss is recorded whenever
the exchange rate changes between the original
transaction date and the settlement date, or between the
original transaction date and the financial statement date
should financial statements be prepared prior to
settlement.
 Example: On September 1, a calendar year U.S.
manufacturer sells, on 90-day credit, goods to a Swedish
importer for SEK 1,000,000. The dollar/krona exchange
rate is $0.14 = SEK1 on September 1, $0.13 = SEK 1 on
September 30, and $0.11 = SEK 1 on December 1.

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Types of Translation Rates
and their Statement Effects
 Historical rate: the exchange rate prevailing when a foreign
currency asset was first acquired or a foreign currency liability
first incurred.
 Preserves the original cost equivalent of a foreign currency item
in the reporting currency.
 Use of historical rates do not give rise to translation gains or
losses, which are increases or decreases in the reporting
currency equivalent of the foreign currency.
 Current rate: the exchange rate prevailing as of the financial
statement date.
 Changes the reporting currency equivalent of a foreign currency
item whenever exchange rates change.
 Use of the current rate gives rise to translation gains and losses.
 Average rate: a simple or weighted average of either
historical or current exchange rates.
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Translation vs. Transaction
Gains or Losses
 Translation gains or losses: result from a
restatement process.
 Transactions gains or losses: result from the
physical exchange of one currency for another.
 Gain or loss on a settled transaction: arises whenever
the exchange rate used to book the original transaction
differs from the exchange rate used at settlement.
 Gain or loss on an unsettled transaction: arises
whenever consolidated financial statements are prepared
before settlement and the current rate has changed since
the transaction date.
 Is similar to a translation gain or loss as it results from a
restatement process.

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Types of Translation Methods
 Single rate method: applies a single
exchange rate, the current rate, to all foreign
currency assets and liabilities.
 Multiple rate methods: Use some
combination or current and historical rates to
translate foreign currency balances.

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Current-Noncurrent Method
 Current assets and current liabilities translated at
the current rate.
 Noncurrent assets and liabilities translated at the
historical rate.
 Revenues and expenses (excluding depreciation
and amortization) translated at average rates.
 Depreciation and amortization charges at historical
rates in effect when related assets are acquired.

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Monetary-Nonmonetary
Method
 Monetary assets and liabilities translated at current
rates.
 Nonmonetary assets and liabilities translated at
historical rates.
 Revenues and expenses, excluding depreciation,
amortization and cost of sales, at average rates.
 Depreciation, amortization charges, and cost of
sales at historical rates in effect when related assets
are acquired.
 See Exhibits 6-8 and 6-9.

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Temporal Method
 Monetary assets and liabilities translated at the current rate.
 Nonmonetary items translated at rates that preserve their original
measurement bases.
 Foreign currency balances at historical cost are translated at
historical rates.
 Foreign currency balances at current cost or market value are
translated at the current rate.
 Revenues and expenses, including cost of sales if inventories
are carried at market, at average rates.
 Depreciation, amortization charges, and cost of sales when
inventories are carried at cost, at historical rates in effect when
related assets are acquired.
 See Exhibits 6-8 and 6-9.

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Current (Single) Rate Method
 All foreign assets and liabilities translated at
the current rate.
 All revenues and expenses are translated by
an appropriately weighted average of current
exchange rates for the period.
 See Exhibits 6-8 and 6-9.

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Features of FASB 52 and IAS
21
 Objectives
 Reflect in consolidated statements the financial results and
relationships measured in the primary currency in which
each consolidated entity does business.
 Provide information compatible with the expected
economic effects of an exchange rate change on an
entity’s cash flows and equity.
 Objectives based on the notion of a
functional currency defined earlier.
 Functional currency can be the parent currency.
 Functional currency can be the local currency.
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Features of FASB 52 and IAS
21 (contin)
 Translation when the parent currency is functional.
 Foreign currency financial statements remeasured to
reporting currency using the temporal method.
 Translation gains and losses resulting from the translation
process are included in current income.
 Translation when the local currency is functional.
 Foreign currency financial statements translated to
reporting currency using the current rate method.
 Translation gains and losses disclosed as a separate
component of consolidated equity.

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Relationship Between Foreign
Currency Translation and Inflation
 The external value of a country’s currency is
inversely related to its rate of inflation.
 IAS 21 permits restatement for local inflation prior to
currency translation.
 FAS 52 requires use of the parent currency as the
functional currency for foreign operations located in
hyperinflationary environments (i.e., countries where
the cumulative rate of inflation exceeds 100% over a
three-year period).

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Other Chapter Exhibits

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Other Chapter Exhibits (contin)

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Other Chapter Exhibits (contin)

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Other Chapter Exhibits (contin)

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Other Chapter Exhibits (contin)

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Other Chapter Exhibits (contin)

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Other Chapter Exhibits (contin)

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