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Lesson 11 - Forex and Derivatives

The document outlines the principles of foreign currency transactions, translation, and exchange rates, detailing how financial statements are affected by these transactions. It distinguishes between accounting and operating exposures, as well as transaction and translation exposures, and explains how to record and report gains or losses from foreign currency transactions. Additionally, it provides examples of journal entries for importing and exporting transactions and discusses the impact of exchange rate fluctuations on financial reporting.

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5 views

Lesson 11 - Forex and Derivatives

The document outlines the principles of foreign currency transactions, translation, and exchange rates, detailing how financial statements are affected by these transactions. It distinguishes between accounting and operating exposures, as well as transaction and translation exposures, and explains how to record and report gains or losses from foreign currency transactions. Additionally, it provides examples of journal entries for importing and exporting transactions and discusses the impact of exchange rate fluctuations on financial reporting.

Uploaded by

ellenpanganiban6498
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Foreign Currency and

Derivatives
Foreign Currency Transactions
• Foreign Currency Transactions – transactions to be
settled in a foreign currency; financial statements of an
affiliate maintained in a foreign currency are translated
into pesos by multiplying the number of units of the
foreign currency by a direct exchange rate
• Foreign Currency Translation – process of expressing
monetary amounts that are stated in terms in a foreign
currency into the currency of the reporting entity by
using an appropriate exchange rate
• Foreign Exchange Rate may be expressed as:

1. Direct quotation – exchange rate is quoted in terms of


how many units of domestic currency can be
converted into one unit of foreign currency (i.e.,
P50/$1)
2. Indirect quotation – exchange rate often stated in
terms of converting one unit of domestic currency into
units of a foreign currency (i.e., P1 = $0.2 ($1/P50)
Exchange Rate
• Spot Rate – immediate, rate in which currencies can be exchanged
today
• Forward Rate – rate in which currencies can be exchanged at some
future date

Spot rate may move above or below, this has no effect on


forward rate
Forward Exchange Contract – contract to exchange at
specified rate (forward rate) currencies of different
countries on a specified future date
Foreign Exchange trader provides a quotation for buying
(bid rate) and a quotation for selling (offer rate)
• Transactions are normally measured and recorded in terms of the
currency in which the reporting entity prepare its financial
statements.
• A transaction may be:
1. Between 2 local firms requiring payment of a fixed number of local
currency is both measured and denominated in pesos – no foreign
currency gain or loss
2. Between a local firm and foreign company, negotiate whether:
 In local currency(no foreign currency gain or loss)
 In domestic currency of foreign company (foreign currency gain or loss is recognized)
3. To be settled by the payment of a fixed amount of foreign currency – local
firm measures receivable or payable in local currency, transaction is
denominated in foreign currency (foreign currency gain or loss is
recognized)
Types of Foreign Exchange Rate
Exposure
1. Accounting Exposure is the exposure to changes in
exchange rates as a result of:
• Entering into foreign currency transactions that result to
contractual rights and obligations
• Translating foreign currency financial statements of foreign
operations from the local currency to the group’s reporting currency
Accounting exposure is quantifiable and directly
impacts the income statement or balance sheet
2. Operating Exposure is not easily quantifiable and reflects
impact of changes in real exchange rates on a firm’s
operations
Types of Accounting Exposure
1. Transaction Exposure
• Arises directly as the consequence of a business firm’s foreign
currency transactions
• Occur at one date settled at a late date
• Exchange gain or loss arises
• Affects cash flow of the company
2. Translation Exposure
• Arises from translation of foreign currency FSs of foreign
operations
• Translation gains or losses (translation differences) do no
affect cash flow
Functional Currency
• currency of the primary economic environment in which
the entity operates, currency that influences the sales
prices of goods or services
• Functional currency is determined by:
1. Currency that mainly influences the sales prices of goods
and services
2. Currency whose competitive forces and regulations
determine the sales prices of goods and services
3. Currency in which financing is obtained
4. Currency in which receipts are usually retained
• PAS 21 requires that a foreign currency transaction be
recorded (and measured) by applying to the foreign
currency using the spot exchange rate.

• Monetary Items
units of currency held and assets and liabilities to be received
or paid in fixed or determinable number of units of currency
balances are fixed in terms of local currency regardless of
changes in the general price level

• Non-Monetary Items
accounts whose local currency amounts are presented in FSs
differ from what they are actually realized or represents
Example are Investments in equity instruments
At balance sheet date:
• Foreign currency monetary items have to be adjusted (or
remeasured) for exchange rate changes using the current
rate/closing rate on balance sheet date, since these
accounts are carried at contractual amounts and settled or
received at a specific currency and should be adjusted for
changes
• Non-monetary items that are measured in terms of historical
cost in a foreign currency are translated using the exchange
rate on the date of the transaction (historical/actual rate)
• Non-monetary items that are measured at FV in a foreign
currency are translated using the exchange rate on the date
when the FV was determined, usually current/closing rate
Importing Transaction
• Transaction Date (TD)
Purchases xxx
Accounts Payable xxx
(Foreign Currency x Selling Spot Rate)
• Balance Sheet Date (BSD)
Foreign Currency Loss xxx
Accounts Payable xxx
(Foreign Currency x (changes in selling spot rate from transaction date
and balance sheet date))
• Settlement Date (SD)
Accounts Payable (sum of A/P from TD to BSD) xxx
Foreign Currency transaction gain xxx
Cash (foreign x selling spot rate on SD) xxx
(Foreign Currency x (changes in selling spot rate from BSD and SD)
Exporting Transaction
• Transaction Date (TD)
Accounts Receivable xxx
Sales xxx
(Foreign Currency x Buying Spot Rate on TD)
• Balance Sheet Date (BSD)
Accounts Receivable xxx
Foreign currency transaction gain xxx
(Foreign currency x (changes in buying spot rate bet. TD and BSD))
• Settlement Date (SD)
Cash (foreign currency x buying spot rates @ SD) XXX
Foreign Currency transaction loss XXX
Accounts Receivable (A/R from TD and BSD) XXX
Comparison of entries of importing transaction
with those of exporting transaction
• Movement in the exchange rate has an opposite effect
on company’s reported income
• Increase in exchange rate results in a transaction loss
on the exposed payable whereas there is a transaction
gain in the exposed receivable
• Decrease in the exchange rate results in a transaction
gain on the exposed payable whereas there is a
transaction loss in the exposed receivable
How should a transaction gain or
loss be reported?
• Peso amount recorded in the Sales accounts and
Purchases account was determined by the exchange
rate prevailing at TD
• Adjustments to the foreign-currency-denominated
receivable or payable were recorded directly to
transaction gain or loss
• Two-transaction approach – sale or purchase is viewed
as a transaction separate and distinct from the
financing arrangement
• A liability settled in units of a foreign currency can be
hedged by entering into a receivable transaction
denominated in the same foreign currency
• On November 15, 20x1, Lemon Co. ordered
merchandise on an FOB shipping point term, from a
foreign entity for 200,000 GBP. The merchandise was
shipped and invoiced to Lemon on December 10, 20x1.
Lemon paid the invoice on January 10, 20x2.
• The spot rates are as follows
Nov. 15, 20x1 Php22.4955
December 10, 20x1 Php22.4875
December 31, 20x1 Php22.4675
January 10, 20x2 Php22.4475
• Requirement: Provide the journal entries in 20x1 and
20x2.
• On September 1, 20x1, Creed Co. sold merchandise to a
foreign entity for 250,000 francs. Terms of the sale
require payment in Swiss Francs on February 1, 20x2.
On September 1, 20x1, the spot exchange rate was
Php1.20 per franc. At December 31, 20x1, the spot rate
was Php1.19, but the rate increased to Php1.22 by
February 1, 20x2, when payment was received.
• Requirement: Provide the journal entries in 20x1 and
20x2.
• Goo Co. sold inventory to a foreign entity for 100,000
FCUs (foreign currency units). Relevant information
follows:
• How much total sale revenue from the transaction is included in Goo’s 20x1
statement of profit or loss?
(13.75 x 100,000) = 1,375,000
• How much total sale revenue from the transaction is included in Goo’s 20x2
statement of profit or loss?
0
• How much is foreign exchange gain (loss) is recognized in Goo’s 20x1
statement of profit or loss?
(13.80 – 13.75) x 100,000 = 5,000 gain
• How much accounts receivable from the transaction is included in Goo’s 20x1
statement of financial position?
(13.80 x 100,000) = 1,380,000
• How much is foreign exchange gain (loss) is recognized in Goo’s 20x2
statement of profit or loss? D
(13.50–13.80) x 100,000 = (30,000) loss
• How much is the total foreign exchange gain (loss) from the transaction?
(13.50–13.75) x 100,000 = (25,000) loss
THANK
YOU

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