P2 GUERRERO CH10 Harvard University HARVARD 216

Chapter 10 Foreign Currency Transaction and Translation of Foreign Currency Financial Statements Problems in these areas are now appearing more often in the CPA examinations. Candidates therefore should be familiar with the standards of financial accounting and recording foreign currency transactions as well as the translation of the financial statements of foreign entity into the presentation currency (Philippine Peso) for purposes of consolidating them in the financial statements of the reporting enterprises. Foreign Currency Transaction These are transactions denominated in foreign currency, the settlement of which is to be made in foreign currency. Foreign currency transactions usually involve purchases (imports) or sales of goods (exports) whose prices are stated in foreign currency. ACCOUNTING FOR IMPORT AND EXPORT TRANSACTIONS An overview of the required accounting procedures for an import or export foreign currency transactions on credit are as follows: 1. On Transaction Date. Record the purchase or sale transactions at the Philippine peso equivalent value using the exchange rate on this date (spot exchange rate). 2. On Statement of Financial Position Date. Adjust the payable or receivable to its Philippine peso equivalent, end-of-period using the closing exchange rate. Recognize any exchange gain or loss for the change in rates between the transaction and statement of financial position dates. 3. On Settlement Date. First adjust the foreign currency payable or receivable for any change in the exchange rate between the statement of financial position date (or transaction date if transaction occurs after the statement of financial position date) and the settlement date, the difference should be recognized as foreign exchange gain or loss. Then record the settlement of the foreign currency payable or receivable. Exchange Rate. This is the rate in which the currencies of two countries are exchange at a particular time. This may be quoted directly or indirectly as follows: Direct exchange rate. This is the number of local currency units (LCU) needed to acquire one foreign currency unit (FCU). From the viewpoint of a Philippine entity the ratio is computed as follows:Philippine pesos equivalent value 1 FCU Indirect exchange rate. This is the reciprocal of the direct exchange rate. This is computed as follows: 1 FCU Philippine peso equivalent value Foreign Exchange Gain or Loss. Foreign exchange (Forex) gains or loss must be recognized in the statement of comprehensive income of the period in which the exchange rate changes. To determine forex gain or loss, the following guidelines may be used: (Importer) Payable in Foreign Currency (Exporter) Receivable in Foreign Currency Increase in direct exchange rate Forex loss Forex gain Decrease in direct exchange rate Forex gain Forex loss ACCOUNTING FOR FORWARD EXCHANGE CONTRACTS A forward exchange contract is an agreement to exchange currencies of different countries on a specified future date at the specified rate (the forward rate). Forward rates may be more or less than the spot rate of foreign currency. Forward contracts are recorded at forward rate. These contracts are considered derivative instruments and are entered into for the following purposes: 1. To designate as a fair value hedge (to hedge is to take measures to reduce or eliminate a potential unfavorable outcome of a future event) of: a. An existing foreign currency asset or liability. b. A foreign currency denominated firm commitment. c. A net investment in a foreign operation.