Session VII

1
Session VII VIII

• Foreign Currency

2
Foreign Exchange Basics

• Exchange rates
• Conversion values
• Exchange rate factors
• Inflation
• Interest rates
• Balance of payments

3
FX Gains and Losses

• Realized gains and losses
• Result of FX transactions
• Exchange of currency takes place
• Unrealized gains and losses
• Result of FX translations
• Conversion for F/S purposes

4
FX Transactions

• Two-transaction approach for US GAAP
• Gain or loss recognized in the income statement

5
Forward Exchange Contracts

• Agreement to exchange currency at a specified
  time at a specified rate
  
• Forward rate
• Spot rate

6
FX Translations

• Current Rate Method (Modified Current Rate
  Method)
  
• Temporal Method
• Only approaches approved under US GAAP

7
Current Rate Method

• Local currency is the functional currency
• Method
• Assets and liabilities translated at current
  rate
  
• Capital accounts translated at historical rate
• Dividends translated at current rate upon
  declaration
  
• Revenue and expense translated at weighted
  average rate
  
• Balancing amount recorded in OCI

8
Temporal Method

• Home currency is functional currency
• Method
• Cash, A/R and A/P translated at current rate
• Other assets and liabilities translated at
  historical rates
  
• Capital accounts translated at historical rate
• Revenue and expense other than items dependent on
  non-monetary items translated at weighted average
  rate
  
• Balancing amount recorded in income statement

9
Translation and Remeasurement

• When local currency is functional currency, it is
  TRANSLATED into the home currency
  
• When the local currency is not the functional
  currency, it is REMEASURED into the functional
  currency, which is usually the home currency

10
FX Risk Management

• Self-sustaining operations support the local
  currency as the functional currency
  
• Integrated operations support the home currency
  as the functional currency
  
• Fixed rate currency
• Floating rate currency
• Intervention
• Arbitrage

11
Mundell-Fleming Model

• Capital mobility offsets the ineffective nature
  of monetary and fiscal policy
  
• Ineffective monetary policy with fixed rate
  currency
  
• Ineffective fiscal policy with floating rate
  currency

12
FX Risk Exposure

• CA CL positive exposure
• CA
• Positive exposure appreciation yields gain
• Negative exposure depreciation yields gain
• FX risk includes both translations and
  transactions
  

13
Transaction Risk Exposure

• Transaction denominated in FX
• Settlement date is different from transaction
  date
  
• Results from actual exchange of cash
• Results from actual changes in exchange rates
• Plan FX strategies and execute them

See Exhibit 2.7
14
Hedging Strategies

• FX forward contract most common
• Transaction denomination US billing
• Risk sharing agreed rate and price
• Price adjustment price protection
• Currency options contract
• Cross-currency swap
• Currency swap

Contract based strategies
15
Forward Exchange Contract Accounting

• A/R
• Sales revenue
• Deferred FX expense
• Deferred credit
• FX expense
• Deferred FX expense
• Cash
• Deferred credit
• A/R

16
The Euro

• Legal tender for most of EU members
• Removal of exchange rate risk
• Lowers transaction costs
• Benefits consumer

17
Translation Risk Exposure

• Accounting exposure only
• Increase net assets under appreciation
• Increase net liabilities under depreciation

18
Managing Economic Exposure

• Consider location of operations
• Use the portfolio approach
• Use flexible planning
• Use pricing and promotional strategies

19
FX Forecasting

• Implement effective information systems
• Consider all relevant factors on a collective
  basis
  
• Political and social environment
• Political risk
• Economic growth
• Inflation
• Balance of payments
• Interest rates

20
US GAAP versusInternational Actg. Stds.

• SFAS 52-FX Translation
• If functional currency is US , remeasure F/S
• If functional currency is local currency,
  translate F/S
  
• Use two-transaction approach for FX transactions
• SFAS 133-Derivatives and Hedging
• Report derivatives at fair value
• Hedging gains losses are recognized immediately

21
US GAAP versusInternational Actg. Stds.-continued

• IAS 21-Foreign Currency
• Temporal method required for integrated ops.
• Current method required for self-sustaining ops.
• Recommends two-transaction approach for FX
  transactions
  
• IAS 39-Hedging
• Similar to SFAS 133 (note the convergence!!)

22
Session IX

• Changing Prices

23
General and Specific Price Increases

• General price level increases (GPI)
• Based on market basket of goods services
• Specific price level increases (SPI)
• Relates to a particular item

24
Tight Money Policy

• Monetary policy influence both inflation and
  economic growth
  
• See Figure 3.1 on page 87

25
Constant Money Restatement(Current Purchase
Power Accounting)

• Balance sheet
• I/D items as monetary or nonmonetary
• Extend monetary items at their face amount
• Adjust nonmonetary items for changes in
  purchasing power
  
• Roll-forward prior year balances
• Income statement
• Adjust items based date of occurrence
• Compute depreciation based on adjusted historical
  cost
  
• Adjust other items based upon weighted average
• Compute cost of goods sold based on adj.
  Inventory items
  
• Calculate purchasing power gain or loss

See comprehensive example on pages 90 - 97.
26
Current Value Accounting

• See pages 97 - 102
• We will place limited focus on this topic due to
  its subjective nature and lack of universal
  application

27
IASC and Inflation

• IAS 15 Price level accounting disclosures
• IAS 29 Hyperinflation report
• Requirement for IAS countries
• Hyperinflation exists when 3-year cumulative
  inflation exceeds 100 percent
  
• Restatement for GPI changes in primary financial
  statements
  
• Hotly debated issue without firm resolution