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Conversion for FS purposes. INTERNATIONAL ACCOUNTING & FIN

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Conversion for F/S purposes. INTERNATIONAL ACCOUNTING & FINANCIAL REPORTING-2006. 7-4 ... Ineffective monetary policy with fixed rate currency ... – PowerPoint PPT presentation

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Title: Conversion for FS purposes. INTERNATIONAL ACCOUNTING & FIN


1
Session VII
  • 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 EU members-excl. UK
  • 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
IASB 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
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