FOREIGN EXCHANGE

Currency Exchange Rates

A. Directly Quoted
➢ Expressed in one unit of the foreign currency into so many units of the functional
currency
➢ Peso is the one who has value
B. Indirectly Quoted
➢ Expressed in one unit of the functional currency into so many units of the foreign
currency
➢ Foreign Currency is the one who has value

Measuring Points

Temporal Method Date of Transaction Balance Sheet Date Date of Settlement

Monetary Current/Spot Rate Current/Spot Rate Current/Spot Rate
Non-Monetary Historical Rate (DOT) Historical Rate (DOT) -
Sales and Expenses Historical Rate (DOT) Historical Rate (DOT) -

Analyzing the Transaction

Increase Decrease

Accounts Payable (Purchase) Loss Gain

Accounts Receivable (Sales) Gain Loss

Effects of Changes in Foreign Exchange Rates on Exposed Foreign Currency Monetary Items

Liability (FC) Asset (FC)

When peso strengthens (Lesser) Gain Loss

When peso weakens (More) Loss Gain

Foreign Currency Hedges

1. Non-Derivative Hedging Instruments (Gross Method)

➢ More investment is needed
2. Derivative Hedging Instruments (Net Method)
➢ Minimal or No investment needed
➢ Forward Contract account is used
➢ Both has underlying factor, the amount can be different from one point to another
➢ Both will be settled on a future date
Hedging Instruments

1. Forward Exchange Contracts

➢ Executory by nature
➢ The contract will push through under any circumstances
2. Option Contracts
➢ There is an option to continue or not continue the contract

Date of Transaction Balance Sheet Date Date of Settlement

Forward Contract Forward Rate Forward Rate Spot Rate

Changes in the Fair Values of a Forward Contract after Inception Date

Forward Purchase Contract Forward Sales Contract

(Receivable) (Payable)

Current FR is MORE than 1. Fair value is positive 1. Fair value is negative

Contracted Forward Rate (FR) 2. A gain is recorded 2. A loss is recorded

(the Peso weakens) 3. In the balance sheet 3. In the balance sheet

the FC is an asset the FC is a liability

4. Cash is received upon 4. Cash is paid upon

expiry expiry

Current FR is LESS than 1. Fair value is negative 1. Fair value is positive

Contracted Forward Rate (FR) 2. A loss is recorded 2. A gain is recorded

(the Peso strengthens) 3. In the balance sheet 3. In the balance sheet

the FC is a liability the FC is an asset

4. Cash is paid upon 4. Cash is received upon

expiry expiry
Option Contracts

A. Put Option – Sales

B. Call Option – Purchase

From the standpoint of option holder

1. At – Equal
2. In – Gain
3. Out – Loss

Firm Commitment

A. Fair Value Hedge – Firm Commitment to Sales

B. Cash Flow Hedge – Hedging Instrument – OCI to Sales

Contract Signing Balance Sheet Date Date of Transaction

Firm Commitment Forward Rate Forward Rate Spot Rate

Translation of Foreign Currency Financial Statements

A. Remeasurement from Local Currency Financial Statements to Functional Currency Financial

Statements by the Temporal Method
B. Translation from Functional Currency Financial Statements to Presentation Currency Financial
Statements by the Current Rate Method

Currencies

1. Local Currency
➢ Is the currency in which the entity initially measures and records its transactions.
➢ It is the currency of the country wherein the entity is located.
2. Functional Currency
➢ Is the currency that affects the economic wealth of the entity. It is the required final
measurement of its transactions.
➢ It is usually, also, the “Local Currency”.
➢ Assumptions under Problem Solving
A. Explicitly - Mentioned
B. Implied
➢ Dependent to the Parent – Same as the parent
➢ Independent from the Parent – Local Currency
C. Silent – Local Currency
➢ Under Theoretical – based on standards
3. Presentation Currency
➢ Is the currency in which the financial statements of the entity are presented.
➢ It is usually, also, the “Functional Currency.”
How to Determine the Functional Currency

First Level: 3 Primary Factors

Sales and Cash Inflow

1. This mainly influences the prices at which goods and services are sold. This will often be the
currency in which sales prices for goods and services are denominated and settled.
2. The country whose competitive forces and regulations mainly influence the entity’s price
structure. Example: Where government regulations determine that the local currency is the
functional currency.

Expenses and Cash Outflow

3. The expenses and cash outflow that influence the cost of the entity. The currency that mainly
influences purchases, materials, labor and other costs of providing goods and services

Secondary Indicators - designed to provide additional supporting evidence in the determination of an

entity’s functional currency.

Financing Activities

➢ The finance activities in which funds are generated.

➢ Example, where financing (issuing of debt and equity instruments) is raised and serviced by a
currency type (i.e. SGD). This indicates that SGD is the functional currency in the absence of
other indicators to the contrary.

Retention of Operating Income

➢ In which receipts from operating activities are retained.

➢ This is the currency in which the entity maintains its excess working capital balances.

General Translation Rules

A. If the Local Currency is not the Functional Currency

➢ A re-measurement to the Functional Currency is Mandatory
➢ Use the Temporal Method to remeasure the financial statements (see Par D)
B. If the Functional Currency will not be the Presentation Currency
➢ A translation to the Presentation Currency is Necessary
➢ Use the Current Rate Method to translate the financial statements (See Par E)
Temporal Method

Asset and Liabilities

A. Monetary – Current Rate

B. Non Monetary and Related Accounts – Historical Rate

Equity

A. Common Shares – Historical Rate

B. APIC - Historical Rate
C. Retained Earnings – by Components
• Dividends - Historical Rate
• Revenue and Expenses – Historical Rate (Theory) / Average (Problem)
D. Cost of Sales – by Components
• Depreciation and Amortization Expense - Historical Rate

Current Rate Method

Asset and Liabilities – Current Rate

Equity

A. Common Shares – Historical Rate

B. APIC - Historical Rate
C. Retained Earnings – by components
• Dividends – Historical Rate
• Revenue and Expenses – Historical Rate (Theory) / Average (Problem)