Foreign Currency Accounting

A] Foreign Subsiduary

Transactional Currency
Remeasurement or
Temporal Method

Functional Currency
Reporting Currency

Reporting Currency

Transactional Currency (Local Currency):

A currency where the foreign company maintain its book of account.

Functional Currency:

It is the currency of the primary economic environment in which the entity operates. It is
usually the currency in which the entity generates and expends cash. A foreign Subsidiary
of a US Parent company should measure its asset and liabilities and operation using
subsidiary functional currency.

Reporting currency (Presentation Currency)

The currency in which the parent company prepares its F/S

$ $
Functional Currency = Reporting Currency
 The Foreign operation are highly integrated with the parent
 Day to day operation is based in US$
 100% inflation in the country
We have to use remeasurement method.

Transactional currency = Functional Currency

Foreign subsidiary is self contained and independent and day to day operation in local
currency

All three Currencies are different

If a foreign subsidiary is self contained and independent is operating in another foreign

country with a different Local currency.
Rules for Translation Method (Current Rate Method)
[Income statement Balance sheet]

1. All Asset and Liabilities are translated using the year end rate or the current rate at
the balance sheet
2. All Income statement items are recorded Weighted average rate
3. Owner’s equity is translated using historical exchange rate.
4. Dividends are translated at historic rate on the date of declaration.

The Translation Adjustment for the period is reported in other comprehensive income
A.OCI (PACE) in shareholder equity section

Rules for Remeasurement Method (Temporal Method)

B/S I/S

1. Monetary Asset and Liabilities are remeasured at year end rate or current rate
2. Non Monetary Asset and liabilities are remeasured at historical rate
3. Common stock and dividend paid are measured at historical rate
4. COGS, Depreciation, Amortization expenses are remeasured at historical rate
5. Income statement items are recorded at weighted average rate
6. Remeasuremt gain and losses are reported in the statement of income (Non
Operating Income)

Only Monetary Asset and liabilities are exposed to exchange rate Volatility. Eg. Currency
Appreciates or Depreciates

Non Monetary Asset and Liabilities are not impacted by exchange rate Volatility. E.g.
Currency Appreciates or Depreciates.

Net Income is more volatile in remeasurement method compared to Translation method

because Remeasurement gain & loss is recorded in the statement of income and
Remeasurement of gain & loss is recorded in shareholder equity.
Q. What is the best recommended action to manage the exchange rate volatility risk the F/S
if remeasurement method (Temporal Method is used)
Sol:

Under the temporal method, firms can eliminate their risk of exchange rate volatility by balancing
monetary asset and liabilities. The best recommended way is to sell a non monetary asset such as
inventory or fixed asset and use the proceed to pay the liabilities.

Under the temporal method the non monetary assets and liabilities are remeasured using the
historical rates and the monetary asset using the current exchange rate. Overall only the monetary
asset and liabilities are exposed to exchange volatility risk. A firm has net monetary asset if its
monetary asset exceed its monetary liabilities. If the monetary liabilities exceed the monetary asset
the firm has a net monetary liabilities exposure.

IF THE PARENT HAS A NET MONETARY LIABILITY EXPOSURE WHEN FOREIGN CURRENCY IS
APPRECIATING, THE RESULT IS A LOSS. A NET MONETARY LIABILITY COUPLED WITH
DEPRECIATING CURRENCY WILL RESULT A GAIN THE RESULT IS VICE VERSA GOR NET
MONETARY ASSET

Forward Exchange Contract.

Forward Exchange Contract is agreement to exchange two different currencies at a future
date ay a specific rate. It is a promise (i.e. right and obligation) to exchange specified
quantity of foreign currency at a future date. It results in foreign exchange gain and loss
due to exchange rate fluctuation between the contract date and the settlement date. The
forward exchange loss will be calculated based on the forward rate and reported as income
from continuing operation on the statement of income as long as kept for speculation.
{FAR616568}

Hyper Inflation
US GAAP

A hyper inflationary environment is one where cumulative inflation exceed 100% over a 3
year period

Under US GAAP, the temporal method is required when the subsidiary is operating in hyper
inflationary environment. Note that the foreign currency accounting treatment for hyper
inflationary countries is different. In hyper inflationary environment, the temporal method
must be used as per US GAAP, even if the functional and presentation currency is differ.
Under the temporal method inventory, fixed asset and tangible asset are remeasured at
historical cost.
IFRS
The monetary asset are not inflation adjusted instead the purchasing power gain or loss is
calculated . A net purchasing power gain or loss is recognized in the income statement
based on the net monetary asset or liability exposure. Holding monetary asset during
inflationary period result in purchasing power loss. Conversely, Holding Monetary
Liabilities during an inflationary period result in purchasing power gain.

Assets that are inflation adjusted

Non Monetary asset like inventory are inflationary adjusted

Monetary asset and liabilities are not inflationary adjusted. instead the purchasing power
gain and losses are calculated,

Q. What amount should the company recognize gain( loss) from the foreign currency
transaction when the receivable is collected.

E.g. 12/22/2010 Export co sold goods on credit to import Co on for 1000 LCu. On
1/20/2011, Export received the payment Below is the info on exchange rates.\

Date value (spot rate)

12/22/2010 1 LCU= $0.65

12/31/2010 1 LCU = $0.75

1/20/2011 1 LCU = $0.80

Solution:

12/22/2010: Date of
Sale
Account Receivable $650
Sales $650

12/31/2010: B/S Date, Adjust the

monetary asset
Account Receivable $100
Gain $100

1/20/2011: Date of collection of

cash
Cash $800
Foreign Exchange
gain(I/S) $50
Account
Receivable $750
Qst . Changes in Ratio due to different method

QST CHANGES IN COGS due to different method?

During the period of currency depreciating, the historical rate will be lower than the
average rate. In the te method COGS is reported using historical rate and in current method
it is reported using average rate. The cost of good sold will be lower under the temporal
method compared to current method.