Foreign Currency Accounting (F6:M4)

Question 1

what rates are used to TRANSLATE the following to the reporting currency:

assets/liabilities

income statement accounts

capital accounts (CS, APIC)

Answer 1

A/L: spot rate (current rate) at BS date

IS: weighted avg exchange rate

Capital: historical exchange rate

*translation method starts with income statement

Question 2

what is the functional currency?

when would the the functional currency be the reporting currency rather than the local currency?

Answer 2

currency of primary economic environment that the entity operates in (usually the local or reporting currency)

foreign entity operates in highly inflationary environment; foreign entity could not operate without US entity’s operations

Question 3

Nov 1: 1 euro = $1.50
Dec 31: 1 euro = $1.35

would this situation create a G or L if a payable was recorded on Nov 1? How about if a receivable was recorded?

*functional currency is $

Answer 3

AP: gain

AR: loss

Question 4

where are the following recorded?

translation G/L

remeasurement G/L

Answer 4

translation: OCI
remeasurement: income from continuing operations

Question 5

where are foreign exchange transaction G/L recorded?

Answer 5

in the income statement for period in which exchange rates change

Question 6

when is the remeasurement (temporal) method used?

Answer 6

if sub’s functional currency is not the same as its local currency (i.e., functional currency is reporting currency or another currency), FS must be remeasured to the functional currency

Question 7

when the remeasurement method is required, which rates are used for the following?

BS
monetary items (fixed) = ?
nonmonetary items (fluctuates) = ?

IS:
non BS related items = ?
BS related items = ?

Remeasurement G/L

Answer 7

BS
current rate
historical rate

IS
weighted avg rate
historical rate

Remeasurement G/L is the “plug” to get net income to required amount needed to adjust RE in order to make BS balance

Question 8

when is the translation (current rate) method used?

Answer 8

if the sub’s functional currency is its local currency, the sub’s FS are simply translated to the reporting currency

Question 9

what do the following mean?

reporting currency

spot rate

Answer 9

reporting currency: currency of entity ultimately reporting financial results of foreign entity

spot rate: current rate

Question 10

when is a transaction first journalized?

Answer 10

when title passes because that’s when a payable/receivable would be recorded

*issuing a purchase order is not the same as actually purchasing something

Question 11

if a US company purchases a machine from a German company and there is no foreign exchange transaction G/L recorded in operating income, what does that likely mean?

Answer 11

the transaction is denominated in US dollars

Question 12

functional currency to reporting currency is considered what?

what if foreign currency is not functional currency?

Answer 12

translation

FS must be restated to functional currency (remeasured) before translation can happen.

i.e., remeasurement is step 1 and translation is step 2

Question 13

if a British business person says “0.63 pounds = 1 USD,” what method is he using to quote the exchange rate?

Answer 13

direct method

Question 14

if a derivative instrument is neither designated for hedging purposes nor held for trading purposes, what section of the CF statement would it be reported?

Answer 14

investing section

held for trading purposes = operating section

instrument contains significant financing element at transaction inception = financing section

Question 15

how do you calculate cumulative inflation?

Answer 15

yr 1: 28% inflation
yr 2: 32% inflation
yr 3: 30% inflation

1. 28 x 1.32 x 1.30 = 2.19
2. 19 - 1 (1 is always used) = 119% > 100% (hyperinflation)

functional currency is reporting currency, so remeasurement method is used (GAAP)

foreign sub’s FS are restated for effects of inflation then converted to reporting currency using current year-end rates (IFRS)