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Chapter 9
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Chapter 9

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  1. Chapter 9 Translation OfForeign Currency Transactions

  2. The Need For Translation • Foreign Currency Transaction • Buying or selling goods or services • Borrowing or lending money denominated in a foreign currency • Acquiring investments that must be paid for in a foreign currency • Hedging transaction

  3. The Need For Translation • Foreign Currency Financial Statements • Significantly influenced companies • Subsidiaries • Integrated • Self-sustaining • Joint ventures

  4. Terminology • SPOT RATE: The term spot rate is used to refer to the exchange rate at a particular point in time. In accounting literature, the most relevant spot rate is the one that prevails at the Balance Sheet date and, in this context, it is generally referred to as the current rate. • There are at least two “spot” rates at any point in time • Bid rate • Ask rate

  5. Terminology • HISTORIC RATE: This term is used to refer to the exchange rate that prevailed at the time a particular Balance Sheet item was:- acquired (asset) or- incurred (liability).

  6. Alternative Methods of Translation • Current / Non-Current Method • Monetary / Non-Monetary Method • Temporal Method • Current Rate Method Completely Discredited

  7. The Temporal Method • The Concept • Items valued at current values are translated using current exchange rates. • Items valued at historic values are translated using historic exchange rates.

  8. The Temporal Method • Example • Inventories carried at cost would be translated at historic rates • Inventories carried at net realizable value would be translated at current rates

  9. Temporal As Per CICA Handbook • Paragraph 1651.03(c)(i) The temporal method is a method of translation that translates assets, liabilities, revenues and expenses in a manner that retains their bases of measurement in terms of the Canadian dollar (i.e., it uses the Canadian dollar as the unit of measure). In particular: • monetary items are translated at the exchange rate in effect at the balance sheet date; • non-monetary items are translated at historical exchange rates, unless such items are carried at market, in which case they are translated at the exchange rate in effect at the balance sheet date; • revenue and expense items are translated at the exchange rate in effect on the dates they occur; • depreciation or amortization of assets translated at historical exchange rates is translated at the same exchange rates as the assets to which it relates.

  10. Temporal As Per CICA Handbook • Monetary Items Defined Paragraph 1651.03(b)Monetary items are money and claims to money the value of which, in terms of the monetary unit, whether foreign or domestic, is fixed by contract or otherwise. Future income tax liabilities and assets are classified as monetary items.

  11. Temporal As Per CICA Handbook • Items specified as non-monetary • Investments in equity instruments carried at cost • Inventories carried at cost • Prepaid items • Property, plant and equipment and accumulated amortization • Patents, trademarks, licenses and formulas • Goodwill • Other intangible assets (including deferred charges) • Deferred income • Share capital • Revenue and expenses related to non-monetary items, including: • Cost of goods sold • Depreciation and amortization (including amortization of deferred income)

  12. Temporal As Per CICA Handbook • Other Guidance On Monetary Items • Paragraph 1651.47 Preference shares of a foreign operation held by the reporting enterprise are translated in the same manner as common shares (i.e., at historical rates) unless redemption is either required or imminent, in which case the current rate is used. ... • Paragraph 1651.52 Future income tax liabilities and assets are monetary items and, as such, are translated at the current rate.

  13. Conceptual Definition Vs. CICA • The two approaches provide identical results • References to monetary confuse temporal with monetary vs. non-monetary

  14. Temporal Method and FC Transactions • Paragraph 1651.14 At the transaction date, each asset, liability, revenue or expense arising from a foreign currency transaction of the reporting enterprise should be translated into Canadian dollars by the use of the exchange rate in effect at that date. [October, 2006] • Use Of Averages If • Transactions occur uniformly over the period • Exchange rate changes uniformly over the period

  15. Temporal Method and FC Transactions • Paragraph 1651.16At each balance sheet date, monetary items denominated in a foreign currency should be adjusted to reflect the exchange rate in effect at the balance sheet date. (July, 1983) • Paragraph 1651.18 At each balance sheet date, for non-monetary assets of the reporting enterprise that are carried at market, the Canadian dollar equivalent should be determined by applying the exchange rate in effect at the balance sheet date to the foreign currency market price. (July, 1983)

  16. Exchange Gains And Losses • Source • Some items are translated at current rates • As the rate changes, gains and losses arise

  17. Exchange Gains And Losses

  18. Required Treatment of Gains and Losses • Paragraph 1651.120An exchange gain or loss of the reporting enterprise that arises on translation or settlement of a foreign currency-denominated monetary item or a non-monetary item carried at market should be included in the determination of net income for the current period. (January, 2002)

  19. Required Treatment of Gains and Losses • An Exception • Changes in fair value on available-for-sale investments to Other Comprehensive Income • Exchange gains and losses receive comparable treatment

  20. Required Treatment of Gains and Losses • Foreign Currency Financial Statements receive different treatment (see Chapter 10)

  21. Disclosure • Paragraph 1651.37 The amount of exchange gain or loss included in net income should be disclosed (see paragraphs 1651.20, 1651.24 and 1651.31). An entity may exclude from this amount those exchange gains or losses arising on financial instruments classified as held for trading in accordance with "Financial Instruments — Recognition And Measurement", Section 3855. An entity may also exclude from this amount exchange gains or losses on available-for-sale financial assets and cash flow hedges (see "Hedges", Section 3865) included in any gains or losses removed from accumulated other comprehensive income and included in net income for the period. (October, 2006)

  22. Disclosure • Paragraph 1520.03contains an identical recommendation

  23. Foreign Currency Purchases and Sales • Two transaction approach required • Transaction recorded at current rate • Exchange gains and losses into income as they arise

  24. Foreign Currency Purchases and Sales On December 12, 2008, a Canadian company purchases Inventory in Switzerland for 100,000 Swiss Francs (SF, hereafter). At this time SF1 = $0.94. When the company closes its books on December 31, 2008, the Inventory is still on hand and the Accounts Payable has not been paid. On this later date SF1 = $0.96.

  25. Foreign Currency Purchases and Sales

  26. Foreign Currency Capital Transaction Example On December 31, 2008, a Canadian Company with a December 31 year end borrows €1,000,000. At this time €1 = $1.40. On December 31, 2009, the rate for the Euro is €1 = $1.50 and on December 31, 2010, the rate is €1 - $1.55. On this latter date the loan is repaid. Ignore interest payments.

  27. Foreign Currency Capital Transaction

  28. Foreign Currency Capital Transaction

  29. Held-To-Maturity Investments Example On January 1, 2008, Empire Inc. acquires £200,000 in long-term debt of a British company. At this time £1 = $2.15. On December 31, 2008, when Empire Inc. closes its books, the exchange rate is £1 = $2.25.

  30. Held-To-Maturity Investments

  31. Available-For-Sale At Cost Investments Example On January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company. At this time £1 = $2.15. The investment is classified as available for sale and the shares do not have a quoted market price. On December 31, 2008, when Empire Inc. closes its books, the exchange rate is £1 = $2.25.

  32. Available-For-Sale At Cost Investments

  33. Held-For-Trading Investments Example On January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company. At this time £1 = $2.15. The investment is classified as held for trading. On December 31, 2008, when Empire Inc. closes its books, the market value of the securities has increased to £215,000 and the exchange rate is £1 = $2.25.

  34. Held-For-Trading Investments

  35. Available-For-Sale At Fair Value Investments Example On January 1, 2008, Empire Inc. acquires £200,000 in equity securities of a British company. At this time £1 = $2.15. The investment is classified as available for sale. On December 31, 2008, when Empire Inc. closes its books, the market value of the securities has increased to £215,000 and the exchange rate is £1 = $2.25.

  36. Available-For-Sale At Fair Value Investments

  37. Available-For-Sale At Fair Value Investments • Reclassification If investments are sold, the Other Comprehensive Income amounts will be reclassified into Net Income

  38. Hedging • An extremely complex area • Our coverage is limited to simple applications in the area of foreign exchange risk

  39. Hedging • Paragraph 3865.02 Hedging is an activity designed to modify an entity's exposure to one or more risks by creating an offset between changes in the fair value of, or the cash flows attributable to, the hedged item and the hedging item (or changes resulting from a particular risk exposure relating to those items).

  40. Hedged Items In General • Paragraph 3865.07(c) A hedged item is all or a specified portion of a recognized asset, a recognized liability, an anticipated transaction, or a net investment in a self-sustaining foreign operation, or a group of similar recognized assets, recognized liabilities or anticipated transactions, having an identified risk exposure that an entity has taken steps to modify.

  41. Hedged Items: Foreign Currency Applications • Foreign currency denominated monetary assets or monetary liabilities • Anticipated Transactions • Firm commitments • Forecasted transactions • Investments in self-sustaining foreign operations

  42. Hedging Items In General • Paragraph 3065.07(d) A hedging item is all or a specified percentage of a derivative, or all or a specified percentage of a group of derivatives offsetting a risk exposure identified in the hedged item. All or a specified percentage of: • (i) a non-derivative financial asset; • (ii) a non-derivative financial liability; or • (iii) a group of non-derivative financial assets or non-derivative financial liabilities, provided that all non-derivative items in a group are similar; • may be designated as a hedging item only for a hedge of a foreign currency risk exposure.

  43. Hedging Items: Foreign Currency Applications Example On July 1, 2008, a Canadian company purchases merchandise in France for €200,000. At this time €1 = $1.40. The merchandise must be paid for on December 31, 2008.

  44. Hedging Items: Foreign Currency Applications • Purchase Euros on July 1, 2008 • Effective but costly (no return on funds) • Purchase financial asset denominated in Euros • Some rate of return • Low rates on short term investments

  45. Hedging Items: Foreign Currency Applications • Purchase non-financial assets denominated in Euros • Inconvenient • May or may not be effective • Forward contract to take delivery of Euros on December 31, 2008 • Effective • Requires no investment of funds

  46. A Derivatives Primer • Paragraph 3855.19(e) A derivative is a financial instrument or other contract within the scope of this Section with all three of the following characteristics: • (i) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable (sometimes called the "underlying"), provided in the case of a non-financial variable that the variable is not specific to a party to the contract; • (ii) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and • (iii) it is settled at a future date.

  47. Types Contracts Forwards Futures Both parties must perform Options Only one party required to perform A Derivatives Primer

  48. Accounting procedures Initial recognition at fair value (often nil) Subsequent measurement at fair value Gains and losses to Net Income (in general) A Derivatives Primer

  49. Forward Exchange Contracts Example (From Text Paragraph 9-99) On January 1, 2009, Sandor Inc., a Canadian public company, enters into a forward exchange contract to take delivery of £100,000 on December 31, 2009 at a rate of £1 = $1.80. On January 1, 2009, the exchange rate is £1 = $1.76.

  50. Forward Exchange Contracts • Initial Recognition • No consideration for contract • Fair value = nil • No recognition in the financial statements