Chapter 12 Chapter 12 ACCOUNTING FOR FOREIGN CURRENCY TRANSACTIONS I. EXCHANGE RATES - MEANS OF TRANSLATION A. T ranslation is the process of expressing monetary amounts that are stated in terms of a foreign currency in the currency of the reporting entity by using an appropriate exchange rate. B. An exchange rate “is the ratio between a unit of one currency and the amount of another currency for which that unit can be exchanged at a particular time.” 1. A direct exchange quotation (for a U.S. company) is one in which the exchange rate is quoted in terms of how many U.S. dollars can be converted into one unit of foreign currency . 2. If the direct exchange rate increases , the foreign currency is strengthening relative to the dollar because more dollars are needed to purchase the equivalent amount of foreign currency. Similarly if the direct exchange rate decrease, the dollar is strengthening relative to the foreign currency. 3. Exchange rates are also stated in terms of converting one unit of the domestic currency into units of a foreign currency, which is called an indirect quotation . 4. Exchange rates may be quoted for the immediate delivery of currencies exchanged ( spot rate ), or for future delivery ( forward or future rate ) of currencies exchanged. The forward rate is an exchange rate established at the time a forward exchange contract is negotiated. 5. A forward exchange contract is a contract to exchange at a specified rate (the forward rate ) currencies of different countries on a stipulated future date. 6. In both the spot and forward markets, a foreign exchange trader provides a quotation for buying (the bid rate ) and a quotation for selling (the offer rate )
foreign currency. The trader's buying rate will be lower than the quoted selling rate, and the spread between the two rates is profit for the trader C. Before the 1970s, most of the IMF member countries agreed to establish exchange rates in terms of U.S. dollars and gold. Although the actual rate was free to fluctuate, the countries that established official or fixed rates agreed to maintain the actual rate within 1% (2% after 1971) of the official rate by buying or selling U.S. dollars or gold. The relationship between major currencies is now determined largely by supply and demand factors, called floating rates . D. Floating rates increase the risk to companies doing business with a foreign company. E. The selection of an exchange rate to be used in the translation process is complicated by the fact that some countries maintain multiple exchange rates. The government of a country may maintain official rates that differ from the market-determined rate, depending on the nature of the transaction II. MEASURED VERSUS DENOMINATED A. Transactions are normally measured and recorded in terms of the currency in which the reporting entity prepares its financial statements. This currency is usually the domestic currency of the country in which the company is domiciled and is called the reporting currency .
- Fall '13
- Accounting, Foreign exchange market, United States dollar, Forward contract