EFFECTS IN CHANGES OF FOREIGN EXCHANGE RATES

Finals

growth in world trade and the significance of foreign operations to Philippine companies These problems are generally subdivided into two (2) broad areas:

• Problems related to transactions that give rise to receivables and payables denominated in foreign currencies must be measured and recorded in the Philippine currency, which is the peso.

• Problems arising from the translation of foreign currency statements into Philippine currency.

Foreign Exchange (forex)

is the conversion of one country's currency into another. In a free economy, a country's currency is valued according to the laws of supply and demand.

• In other words, a currency's value can be pegged to another country's currency, such as the U.S. dollar, or even to a basket of currencies.

Measured vs. Denominated

• Assets and liabilities are denominated in one currency if either amount is fixed in terms of that currency.

• However, they must be measured in another currency.

Conversion vs. Translated.

• Philippine importer converts Philippine pesos on the date of payment into another foreign currency at the prevailing rate of exchange.

• On the other hand, the assets, liabilities, and equity of a foreign branch or subsidiary are translated into Philippine pesos to consolidate them into financial statements of the Philippine home office.

Exchange Rate

It is the rate at which the currencies of two (2) countries are exchanged at a particular time.

• The buying and selling of foreign currencies as though they were commodities result in variation of the exchange rate between currencies of two (2) countries.

foreign currency transaction

A transaction that requires settlement or payment in a foreign currency

not a foreign currency transaction to a Philippine company

A transaction with a foreign country to be paid in the Philippine peso is

• It is because the amount to be received or paid to settle the account is fixed and is not affected by the subsequent changes in the exchange rate.

Importing and exporting goods

The most common form of foreign currency transactions

In each unsettled foreign currency transaction, there are three (3) concerns to the accountant:

• Each asset, liability, revenue, gain, or loss arising from the transaction on the date it was initially recognized, shall be initially measured and recorded in Philippine peso.

  • It can be done by multiplying the units of foreign currency by the closing exchange rate, that is, the spot rate in effect on a given date.

• Recorded balances that are denominated in a foreign currency are adjusted to reflect the closing exchange rate in effect at the date of the statement of financial position.

  • Foreign exchange gain or loss is recognized for the difference in the exchange rate between the transaction date and the balance sheet date.

• In the case of a foreign currency payable, a Philippine company must convert Philippine pesos into foreign currency units to settle the account.

  • On the other hand, foreign currency receivable will be converted into pesos.

  • Although translation is not required, a foreign exchange gain or loss is recognized if the amount of pesos paid or received upon conversion does not equal the carrying value of the related payable or receivable.

To record bank charges.

Dr. Bank Charges

Cr. Cash

To record the receipts of goods. $10,000 xP50.50

Dr. Purchases

Cr. Acceptance Payable

To adjust acceptance payable and recognize forex loss for the increase in the exchange rate.

Dr. Foreign Exchange Loss

Cr. Acceptance Payable

To record the payment of the letter of credit (LC) to BPI, and recognition of forex loss

Dr. Acceptance Payable

,,,,Foreign Exchange Loss

Cr. Cash

To record marginal deposit on Letter of Credit

Dr. Marginal Deposit on LC

Cr. Cash

To record availment of packing credit line

Dr. Cash

Cr. Packing Credit Line

To record shipment of merchandise

Dr. Accounts Receivable

Cr. Sales

To adjust acceptance payable and recognize forex loss for the increase in the exchange rate

Dr. Accounts Receivable

Cr. Forex Gain

To record settlement received from BPI for the LC and recognition of the forex gain.

Dr. Cash

Cr. Accounts Receivable ; Forex gain

Borrowing or lending denominated foreign currency

The rule in importing and exporting goods shall be applied. However, interest income shall be recognized.

forex loss

it shows that increases in the selling spot rate for a foreign currency required by a Philippine Company to settle liability in that currency generate

• It is because more Philippine pesos are required to obtain foreign currency.

forex gains

decreases in the selling spot rate result in

• to the company because fewer Philippine pesos are required to obtain the foreign currency.

increases in the buying spot rate for a foreign currency to be received by a Philippine company in settlement of a receivable denominated

in that currency generate forex gains to the company.

decreases in the buying spot rate produce

forex losses.

Derivatives

These are financial contracts or other contracts with all of the following three (3) characteristics:

Derivatives 3 Characteristics:

• Whose value changes in response to changes in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variables.

  • One example of it is the call option which gives the holder a right to purchase a share for a fixed price increases in value when the price of that share increases. In that case, the share price is an intrinsic value that affects the value of the option.

• It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts.

  • For instance, a call option on a share can usually be purchased for an amount much smaller than what will be required to purchase the share itself.

• It is settled at future date.

  • For instance, a call option on a share is settled on the future date on which the holder may exercise the call option to purchase the share of a fixed price.

Common examples of derivatives are

forward contracts, swaps, and options.

A foreign currency forward contract

is an agreement to exchange currencies of different countries on a specified future date at the specified rate.

determined by reference to changes in the forward rate over the life of the contract

The fair value of a foreign currency forward contract is

a fair value hedge

One of the purposes of entering forward contracts is

Hedging

is a risk management technique that involves using one or more derivatives to offset changes in fair value or cash flow of hedged items.

There are two (2) items that must be remembered in fair value hedging

• the foreign currency exposed net asset and

• net liability position.

foreign currency exposed net asset position

is the excess of assets denominated in foreign currency over the liabilities denominated in the same foreign currency and translated at the current rate.

foreign currency exposed net liability position

is the excess of liabilities denominated in a foreign currency over assets denominated in that foreign currency and translated at the current rate.

To adjust accounts payable to the year-end spot rate

Dr. Forex Loss

Cr. Accounts Payable

To record settlement of the Accounts Payable

Dr. Accounts Payable- FC; Forex Loss

Cr. Foreign Currency

Purchase of forward contract

Dr, Forward Contract Receivable - FC

Cr. Forward Contract Payable

To record increase in the value of the forward contract.

Dr. Forward Contract Receivable - FC

Cr. Gain on Forward Contract

To record receivable of 500,000 Yen according to the forward contract.

Dr. Foreign Currency; Loss on Forward Contract

Cr. Forward Contract Receivable

steps in the translation and consolidation of the foreign entity financial statements:

1. Receive foreign entity’s financial statements, which are reported in foreign currency.

2. Translate the statements in foreign statements in foreign currency to the Philippine peso. Each foreign entity account balance must be individually translated into its Philippine equivalent peso. 3Consolidate the translated foreign entity’s accounts, which are now stated in the Philippine peso, with the Philippine company’s accounts.

the results and financial position of an entity shall be translated into a different presentation currency using the following procedures:

• Assets and liabilities for each statement of financial position presented, including comparatives, shall be translated at the closing rate at the date of that statement of financial position;

• Income and expenses for each statement of comprehensive income or separate income statement presented, including comparatives, shall be translated at exchange rates at the dates of the transactions; and

• All resulting exchange differences shall be recognized in other comprehensive income