Forex

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II

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EFFECTS OF CHANGES IN FC EXCHANGE RATES FOREIGN CURRENCY FINANCIAL STATEMENTS TRANSLATION Key Definitions: 1. Foreign currency transactions – specific transactions not denominated in the functional currency of the entity; 2. Foreign currency financial statements – financial statements measured and recorded in currency (local currency) that is not the entity’s functional currency; 3. Functional currency financial statements – financial statements that are measured in the entity’s functional currency, either as a direct result of its accounting recognition process as required by PAS21. 4. Local currency – the currency in which the foreign operation measures and records its transactions. 5. Functional currency – the currency of the primary economic environment in which the entity operates. It is the currency that affects the economic wealth of the entity. 6. Presentation currency – the currency in which the financial statements of the entity are presented. 7. Exchange difference – the difference resulting from translating a given number of units of one currency into another currency at different exchange rates. 8. Foreign operation – a subsidiary, associate, joint venture, or branch whose activities are based in a country other than that of the reporting enterprise. Rules for translating Foreign Currency Transactions (FCT) into the entity’s Functional Currency: a. A FCT shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction. b. At each balance sheet date the foreign currency monetary item shall be adjusted to conform the closing rate (the spot rate at the balance sheet date), which same adjustment is recognized as foreign exchange gain or foreign exchange loss, as the case may be, and carried to current income determination even though such gain or loss is unrealized at that point. c. At the date of settlement, any difference between the book carrying value of the foreign currency monetary item (established at the most recent balance sheet date) and the functional currency amount is recognized either as foreign exchange gain or loss, as the case may be, and carried to current income determination. The functional currency amount is calculated by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the settlement. Steps for translating Foreign Currency Amounts into the Functional Currency The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash. An entity considers the following factors in determining its functional currency: a. The Currency: a. That mainly influences sales prices for goods and services (this will often be the currency in which sales price for its goods and services are denominated and settled); and b. Of the currency whose competitive forces and regulations mainly determine the sales prices of the goods and services b. The Currency that mainly influences labor, materials, and other costs of providing goods and services this will often be the currency in which sales price for its goods and services are denominated and settled. Steps apply to a stand-alone entity, an entity with foreign operations (such as parent with foreign subsidiaries), or a foreign operation (such as foreign subsidiary or branch). 1. The reporting entity determines its functional currency. 2. The entity translates all foreign currency items into its presentation currency. 3. The entity reports the effects of such translation in accordance with paragraphs 20-37 and 50 of PAS 21. Note: In most cases, a stand-alone entity’s presentation currency is also its functional currency. PAS 21 specifies two approaches to translation and the approach to be used depends on whether the functional currency of the foreign subsidiary is the same as the presentation currency and whether the books are kept in the functional currency: Method 1. Translation from the Functional Currency into the Presentation Currency (Closing/Current Rate Method/Net Investment Method/Translation Method). This method is used on the following basis: • • •

Foreign operations operates independently in economic and financial matters (or not integral to the operations of the parent) Functional currency (is not the presentation currency) should be the LCU (local currency unit – the currency in the country in which the subsidiaries operates) or a third country currency. The functional currency is not the currency of hyperinflationary economy, otherwise apply PAS 29.

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II •

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The main features of the closing/current rate method are summarized as follows: o Assets and Liabilities – both monetary and non-monetary are translated at current rate o Stockholders’ equity accounts – are translated using historical rates in effect at the time equities were first recognized (date of investment) in the foreign entity’s accounting records, except: ➢ Beginning Retained Earnings – is set equal to the ending balance of last year. ➢ Dividends – historical rate on date of declaration, otherwise date of payment. o Revenue and Expense of Foreign Operation – are translated at the dates of transactions, i.e. actual or spot rates (historical rates). For practical reasons, the the average rate is usually used for items whose transactions are numerous and occur evenly throughout the year, for example, sales, purchases and operating expenses, but, if exchange rates fluctuate significantly, the use of the average for a period is inappropriate. Any exchange difference resulting from its application is called cumulative translation adjustment (CTA) shown as a component of stockholders’ equity.

Method 2. Translation into the Functional currency/Re-measurement of Foreign Currency Financial Statements to the Functional Currency (Temporal/Re-measurement Method). This method is used on the following basis: • • •

•

Foreign operation is integrated with parent’s operation Functional currency should be the parent’s currency/presentation or reporting currency The main features of the Temporal or Remeasurement Method are summarized as follows: o Monetary assets and liabilities (i.e. cash and fixed deposits, receivables, payables and most liabilities) shall be translated (remeasured) using the closing rate. o Non-monetary items – (i.e. fixed assets, investment at cost, prepaid items except prepaid interest, inventories and intangible assets) shall be translated (remeasured) using the exchange rate at the date of the transaction (historical rate). o Non-monetary items at fair value or at current of future exchange prices (i.e. trading securities, inventories carried at reprlacement cost and revalued fixed assets shall be translated (remeasured using the exchange rate at the date of revaluation or fair value determination. o Stockholder’s equity accounts – are translated (or remeasured) using the historical rates in effect at the time equities were first recognized (date of investment) in the foreign entity’s accounting records, except: ➢ Beginning Retained Earnings – is set equal to the ending balance of last year. ➢ Dividends – historical rate on date of declaration, otherwise date of payment. Income statement items: o Related to non-monetary items such as cost of sales, depreciation of plant assets, amortization of intangible assets, amortization of deferred charges or credits and other allocation of non-monetary items shall be translated (or remeasured) using historical rate (either at the date of purchase for historical items or the date of valuation for items carried at fair value). o Not related to non-monetary items (or related to monetary items) such as sales, purchases, expenses, and income items that result in inflow/outflow of monetary items shall be translated (remeasured) using actual rate (historical rate); however for practical reasons, an average rate may be used. o Resulting difference (remeasurement gain or loss) should be reported as profit or loss for the period either as foreign exchange gain or loss.

Hedging Foreign Currency transactions Companies with assets or liabilities denominated in a foreign currencty are exposed to the risk that the exchange rate might fluctuate, thus causing transaction gains and losses. A company wishing to eliminate this risk could enter a transaction called a hedge. Except for speculative hedges, which is a stand-alone contract, hedge agreements have underlying transactions that justify the creation of the hedge instrument. The underlying transaction is the hedged item, and the hedge instrument is the mechanism established to minimize adverse effects of changes in exchange rates on the hedged item.

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II

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Multiple Choice Problems 1. Cebuana Company, a Philippine Corporation, bought inventory from a supplier in Japan on November 2, 2017 for 50,000 yen, when the spot rate was P.4245. On December 31, 2017, the spot rate was P.4295. On January 15, 2018, Cordillera bought 50,000 yen at a spot rate of P.4250 and paid the invoice. How much should Cebuana report in its income statements for (1) 2017 and (2) 2018 as foreign exchange gain or (loss) a. b. c. d.

(1) P250; (2) (P225) (1) (P250); (2) P225 (1) P0; (2) (P225) (1) P0; (2) P220

2. On October 1, 2017, Ilocandia Company acquired goods from USA Company for $10,000 payable in US dollars on April 1, 2018. Spot rates on various dates follow: Transaction date P1 = $0.018 Balance sheet date, 12/31/17 P1 = $0.017 Settlement date P1 = $0.020 As a result of this transaction, Ilocandia Company has a foreign exchange gain or loss in 2017 and 2018, respectively of a. P(32,680) and P88,235 b. P32,680 and P(88,235) c. P(100) and P300 d. P(10) and P30 3. On July 1, 2017, Southern Tagalog Company lent P308,000 to a US supplier, evidenced by an interest-bearing note due on July 1, 2018. The note is equivalent to $8,000 on the loan date. The note principal was appropriately included at P32,000 in Southern Tagalog’s December 31, 2018 balance sheet. The note was repaid to Southern Tagalog on July 1, 2018 due date when the exchange rate was P39 to $1. In its income statement for the year ended December 31, 2018, what amount should Southern Tagalog include as a foreign currency transaction gain or loss? a. P0 b. P26,000 gain c. P16,000 gain d. P16,000 loss 4. Certain balance sheet accounts of a foreign subsidiary in Japan of Metro Manila, Inc. at December 31, 2017 have been translated into Philippine pesos as follows: Current Rate Historical Rate Accounts Receivable P120,000 P100,000 Prepaid Insurance 55,000 50,000 Copyright 75,000 85,000 What was the total amount included in Metro Manila’s December 31, 2017 consolidated balance sheet for the above accounts? a. P255,000 b. P235,000 c. P240,000 d. P250,000 5. A wholly-owned subsidiary in Hongkong of Panay Corporation has certain expense accounts for the year eneded December 31, 2017 stated in Hongkong dollars, as follows: Depreciation (related assets were purchased on January 1, 2012) P120,000HK$ Provision for doubtful accounts 80,000 Rent 200,000 The functional currency of Panay Corporation and its Hongkong subsidiary is the Phil. Peso The exchange rates for HK$ at various dates were as follows: December 31, 2017 P5.40 Average for the year ended December 31, 2017 5.44

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II January 1, 2012

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5.50

What total peso amount should be included in Panay Corporation’s 2017 consolidated income statement to reflect these expenses? a. P2,176,000 b. P2,183,200 c. P2,180,000 d. P2,132,000 6. On December 31, 2017 a foreign subsidiary of a NCR Corporation submitted the following balance sheet in foreign currency. FC Total assets 100,000 Total liabilities 20,000 Common Stocks 50,000 Retained Earnings, 12/31/17 30,000 The exchange rates for 1FC are as follows: Current rate P3.40 Historical rate 3.10 Weighted average rate 3.00 Assuming the retained earnings of the subsidiary on December 31, 2017 translated to Philippine pesos is P92,000, what amount is to be reported in the consolidated balance sheet on December 31, 2017? a. P25,000 gain b. P20,000 gain c. P25,000 loss d. P22,000 loss 7. Bukidnon Enterprises, A Philippine importer, purchased merchandise from the Star Company of Thailand for 100,000 Baht on March 1, 2017, when the spot rate for a Baht was P1.630. The accounts payable denominated in baht was not due until May 30, 2017 so Bukidnon immediately entered into a 90-day forward contract to hedge the transaction against exchange rate changes. The contract was made at forward exchange rate of P1.650. Bukidnon settled the forward contract and the account payable on May 30, when the spot rate for Baht was P1.600. On the settlement of the forward contract on May 30, 2017, Bukidnon should record a forex gain or (loss) of: a. P5,000 b. P(5,000) c. P2,000 d. P(2,000) 8. Gensan Corporation purchases merchandise from Lacoste Company of France for 1,000,000 Franc. The merchandise is received on December 1, 2017, with payment due in 60 days on January 30, 2018. Also on December 1, 2017, Gensan enters into a 60-day forward contract with the Bank to purchase 1,000,000 francs. The relevant rates for Franc on selected dates are as follows:

Spot rate 30-days futures 60-days futures

12/01/17 P6.01 6.05 6.06

12/31/17 P6.16 6.07 6.08

1/30/18 P6.01 6.07 6.08

What is the next forex gain (loss) from this transaction and hedge that will be reported on Gensan’s 2017 income statement? a. P(130,000) b. P130,000 c. P20,000 d. P(140,000)

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II

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9. Benguet Company, a money changer, speculates in foreign currency as its business. On October 1, 2017, Benguet bought a 180-day forward contract to purchase 5,000 FC at a forward rate of 1FC=P56.50 when the spot rate was P56.00. Other exchange rates were as follows: Spot rate Forward Rate for March 31, 2018 Dec. 31, 2017 P56.30 P56.60 Mar. 31, 2018 56.32 The forex gain(loss) recognized by Benguet from this forward contract is: a. P1,500 b. P(900) c.P500 d. P(10,000) 10. The following information applies to Bohol Corporation’s sales of 10,000 foreign currency units under a forward contract dated November 1, 2017, for delivery on January 31, 2018: November 1, 2017 December 31, 2017 Spot rate P0.80 P0.83 30-day futures 0.79 0.82 90-day futures 0.78 0.81 Bohol entered into a contract to speculate in the foreign currency. In Bohol’s income statement for the year ended December 31, 2017, what amount of foreign exchange gain (loss) should be reported from this forward contract? a. P100 b. P300 c. P200 d. P(400) On December 31, 2017, Misamis, Inc. paid P3,000 to purchase a 90-day call option for P500,000 Thailand Baht. The option’s purpose is to protect an exposed liability of 500,000 baht relating to a purchase of merchandise received on December 1, 2017 and to be paid on March 1, 2018. Relevant rates and market values at different dates are as follows: 12/01/17 12/31/17 03/01/18 Spot rate (market P1.20 P1.28 P1.27 price) Strike price 1.20 1.20 1.20 (exercise price) Fair value of call P ? P ? P ? option 11. On December 31, 2017, the accounts payable amounted to a. P600,000 b. P640,000 c. P635,000 d. P0 12. On December 31, 2017, the fair value of the Contract Option is a. P3,000 b. P42,000 c. P35,000 d. P39,000 13. At the March 1, 2018 expiration date, the intrinsic component of the Currency contract Option is a. P3,000 b. P35,000 c. P40,000 d. P42,000 14. Calculate the option’s time value at December 1, 2017 a. P3,000 b. P35,000 c. P40,000

d. P42,000

15. Calculate the option’s intrinsic value at December 31, 2017 a. P3,000 b. P35,000 c. P40,000 d. P42,000 16. Calculate the option’s (1) time value and (2) intrinsic value at March 1, 2018 just before the cash settlement a. (1) P3,000 and (2) P35,000 b. (1) P4,000 and (2) P39,000 c. (1) P 0 and (2) P35,000 d. (1) P35,000 and (2) P 0

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II

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Take Home Drill 1. On September 1, 2018, Junjun Company received an order for equipment from a foreign customer for FC 300,000 when the Philippine peso equivalent was P96,000. Junjun shipped the equipment on October 15, 2018, and billed the customer for FC 300,000 when the Phil. Peso equivalent was P100,000. Junjun received the customer’s remittance in full on November 16, 2018, and sold the FC 300,000 for P105,000. In its income statement for the year ended December 31, 2018, Junjun should report a foreign exchange gain of a. P5,000 b. P4,000 c. P9,000 d. No gain or loss 2. Alecks Corporation had the following foreign currency transactions during 2018 a. Merchandise was purchased from foreign supplier on January 20, 2018 for the peso equivalent of P90,000. The invoice was paid on March 20, 2018 at the Phil. Peso equivalent of P96,000. b. On July 1, 2018, Alecks borrowed the Philippine peso equivalent of P500,000 evidenced by a note that was payable in the lender’s local currency on July 1, 2018. On December 31, 2018, the Phil. Peso equivalent of the principal amount and accrued interest were P520,000 and P26,000 respectively. Interest on the note is 10% per annum. In Aleck’s Income statement, the amount that should be included as a foreign exchange loss a. P0 b. P21,000 c. P6,000 d. P27,000 3. On April 8, 2017, Calamba Corporation purchased merchandise from an unaffiliated foreign company for 5,000 units of the foreign company’s local currency. Calamba paid the bill in full on March 1, 2018 when the spot rate was P0.45. The spot rate was P0.60 on April 8, 2017 and was P0.55 on December 31, 2017. For the year ended December 31, 2018, Calamba should report a transaction gain of a. P1,500 b. P500 c. P1,000 d. P0 4. On July 1, 2017, Boracay, Inc. lend FC 100,000 to a foreign supplier, evidenced by an interest-bearing note due on July 1, 2018. The note is denominated in the currency of the borrower and was equivalent to P840,000 on the loan date. The note principal was approximately included at P820,000 in the receivables section of Tawi-Tawi’s December 31, 2017 balance sheet. The note principal was repaid to Boracay on the July 1, 2018 due date when the exchange rate was FC1 to P8. In its income statement for the year ended December 31, 2017, the amount Conception should include as a foreign currency transaction gain or (loss) is a. P40,000 b. P(40,000) c. P80,000 d. P(20,000) On June 15, 2018, Bulacan Corp. purchased merchandise worth 100,000 Swiss francs from its Swiss supplier payable within 30 days under an open account arrangement. Bulacan issued a 30-day 6% note payable in Swiss francs. On July 15, 2018 Bulacan paid the note in full. The following information on spot rates (P/SF) are provided: June 15, 2018 July 15, 2018

Buying P24.03 24.10

5. Bulacan’s foreign exchange gain or (loss) for the transaction is a. P(5,040) b. P(7,035) c. P12,075 d. P(19,110) 6. How much did Bulacan pay the Swiss supplier on July 15, 2018? a. P2,415,015 b. P2,422,050 c. P2,434,110 d. P2,427,075

Selling P24.15 24.22

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7. A foreign subsidiary of Mindanao Company, (a Philippine firm) has certain balance sheet accounts on December 31, 2018. The functional currency and reporting, and parent’s books are kept in Philippine pesos. Information relating to these accounts in Phil. Pesos is as follows: Translated at Current Rate Historical Rate Accounts Receivable P75,000 P85,000 Inventories (carried at average 600,000 700,000 cost) Prepaid Insurance 25,000 30,000 Land 55,000 70,000 What amount should be included as total assets on Mindanao’s balance sheet on December 31, 2018 as the result of above information? a. P770,000 b. P755,000 c. P780,000 d. P875,000 On December 10, 2017, Quezon Corp. entered into a 90-day forward exchange contract involving FC 1,000,000 in anticipation that the FC would weaken. The following direct exchange rates are assumed: Spot rate December 10, 2017 December 31, 2017 March 10, 2018

P0.90 0.80

Forward rate (for March 10, 2018) P0.86 0.87

8. The amount of the foreign currency transaction gain or loss that would be reported in the income statement for the year 2017 on the forward exchange contract, assuming that the contract is a hedge of a recorded but unsettled inventory sale transaction is a. P20,000 gain b. P40,000 gain c. P10,000 loss d. P20,000 loss 9. Same information as in No. 8, but assume that the forward exchange contract pertains to speculation in foreign currency. a. P40,000 loss b. P30,000 loss c. P0 d. P10,000 loss 10. If one Taiwan dollar can be exchanged for P1.025 Philippine Money, the fraction to be used to compute indirect quotation of exchange rate expressed in Taiwanese currency is a. 0.975/1.00 b. 1.000/0.975 c. P1.000/1.025 d. 1.025/1.00 On December 1, 2017, a Philippine firm purchased a speculative hedge to buy 30,000 foreign currency when the spot rate was P1.10 and a 60 day forward rate was P1.12. The spot rate at December 31 (the company’s year-end was P1.25 and a 30-day forward rate as P1.13). When the speculative hedge was exercised on January 31, 2018 the spot rate was P1.11 and a 30 day forward rate, P1.12. 11. The journal entry to record this hedge would include a debit to Contract Receivable in the amount of a. P33,600 b. P600 c. P33,000 d. P0 12. The amount of foreign exchange gain/loss that would appear on the income statements of the Philippine company resulting from this speculative hedge for the years ended 2017 and 2018 are a. 2017 = P300 loss; 2018 = 600 loss b. 2017 = P300 gain; 2018 = 600 gain c. 2017 = P300 loss; 2018 = 600 gain d. 2017 = P300 gain; 2018 = 600 loss 13. The Pangasinan, Inc. owns a foreign subsidiary that had net income for the year ended December 31, 2017 of FC 4,800,000, which was approximately translated into P800,000. On December 15, 2017, when the date of exchange was FC5.7 to P1.00, the foreign subsidiary paid a dividend to Subic of FC 2,400,000. The dividend represented the net income of the foreign subsidiary for the six months ended June 30, 2015, during which time the weighted average exchange rate was FC 5.81 to P1.00, the exchange rate in effect at December 31, 2016 was FC5.9 to P1.00 What rate of exchange should be used to translate the dividend for the December 31, 2016 financial statements? a. FC5.7 to P1.00 b. FC5.8 to P1.00 c. FC5.90 to P1.00 d. FC6.00 to P1.00

University of Nueva Caceres College of Business and Accountancy Comprehensive Accounting (Batch 2019) Advanced Financial Accounting and Reporting II

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14. Cagayan de Oro Corp. has acquired a fully- controlled subsidiary in Thailand on January 1, 2018. The determined functional currencies of the entities are: for the parent, Philippine pesos; for the subsidiary, Thailand Baht. The following are summarized from the balance sheets of the affiliated companies at December 31, 2018. (Summary figures exclude inter-company balances.) Phil. Parent Thai Subsidiary Monetary assets P10,000,000 B3,000,000 Non-monetary assets 20,000,000 B6,500,000 The relevant spot rates are to be used Current rate TB1 Historical rate TB1 Weighted average rate TB1

is to is to is to

P1.50 P1.40 P1.45

Based on the above data, determine the consolidated balances (1) for monetary assets, and (2) for non-monetary assets, if the group decide on a baht presentation currency. a. (1) B 9,666,667; (2) B19,833,333 b. (1) B10,142,857; (2) B20,833,333 c. (1) B 9,666,667; (2) B20,785,714 d. (1) B 9,896,552; (2) B20,833,333 15. Davao Corporation sold handicraft goods to a US firm for $100,000 in 2017. Pertinent information on exchange rates follows:

September 4 October 15 December 31 January 6, 2018

Receipt of order Date of shipment Date of balance sheet Date of settlement

The sale would be appropriately recorded at a. P4,700,000 b. P4,580,000 c. P4,720,000 d. P4,600,000 Answer Key: 1. A 2. D 3. B 4. D 5. B 6. C 7. B 8. C 9. D 10. C 11. A 12. D 13. A 14. A 15. A

Conversion Rate (Peso to US$) P45.80 P47.00 P47.20 P46.00