RSM321H1 Chapter Notes - Chapter 10: Foreign Exchange Spot, Canadian Dollar, Spot Contract

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Published on 3 Dec 2017
School
UTSG
Department
Rotman Commerce
Course
RSM321H1
Chapter 10
Currency Exchange Rates
Many Canadian companies conduct business in foreign countries as well as in Canada. No
specific accounting issues arise when the parties involved in an import or export transaction
agree that the settlement will be in Canadian dollars. Because it is a Canadian-dollar-
denominated transaction, the company will record the foreign purchase or sale in exactly the
same manner as any domestic purchase or sale. In many situations, however, the agreement calls
for the transaction to be settled in a foreign currency. This means one of two things: (a) the
Canadian company will have to acquire foreign currency in order to discharge the obligations
resulting from its imports, or (b) the Canadian company will receive foreign currency as a result
of its exports and will have to sell the foreign currency in order to receive Canadian dollars.
Transactions such as these are called foreign-currency-denominated transactions.
Both the recording of foreign-currency-denominated transactions and the translation of foreign-
currency financial statements require the use of currency exchange rates. An exchange rate is
simply the price of one currency in terms of another currency. Exchange rates fluctuate on a daily
basis.
Transactions denominated in foreign-currency are recorded in Canadian dollars at the spot rate in
effect on the date of the transaction. At the date of the balance sheet, foreign-currency assets and
liabilities are translated into Canadian dollars to preserve the normal measurement at either
historical cost or current value. Any gains or losses arising from changes in exchange rates on the
exposed items are reflected in profit for the period.
Some points to remember about foreign-currency transactions:
Exchange rates fluctuate over time due primarily to differences in inflation rates, interest rates,
and trading practices between the two countries.
Exchange rates can be quoted directly or indirectly. The direct method is the reciprocal of the
indirect method.
• The spot rate is the rate to exchange currency today, whereas the forward rate is the rate agreed
to today for exchanging currency at a future date.
A forward exchange contract is an agreement between a bank and a customer to exchange
currencies on a specified future date at a specified rate.
It is important to note that currency issues can be discussed and analyzed from many different
perspectives. There are four main perspectives: (1) denominated currency (the currency in which
the transaction is denominated); (2) recording currency or internal record-keeping currency (the
currency in which the transaction is recorded in the internal accounting records); (3) functional
currency (the currency of the primary economic environment in which the entity operates); and
(4) presentation or reporting currency (the currency in which the financial statements are
presented by the reporting entity).
IAS 21 The Effects of Changes in Foreign Exchange Rates requires that individual transactions
be translated into the functional currency of the reporting entity. In turn, IAS 21 states that an
entity can present or report its financial statements in any currency it wants to use. IAS 21
defines functional currency as the currency of the primary economic environment in which the
entity operates and foreign currency as any currency other than the functional currency of the
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entity. The primary economic environment is normally the one in which the entity primarily
generates and expends cash.
• A monetary item is converted into cash at a fixed and predetermined amount of currency.
For accounting purposes, there are basically three rates used in translating foreign currency into
the reporting currency: the closing rate, the historical rate, and the forward rate. The spot rate at
the end of the reporting period of the financial statements is called the closing rate. The spot rate
on the date of a transaction is called the historical rate for that transaction. The agreed rate for
exchange of currencies at a future date is called the forward rate.
The average rate is the weighted average of the historical rates for the period. Individual
transactions must be translated into the functional currency at the historical rate.
According to IAS 21, a foreign-currency transaction must 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. At the end
of each reporting period, (a) foreign-currency monetary items must be translated using the
closing rate; (b) non-monetary items that are measured in terms of historical cost in a foreign
currency must be translated using the historical rate; and (c) non-monetary items that are
measured at fair value in a foreign currency must be translated using the exchange rates at the
date when the fair value was determined. We will refer to this method of translation as the
temporal method. The translation method should ideally produce either historical cost in dollars
or fair value in dollars consistent with normal measurement rules for the financial statement
items. Recall that according to Canadian GAAP, monetary assets and monetary liabilities are
typically valued at fair value, non-monetary assets are usually valued at the lower of historical
cost and market value, and non-monetary liabilities and shareholders’ equity are usually valued at
historical amounts. Revenues and expenses are usually measured at historical amounts.
Any exchange adjustments arising on the settlement of monetary items or on the translation of
monetary items at rates different from those at which they were translated on initial recognition
during the period or in previous financial statements must be recognized in profit or loss in the
period in which they arise, with two exceptions. First, when a gain or loss on a non-monetary
item is recognized in other comprehensive income, any exchange adjustment pertaining to that
item must also be recognized in other comprehensive income (for example, IAS 16 revaluation
model for property, plant, and equipment). Second, a monetary available-for-sale financial asset
(such as an investment in bonds) is treated as if it were carried at amortized cost in the foreign
currency. Exchange differences resulting from changes in the amortized cost of this asset are
recognized in profit or loss, and other changes in carrying amount are recognized in other
comprehensive income.
Import/Export Transactions Denominated in Foreign Currency
• Foreign-exchange adjustments are included in profit in the period in which they occur.
• The sale is translated at the historical rate to produce a historical price in Canadian dollars. This
is consistent with normal measurement rules to record sales at historical values.
The accounts receivable (or accounts payable) is translated at the closing rate to produce a
current value in Canadian dollars. This is consistent with normal measurement rules to record
monetary items at current values.
• Exchange gains are reported in profit even though they are unrealized.
Transaction Gains and Losses from Non-current Monetary Items
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Document Summary

Many canadian companies conduct business in foreign countries as well as in canada. No specific accounting issues arise when the parties involved in an import or export transaction agree that the settlement will be in canadian dollars. Because it is a canadian-dollar- denominated transaction, the company will record the foreign purchase or sale in exactly the same manner as any domestic purchase or sale. In many situations, however, the agreement calls for the transaction to be settled in a foreign currency. This means one of two things: (a) the. Transactions such as these are called foreign-currency-denominated transactions. Both the recording of foreign-currency-denominated transactions and the translation of foreign- currency financial statements require the use of currency exchange rates. An exchange rate is simply the price of one currency in terms of another currency. Transactions denominated in foreign-currency are recorded in canadian dollars at the spot rate in effect on the date of the transaction.

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