Foreign Currency Issues

Overview

When a U.S. company engages in transactions denominated in a foreign currency or has foreign subsidiaries, it must account for the effects of exchange rate fluctuations. ASC 830, Foreign Currency Matters, addresses two main areas:

1. Foreign currency transactions — buying/selling goods in a foreign currency
2. Foreign currency translation and remeasurement — converting a foreign subsidiary's financial statements

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Foreign Currency Transactions

A foreign currency transaction occurs when a U.S. company enters into a transaction denominated in a currency other than the U.S. dollar (its functional currency).

Recording at the Spot Rate

Transactions are initially recorded at the spot rate (the exchange rate on the transaction date). Example: On November 1, Bear Co. sells merchandise to a customer in the UK for £100,000 when the spot rate is $1.30/£.

$$\text{Receivable} = £100{,}000 \times \$1.30 = \$130{,}000$$

Debit

Credit

Accounts receivable

$130,000

Sales revenue

$130,000

Year-End Remeasurement

At the balance sheet date, monetary items (receivables, payables, cash) denominated in a foreign currency are adjusted to the current spot rate. The resulting gain or loss is recognized in net income. On December 31, the spot rate is $1.35/£:

$$\text{New receivable value} = £100{,}000 \times \$1.35 = \$135{,}000$$ $$\text{Foreign currency gain} = \$135{,}000 - \$130{,}000 = \$5{,}000$$

Debit

Credit

Accounts receivable

$5,000

Foreign currency gain

$5,000

:::tip Exam Tip

Receivables: If the foreign currency strengthens, the U.S. company has a gain (the receivable is worth more in USD). If it weakens, the company has a loss. Payables: The effect is opposite — a strengthening foreign currency means a loss (the payable costs more in USD).

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Settlement

On February 1, Bear Co. collects the £100,000 when the spot rate is $1.28/£:

$$\text{Cash received} = £100{,}000 \times \$1.28 = \$128{,}000$$ $$\text{Foreign currency loss} = \$135{,}000 - \$128{,}000 = \$7{,}000$$

Debit

Credit

Cash

$128,000

Foreign currency loss

7,000

Accounts receivable

$135,000

Summary of Exchange Rate Effects

Situation	FC Strengthens	FC Weakens
A/R in FC	Gain	Loss
A/P in FC	Loss	Gain

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Forward Contracts (Hedging)

A company may enter into a forward contract to hedge against exchange rate risk. A forward contract locks in a future exchange rate for buying or selling foreign currency.

Hedging a Recognized Foreign Currency Receivable

On November 1, Bear Co. enters into a forward contract to sell £100,000 in 90 days at a forward rate of $1.32/£. The forward contract is a fair value hedge of the receivable. At December 31:

• Spot rate: $1.35/£
• Forward rate for remaining 30 days: $1.33/£ The receivable gain of $5,000 was recorded above. The forward contract generates: $$\text{Forward contract loss} = (£100{,}000) \times (\$1.33 - \$1.32) = \$1{,}000$$ This simplified example shows how the hedge offsets (but may not perfectly match) the gain/loss on the hedged item.
  info

  The forward contract is recorded at fair value on the balance sheet. Changes in fair value are recognized in earnings for fair value hedges, offsetting the gain/loss on the hedged item.

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Foreign Currency Translation vs. Remeasurement

When a U.S. parent company has a foreign subsidiary, the subsidiary's financial statements must be converted to U.S. dollars. The method depends on the subsidiary's functional currency.

Functional Currency Concept

The functional currency is the currency of the primary economic environment in which the subsidiary operates.

Functional Currency	Method	Where Gains/Losses Go
Foreign currency (local)	Translation (current rate method)	OCI (CTA)
U.S. dollar	Remeasurement (temporal method)	Net income

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Translation (Current Rate Method)

Used when the functional currency is the foreign (local) currency. This method preserves the subsidiary's financial relationships.

Financial Statement Item	Exchange Rate Used
Assets	Current rate (balance sheet date)
Liabilities	Current rate (balance sheet date)
Equity (common stock, APIC)	Historical rate (date of issuance)
Revenues and expenses	Weighted-average rate for the period
Dividends	Historical rate (date declared)
The cumulative translation adjustment (CTA) is reported in accumulated other comprehensive income (AOCI) — a component of equity.
Example: Gies Co. (U.S. parent) has a subsidiary in Japan. The yen is the functional currency. At year-end:
Item	Yen Amount
---	---
Total assets	¥50,000,000
Total liabilities	¥20,000,000
Common stock	¥10,000,000
Retained earnings	¥15,000,000
Revenue	¥30,000,000
Expenses	¥25,000,000
The CTA is the plug that makes the balance sheet balance in USD.

$$\text{CTA} = \text{Total Assets (USD)} - \text{Total Liabilities (USD)} - \text{Equity accounts (USD)}$$ $$\text{CTA} = \$340{,}000 - \$136{,}000 - \$80{,}000 - \$110{,}000 = \$14{,}000$$

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Remeasurement (Temporal Method)

Used when the functional currency is the U.S. dollar (or the subsidiary operates in a highly inflationary economy).

Financial Statement Item	Exchange Rate Used
Monetary assets/liabilities (cash, receivables, payables)	Current rate
Nonmonetary assets (inventory at cost, fixed assets, intangibles)	Historical rate
Revenues and expenses	Weighted-average rate
Depreciation, amortization, COGS (if from historical cost inventory)	Historical rate
Common stock, APIC	Historical rate
The remeasurement gain or loss is reported in net income (not OCI).

warning

A key difference: under translation, all assets use the current rate. Under remeasurement, only monetary items use the current rate while nonmonetary items use historical rates.

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Highly Inflationary Economies

An economy is considered highly inflationary if the cumulative inflation rate over a 3-year period exceeds approximately 100% (roughly 26% per year compounded). In such cases, the functional currency is deemed to be the reporting currency (USD), and the temporal method (remeasurement) is used regardless of the subsidiary's actual operating environment.

Key Comparison

Feature	Translation	Remeasurement
When used	FC = local currency	FC = USD
Assets rate	Current	Monetary: current; Nonmonetary: historical
Revenue/expense rate	Average	Average (except historical-cost items)
Equity rate	Historical	Historical
Gain/loss reported in	OCI (CTA)	Net income

:::tip Exam Mnemonic

"Current goes to CTA" — the current rate method produces a CTA that goes to OCI. "Temporal goes to the temporaries (income statement)" — remeasurement gains/losses go directly to net income.

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Summary

:::note Chapter Checklist

• Record foreign currency transactions at the spot rate
• Remeasure monetary items at year-end and recognize gains/losses in income
• Calculate settlement gains/losses on collection or payment
• Understand the basics of forward contracts as hedges
• Determine the functional currency to choose translation vs. remeasurement
• Apply the current rate method (translation) and report CTA in OCI
• Apply the temporal method (remeasurement) and report gains/losses in income
• Identify highly inflationary economies and use the temporal method :::