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Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
CHAPTER 11
MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY
TRANSACTIONS AND FINANCIAL INSTRUMENTS
OVERVIEW OF CHAPTER
Chapter 11 presents students with a foundation in the language of international business
and the effects of changes in foreign currency exchange rates. The chapter begins with an
introduction to the global business environment. The six major currencies, the European Union,
and major regional agreements are mentioned. The chapter then provides examples of foreign
currency transactions that are denominated in a foreign currency, which require revaluations into
their U.S. dollar equivalent values as of the date of the transaction, the end of the fiscal year, and
the settlement date.
Pertinent provisions of ASC 830 and 815, and their applications are discussed in the
chapter. The chapter emphasizes the journal entries and financial disclosures required for foreign
currency transactions. Methods for managing international currency risk utilizing foreign
currency forward contracts are discussed and illustrated in detail. Derivatives and forward
contracts are fully discussed. Four cases are utilized to illustrate the major uses of forward
exchange contracts: (1) managing an exposed foreign currency net asset or liability position, (2)
hedging an unrecognized foreign currency firm commitment, (3) hedging a forecasted foreign
currency transaction - cash flow hedge, and (4) speculation in foreign currency markets.
For hedges of an exposed foreign currency payable or receivable, the gain or loss from
the change in value of the forward exchange contract offsets the loss or gain on the underlying
item being hedged. For hedges of an unrecognized foreign currency commitment, the gain or loss
on the forward exchange contract offsets the loss or gain on the financial instrument component
of the firm commitment. The basis of the nonfinancial component of the commitment (e.g.,
inventory that will be acquired in the future) is adjusted at the date of the future transaction. For
hedges of a forecasted foreign currency transactions, the revaluation of accounts payable or
receivable is recognized in current income, while the effective portion of the forward contract
revaluation is recorded in other comprehensive income. An amount equal to the related foreign
exchange transaction gain or loss is reclassified each period from comprehensive income to
earnings. For speculation, the forward exchange contract is measured using its forward exchange
rate for the remaining term, and the gain or loss is recognized in income. In the case of a hedge
of a net investment in a foreign entity, the gain or loss on the hedge is reported as part of other
comprehensive income.
As a general rule, derivative financial instruments should be reported at their fair values,
and the gain or loss for the period should be recognized.
Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
11-2
Appendix 11A presents illustrations of valuing forward exchange contracts and hedges.
Appendix 11B discusses use of other financial instruments by multinational companies.
LEARNING OBJECTIVES
When students finish studying this chapter, they should be able to:
LO 11-1 Understand how to make calculations using foreign currency exchange rates.
LO 11-2 Understand the accounting implications of and be able to make calculations related to
foreign currency transactions.
LO 11-3 Understand how to hedge international currency risk using foreign currency forward
exchange financial instruments.
LO 11-4 Know how to measure hedge effectiveness, make interperiod tax allocations for
foreign currency transactions, and hedge net investments in a foreign entity.
SYNOPSIS OF CHAPTER 11
Multinational Accounting: Foreign Currency Transactions and Financial Instruments
Microsoft’s Multinational Business
LO 11-1 Understand how to make calculations using foreign currency exchange rates.
Doing Business in a Global Market
The Accounting Issues
Foreign Currency Exchange Rates
The Determination of Exchange Rates
Direct versus Indirect Exchange Rates
Changes in Exchange Rates
Spot Rates versus Current Rates
Forward Exchange Rates
LO 11-2 Understand the accounting implications of and be able to make calculations related to
foreign currency transactions.
Foreign Currency Transactions
Foreign Currency Import and Export Transactions
LO 11-3 Understand how to hedge international currency risk using foreign currency forward
exchange financial instruments.
Managing International Currency Risk with Foreign Currency Forward Exchange
Financial Instruments
Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
11-3
Derivatives Designated as Hedges
Forward Exchange Contracts
Case 1: Managing an Exposed Foreign Currency Net Asset or Liability
Position: Not a Designated Hedging Instrument
Case 2: Hedging an Unrecognized Foreign Currency Firm
Commitment: A Foreign Currency Fair Value Hedge
Case 3: Hedging a Forecasted Foreign Currency Transaction: A
Foreign Currency Cash Flow Hedge
Case 4: Speculation in Foreign Currency Markets
Foreign Exchange Matrix
LO 11-4 Know how to measure hedge effectiveness, make interperiod tax allocations for
foreign currency transactions, and hedge net investments in a foreign entity.
Additional Considerations
A Note on Measuring Hedge Effectiveness
Interperiod Tax Allocation for Foreign Currency Gains (Losses)
Hedges of a Net Investment in a Foreign Entity
Appendix 11A: Illustration of Valuing Forward Exchange Contracts with Recognition for the
Time Value of Money
Appendix 11B: Use of Other Financial Instruments by Multinational Companies
Definitions and Descriptions
Forward and Futures Contracts
Option Contracts
Swaps
Example of the Use of an Option to Hedge an Anticipated Purchase of Inventory: A Cash
Flow Hedge
Example of an Option Contract to Hedge Available-For-Sale Securities: A Fair Value
Hedge
Example of an Interest-Rate Swap to Hedge Variable-Rate Debt: A Cash Flow Hedge
Reporting and Disclosure Requirements: Disclosures about Fair Value of Financial
Instruments
Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
11-4
NOTES ON POWERPOINT SLIDES
We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.
If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.
We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.
The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple-choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.
LO 11-1 Understand how to make calculations using foreign currency exchange rates.
• Slides 3-4 summarize key issues related to foreign currency transactions
• Slides 5-18 explain important concepts related to foreign currencies.
LO 11-2 Understand the accounting implications of and be able to make calculations related to
foreign currency transactions.
• Slides 22-23 explain how to record foreign currency transactions.
• Slide 24 provides an example illustrating how to account for foreign currency
transactions.
Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
11-5
• Slides 25-28 summarize additional details regarding entries on different relevant
dates.
• Slides 29-31 provide an illustration showing journal entries for foreign currency
transactions.
LO 11-3 Understand how to hedge international currency risk using foreign currency forward
exchange financial instruments.
• Slides 35-37 introduce the concept of hedging of foreign currency transactions.
• Slides 38-44 explain how derivatives can be used to hedge foreign currency
transactions. These slides also explain the differences between fair value and cash
flow hedges.
• Slides 45-83 provide four cases illustrating forward exchange contracts.
LO 11-4 Know how to measure hedge effectiveness, make interperiod tax allocations for
foreign currency transactions, and hedge net investments in a foreign entity.
• Slides 87-89 cover additional topics:
o Measuring the effectiveness of hedges
o Interperiod tax allocations for foreign currency transactions
o Hedges of a net investment in a foreign entity.
Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
11-6
TEACHING IDEAS
1. Students could be assigned to locate a current set of currency quotations. This may be
found in any Wall Street Journal or other major business press. Students could then be
asked to determine the current U.S. dollar equivalent value of 100,000 (Euro), or £5,000
(British pounds). In addition, students could be asked to compare the current spot rate for
a foreign currency with the forward rate for 180 days to determine which way (increase
or decrease) the market expects the exchange rate to change in the future. Finally,
students could be asked to compare the direct and indirect rate and determine if they are
exactly reciprocal to each other. A slight difference is normally found due to slight
differences in brokerage commissions and fees.
2. Students could perform a historical review of currency exchange rates to determine if the
dollar has strengthened or weakened relative to another currency (e.g., the yen) for the
last two years and determine the impact that change has had on import and export
transactions with companies in that country (e.g., Japan). Exchange rates are available in
the daily business press so students may obtain these historical rates from past copies of
the Wall Street Journal.
3. Students could review an actual annual report to determine the magnitude of the foreign
exchange gain or loss of the company. Many firms may list these only in the footnotes as
an item included in other income. Students could then determine the relative contribution
to income or loss from the foreign currency transactions' gains or losses during a period.
In addition, students could review the financial instruments footnote to determine the
types of hedging activities used by the company. Larger companies typically have a
variety of hedging activities.
4. Students could be asked to review the financial statement notes of a Fortune 500
company and write a report describing their disclosures regarding derivatives.
Chapter 11 - MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND
FINANCIAL INSTRUMENTS
11-7
DESCRIPTIONS OF CASES, EXERCISES, AND PROBLEMS
C11-1
LO 11-1,
LO 11-2
30 min.
M
Effects of Changing Exchange Rates
Students are asked to identify and explain the major factors affecting exchange
rates and to show the impact of changing exchange rates on U.S. consumers and
businesses.
C11-2
LO 11-2
15 min.
E
Reporting a Foreign Currency Transaction on the Financial Statements
[AICPA Adapted]
A purchase transaction denominated in a foreign currency is presented. The
dollar's value declined between the transaction date and the end of the year, but
is expected to recover by the time the liability is paid. Students must discuss and
evaluate the required disclosures.
C11-3
LO 11-1
60 min.
M
Changing Exchange Rates
This research case asks students to access database resources to determine the
monthly changes over the last two years between the U.S. dollar and (a) the
Japanese yen, (b) the European Euro, (c) the British pound, and (d) the Mexican
peso. A graph of the exchange rates over the 2-year period is then requested.
Students must then assess possible reasons for the changes in the exchange rates.
C11-4
LO 11-2
40 min.
M
Accounting for Foreign Currency-Denominated Accounts Payable
Students must review the authoritative accounting standard pertaining to foreign
currency transactions and write a memorandum from the perspective of an audit
staff addressing the client’s accounting for its purchase transactions with a Swiss
supplier.
C11-5
LO 11-3
30 min
M
Accounting for Foreign Currency Forward Contacts
Students must review the authoritative accounting standard for foreign currency
forward contracts and write a memo to the treasurer outlining the accounting for
these types of contracts. References to the authoritative standard must be
included.
C11-6
LO 11-3
40 min.
H
Accounting for Hedges of Available-for-Sale Securities
An insurance company holding an extensive portfolio of available-for-sale
securities is considering entering into an interest rate future contract to hedge its
exposure to interest rate changes. Students are asked to review the pertinent
accounting standard and determine whether hedge accounting can be utilized by
the company. A memorandum to the CFO must include authoritative cites.
