Foreign Currency Transactions and Hedging Foreign Currency Risk | Advanced Accounting | CPA Exam FAR |

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These lectures cover foreign Currency Transactions and hedging foreign currency risk including forward contract, fair value, and cash flow hedge.

Foreign Currency Transactions

Hedging of Foreign Currency using Forward Contract

Fair Value Hedge Foreign Currency

Cash flow Hedge Foreign Currency

At the initial date, the transaction is recognized (in conformity with GAAP), the account (balance sheet or income statement) arising from the transaction is measured and recorded in dollars by multi- plying the foreign currency unit by the current exchange rate. At each subsequent balance sheet date until settlement, recorded balances that are denominated in a foreign currency are adjusted to reflect the current exchange rate in effect at the balance sheet date. At the settlement date, the treatment depends on whether the balance to be settled is a foreign currency payable or receivable. If a foreign currency payable is being settled, a U.S. firm must convert U.S. dollars into foreign cur- rency units to settle the account. At the settlement of a foreign currency receivable, the foreign currency units received are converted into dollars.
A forward exchange contract is an agreement to exchange currencies of two different countries at a specified rate (the forward rate) on a stipu- lated future date. At the inception of the contract, the forward rate is usually different from the spot rate.
Hedges may be used to hedge a foreign currency exposed receivable or payable position, to hedge a net investment in a foreign subsidiary, to hedge an identifiable foreign currency commitment, or to hedge a forecasted transaction.

A derivative is an executory contract between two parties to be executed at a later date, with the resulting future cash flows dependent on the change in some other underlying measure of value. The eventual dollar amount of the performance is determined by subsequent value changes, and the eventual outcome is necessarily favorable to one of the parties involved and unfavorable to the other.

TheFASBallowsdeferral of the exchange gain and loss on cash flow hedges (a forecasted transaction). Like other gains and losses that are excluded from the income statement, they are included as components of “other comprehensive income” and reported in the stockhold- ers’ equity section of the balance sheet. On the other hand, exchange gains and losses on fair value hedges (unrecognized firm commitments) are reported in current periods earnings along with the exchange gain or loss on the hedged item.