Advanced Accounting Ch9

Card Set Information

Author:
Anonymous
ID:
83127
Filename:
Advanced Accounting Ch9
Updated:
2011-05-03 22:59:01
Tags:
Foreign Currency Transactions
Folders:

Description:
Foreign Currency Transactions
Show Answers:

Home > Flashcards > Print Preview

The flashcards below were created by user Anonymous on FreezingBlue Flashcards. What would you like to do?


  1. Foreign Exchange Rate
    The price at which the foreign currency can be acquired
  2. Direct Quotes
    the number of U.S. dollars needed to purchase one unit of foreign currency
  3. Indirect Quotes
    the number of foreign currency units that could be purchased with one U.S. dollar
  4. Spot rate
    the price at which a foreign currency can be purchased or sold today
  5. Forward rate
    the price today at which foreign currency can be purchased or sold sometime in the future
  6. Premium
    forward rate exceeds spot rate

    foreign interest rate is less than the domestic rate - the foreign currency sells at a premium
  7. Discount
    forward rate less that spot rate

    foreign interest rate exceeds domestic interest rate - foreign currency sells at a discount
  8. Foreign Currency Option
    gives the holder of the option the right but not the obligation to trade foreign currency in the future
  9. Put Option
    for the sale of foreign currency by the holder of the option
  10. Call
    for the purchase of foreign currency by the holder of the option
  11. Strike Price
    the exchange rate at which the option will be executed if the option holder decides to exercise the option
  12. two components of option premium
    • intrinsic value
    • time value

    Option premium - option must actually be purchased by paying an option premium
  13. Intrinsic value
    equal to the gain that could be realized by exercising the option immediately

    Postitive intrinsic value - "in the money"
  14. Time Value
    relates to the fact that the spot rate can change over time and cause the option to become in the money.
  15. Black - Scholes option pricing formula
    the value of a foreign currency option can be determined by applying an adaptation of the Black - Scholes option pricing formula.

    The value of an option is a function of the difference between teh current spot rate and strike price, the difference between domestic and foreign interest rates, the length of time to expiration, and the potential volatility of changes in the spot rate.
  16. Trade
    export sales and import purchases are internation transaction - components of trade.
  17. one-transaction perspective (not GAAP)
    • assumes export sale is not complete until the foreign currency receivable has been collected and converted into U.S. dolllars.
    • criticized because it hides the fact that the company could have received more that other company had been required to pay at the date of sale
    • loss is buried in an adjustment to sales.
  18. Two-transaction perspective (GAAP)
    treats the export sale and teh subsequent collection of cash as two separate transactions.

    • Because management has made two decisions
    • 1. to make the export sale
    • 2. to extend credit in foreign currency to the customer
    • the company should report the income effect from each of these decisions separately.
  19. Accrual approach to account for unrealized foreign exchange gains and losses (GAAP)
    a firm reports unrealized foreign gains and losses in net income in the period in which the exchange rate changes.

    • criticism - leads to a violation of conservatism
    • one of only two situation in which it is acceptable to recognize an unrealized gain in income.
  20. Two most common derivaties used to hedge foreign exchange risk (to hedge against the efeect of unfavorable changes in the value of foreign currencies)
    • foreign currency forward contracts
    • foreign currency options
  21. Foreign currency forward contract
    a company can lock in the price at which it will sell the euros
  22. foreign currency option
    establishes a price at which a company will be able, but is not required, to sell the euros
  23. Foreign currency firm commitment
    noncancelable order that specifies the foreign currency price and date of delivery
  24. Sources of foreign exhange risk (hedged)
    • 1. Recognized foreign currency denominated assets and liabilities
    • 2. Unrecognized foreign currency firm commitments
    • 3. Forcasted foreign currency denominated transactions
    • 4. Net investments in foreign operations
  25. Fundamental requirement of Derivatives Accounting
    • carry on balance sheet at fair value
    • assets when positive fair value
    • liabilities when negative fair value
    • FV change over time - adjustments to carrying values of assets and liabilities
    • treatment of gains and losses arise from these adjustments
  26. The fair value of a foreign currency forward contract is determined by reference to changes in the forward rate over the life of the contract.
    • 3 pieces of information needed to determine fair value of forwary contract:
    • 1. The forward rate when the forward contract was entered into
    • 2. The current forward rate for a contract that matures on the same date as the forward contract entered into
    • 3. A discount rate - typically, the company's incremental borrowing rate
  27. Changes in fair value must be included in comprehensive income (all changs in equity from nonowner sources)

    2 components

    • Net income
    • Other Comprehensive Income
  28. Gains and losses arising from changes in the fair value of derivatives are recognized initially either
    • 1. on the income statement as a part of net income
    • or
    • 2. on the balance sheet as a component of other comprehensive income.
  29. Hedge Accounting
    account for hedges in such a way to recognize the gain or loss from the hedge in net incom in the same period as the loss or gain on risk being hedged
  30. 3 conditions to allow hedge accounting for foreign currency derivatives
    • 1. The derivative is used to hedge either a fair-value exposure or cash flow exposure to foreign exchange risk
    • 2. The dervative is highly effective in offsetting changes in the fair value or cash flows related to the hedged item
    • 3. the derivative is properly documented as a hedge
  31. Fair-value exposure
    exists if changes in exchange rates can affect the fair value of an asset or liability reported on the balance sheet

    must have the potential to affect net income if it is not hedged
  32. Cash flow exposure
    exists if changs in exchange rates can affect the amount of cash flow to be relaized from a transaction with changes in cash flow reflected in net income
  33. A Cash flow exposure exists for
    • 1. recognized foreign currency assets and liabilities (Fair value or cash flow hedge)
    • 2. foreign currency firm commitments (Fair value or cash flow hedge)
    • 3. forcasted foreign currency transactions (only cash flow hedge)
  34. Gains and losses on fair value hedges are recognized immediately in net income

    Gains and losses on cash flow hedges are included in other comprehensive income.
  35. Hedge effectiveness
    if critical terms of the hedging instrument match those of the hedged item

    Critical terms: currency type, currency amount, and settlement date

    ongoing assessment: cumulative dollar offset method

What would you like to do?

Home > Flashcards > Print Preview