Page 52 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2
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LOS 16.a: Distinguish among presentation (reporting)                                    READING 16: MULTINATIONAL OPERATIONS
    currency, functional currency, and local currency.

                                                                                       MODULE 16.1: TRANSACTION EXPOSURE
    •  Local currency is the currency of the country being referred to.
    •  Functional currency, determined by management, is the currency of the primary economic environment in which the entity operates. It is usually the currency in which
      the entity generates and expends cash. The functional currency can be the local currency or some other currency.
    •  Presentation (reporting) currency is the currency in which the parent company prepares its financial statements.

    LOS 16.b: Describe foreign currency transaction exposure, including accounting for and disclosures about foreign currency transaction gains and losses.

    Foreign currency sales, are measured in the presentation (reporting) currency at the spot rate. Transaction risk could materialize as follows:
    A U.S. firm sells goods to a company located in Italy for €10,000 when the spot exchange rate is $1.60 per euro. Payment is due in 30 days. When
    payment is actually received, the euro has depreciated to $1.50.
    •  On the transaction date, the U.S. firm recognizes a sale, and an account receivable, in the amount of $16,000 (€10,000 × $1.60).
    •  On the payment date, the U.S. firm receives €10,000 and immediately converts the euros to $15,000 (€10,000 × $1.50).

    As a result of the depreciating euro, the U.S. firm recognizes a $1,000 loss in the income statement [€10,000 × ($1.50 − $1.60)].
    If the balance sheet date occurs before the transaction is settled, gains and losses on foreign currency transactions are recognized. Accordingly, the
    balance sheet amounts are adjusted based on the exchange rate on the balance sheet date, and an unrealized gain or loss is recognized in the income
    statement.  Once the transaction is settled, additional gain or loss is recognized if the exchange rate changes after the balance sheet date.

    Returning to our earlier example, say the sale occurred on December 15 of last year when the euro exchange rate was $1.60. At the end of the year, the euro
    depreciated to $1.56. The transaction was settled on January 15 when the euro exchange rate was $1.50.
    •  At EOY, the U.S. firm will reduce its account receivable by $400 and recognize a $400 loss [€10,000 × ($1.56 − $1.60)] in the December income statement.
    •  When the receivable is collected, the U.S. firm receives €10,000 and immediately converts the euros to $15,000 (€10,000 × $1.50). As a result, a loss of
       $600 [€10,000 × ($1.50 − $1.56)] is recognized in the January income statement.

    If the U.S. firm purchases goods (denominated in euros) from the Italian firm with payment due in 30 days, the same concepts are applied except that the
    U.S. firm would recognize a gain on the payment date. In this case, the U.S. firm has an account payable denominated in euros. If the euro depreciates, the
    U.S. firm recognizes a gain in the income statement because it will take less U.S. dollars to buy the necessary euros to settle the transaction.


     Analyst Issues: IFRS requires disclosure of the “amount of exchange rate differences recognized in profit or loss” while U.S. GAAP requires disclosure of
     “the aggregate transaction gain or loss included in determining net income for the period.” However, neither standard requires disclosure of where such
     gains/losses would be recorded. Obviously, the comparability of operating margins between entities would be diminished if the compared entities used
     different methods.
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