The Effects of Changes in Foreign Exchange Rates (IAS 21)

Definition of Terms:

Closing rate is the spot exchange rate at the end of the reporting period.

Exchange rate is the ratio of exchange for two currencies.

Foreign currency is a currency other than the functional currency of the entity.

Foreign operation is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the activities
of which are based or conducted in a country or currency other than those of the reporting entity.

Functional currency is the currency of the primary economic environment in which the entity operates.

Net investment in a foreign operation is the amount of the reporting entity’s interest in the net assets of that
operation.

Presentation currency is the currency in which the financial statements are presented.

Spot exchange rate is the exchange rate for immediate delivery.

Translation is expressing a foreign currency in the reporting entity’s currency by using an exchange rate.

Forward exchange rate – the exchange rate on a specific future date

Forward exchange contract – a contract to exchange two currencies at a specific exchange rate (forward rate) at some
specific time in the future

Bid rate – an offer to buy foreign currency in the future at a specific rate

Offer rate – an offer to sell foreign currency in the future at a specific rate

A foreign currency transaction is a transaction that is denominated or requires settlement in a foreign currency,
including transactions arising when an entity:

a. buys or sells goods or services whose price is denominated in a foreign currency;

b. borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency; or
c. otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency

Three Essential Dates

Transaction Date – Each asset, Liability, revenue, gain or loss, arising from the transaction is measured and recorded
in Philippine pesos by multiplying the units of foreign currency by the closing exchange rate that is the spot rate.

Balance Sheet Date – recorded balances that are denominated in a foreign currency are adjusted to reflect the
closing exchange rate in effect at the date of the statement of financial position. Foreign exchange gain or loss is
recognized for the difference in the exchange rate between transaction date and balance sheet date.

Settlement Date – foreign currency payable – a Philippine company must converts Philippine pesos into foreign
currency units to settle the account, while foreign currency received will be converted into pesos. A foreign
exchange loss or gain is recognized if the amount of pesos paid or received upon conversion does not equal the
carrying amount of the related payable or receivable.
A direct quote measures how much of the domestic currency must one exchanged to receive one unit of a foreign
currency, (i.e. Peso: Foreign Currency) Indirect quote measures how many units of a foreign currency will be received for
one unit of domestic currency, (i.e. Foreign Currency: Peso)

Problems

Direct and Indirect Quotation

1. If one Taiwanese dollar can be exchanged for P1.025, the fraction for computing indirect quotation of exchange
rate expressed in Taiwanese currency would be:
a. 0.975/1.00 c. 1.00/1.025
b. 1.00/0.975 d. 1.025/1.00

2. In October 2011, United Corporation obtained a loan amounting to US $ 120,000 for the purchase of machinery
and equipment. By the end of the year, one-half of the loan was still unpaid and a ten per cent decrease has
taken place. If the foreign loan payable account is correctly reported in the balance sheet at P1,848,000, the rate
of exchange at the time the loan was obtained must have been:
a. $1.00 = P27.00 c. $1.00 = P29.00
b. $1.00 = P28.00 d.$1.00 = P30.00

3. If P56.50 can be exchanged for 1 US dollar, the direct and indirect exchange rate quotations are:
Direct Indirect
a. P56.50 $1
b. P56.50 $.018
c. P1.00 $56.50
d. P 1.00 $.018

Transaction Gains or Losses

4. Filcraft Corp. sold metal crafts to a US firm for $70,000 and pertinent information on exchange conversion rates
related to this transaction were as follows:
Conversion Rate
(Peso to US$)
Nov. 4 Receipt of order P27.40
Nov. 22 Date of shipment 27.50
Dec. 31 Balance sheet date 27.60
Jan. 6 Date of collection 27.00

The sale would be appropriately recorded at:

a. 1,890,000 c. 1,925,000
b. 1,918,000 d. 1,932,000

5. Century Buildings Company, a parent company of a group of companies, acquired machinery for US $50,000 on
October 31, 2011 when the peso/ dollar rate was P26.00, the liability is to be paid six-months after. By the end
of the year, the peso/dollar rate drastically increased to P32.00 and this is considered as a devaluation or
severe fluctuation. On its year-end balance sheet, Century should report the machinery at:
a. 1,040,000 c. 1,300,000
b. 1,280,000 d. 1,600,000
6. On September 1, 2009, Cano & Co. sold merchandise to a foreign firm for 250,000 francs. Terms of the sale
require payment in francs on February 1, 2010. On September 1, 2009, the spot exchange rate was P1.20 per
franc. At December 31, 2009, Cano's year-end, the spot rate was P1.19, but the rate increased to P1.22 by
February 1, 2010, when payment was received. How much should Cano report as foreign exchange transaction
gain or loss in its 2010 income statement?
a. 0 c. 5,000 gain
b. 2,500 loss d. 7,500 gain

7. On November 15, 2011, Celt, Inc., a Philippine Company, ordered merchandise FOB shipping point from
Japanese Company for 200,000 yens. The merchandise was shipped and invoiced to Celt on December 10, 2011.
Celt paid the invoice on January 10, 2012. The spot rates for yens on the respective dates are as follows:

November 15, 2011 P.4955

December 10, 2011 .4875
December 31, 2011 .4675
January10, 2012 .4475

In Celt's December 31, 2011 income statement, the foreign exchange gain is:
a. 9,600 c. 4,000
b. 8,000 d. 1,600

8. Domestic Company has an accounts payable in the amount of 10,000 Bahrain Dinar on its books on October 1,
2011. This account was unpaid at the end of the fiscal year, October 31, 2011. The spot rate for the dinar was:
October 1, 2011: 1 Dinar = P131 October 31. 2011: 1 Dinar = P133 On October 31, 2011, Domestic Company
should report:
a. An accounts payable of P1,310,000.
b. An accounts payable of P1,330,000.
c. An accounts payable of 10,000 Bahrain Dinar.
d. An exchange gain of P20,000.

9. On November 15, 2009, Celt, Inc., a Philippine company located in Baguio City, ordered merchandise FOB
shipping point from a German company for 200,000 marks. The merchandise was shipped and invoiced to Celt
on December 10, 2009. Celt paid the invoice on January 1, 2010. The spot rates for marks on the respective
dates are as follows:
November 15, 2009 P22.4955
December 10, 2009 22.4875
December 31,2009 22.4675
January 10, 2010 22.4475

In Celt's December 31, 2009 income statement, the foreign exchange gain is
a. 9,600 c. 4,000
b. 8,000 d. 1,600

10. On October 1, 2011, Boni Co. purchased merchandise worth a total of 100,000 Swiss francs from its Swiss
supplier, payable within 30 days under an open account arrangement. Boni Co. issued a 30-day, notes payable
in Swiss francs. On October 31, 2011, Boni Co., paid the note. The following information on spot rates (P/SF) is
provided:
Buying Selling
October 01,2011 P24.03 P24.15
October 31,2011 24.10 24.22
Boni Co.'s foreign exchange gain or loss on the transaction is:
a. 5,040 loss c. 12,075 gain
b. 7,000 loss d. 19,110 loss
A derivative is a financial instrument:

a. Whose value changes in response to the change in an underlying variable such as an interest rate, commodity or
security price, or index;
b. That requires no initial investment, or one that is smaller than would be required for a contract with similar
response to changes in market factors; and
c. That is settled at a future date.

Examples of derivatives

a. Forwards: Contracts to purchase or sell a specific quantity of a financial instrument, a commodity, or a foreign
currency at a specified price determined at the outset, with delivery or settlement at a specified future date.
Settlement is at maturity by actual delivery of the item specified in the contract, or by a net cash settlement.

b. Futures: Contracts similar to forwards but with the following differences: futures are generic exchange-traded,
whereas forwards are individually tailored. Futures are generally settled through an offsetting (reversing) trade,
whereas forwards are generally settled by delivery of the underlying item or cash settlement.

c. Options: Contracts that give the purchaser the right, but not the obligation, to buy (call option) or sell (put
option) a specified quantity of a particular financial instrument, commodity, or foreign currency, at a specified
price (strike price), during or at a specified period of time. These can be individually written or exchange-traded.
The purchaser of the option pays the seller (writer) of the option a fee (premium) to compensate the seller for
the risk of payments under the option.

d. Interest rate swaps and forward rate agreements: Contracts to exchange cash flows as of a specified date or a
series of specified dates based on a notional amount and fixed and floating rates.

Hedge accounting
IAS 39 permits hedge accounting under certain circumstances provided that the hedging relationship is

 formally designated and documented, including the entity's risk management objective and strategy for
undertaking the hedge, identification of the hedging instrument, the hedged item, the nature of the risk being
hedged, and how the entity will assess the hedging instrument's effectiveness and

 expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the
hedged risk as designated and documented, and effectiveness can be reliably measured and

 assessed on an on-going basis and determined to have been highly effective

Hedging instrument is an instrument whose fair value or cash flows are expected to offset changes in the fair value or
cash flows of a designated hedged item.

Hedged item is an item that exposes the entity to risk of changes in fair value or future cash flows and is designated as
being hedged.

Effectiveness
IAS 39 requires hedge effectiveness to be assessed both prospectively and retrospectively. To qualify for hedge
accounting at the inception of a hedge and, at a minimum, at each reporting date, the changes in the fair value or cash
flows of the hedged item attributable to the hedged risk must be expected to be highly effective in offsetting the
changes in the fair value or cash flows of the hedging instrument on a prospective basis, and on a retrospective basis
where actual results are within a range of 80% to 125%. All hedge ineffectiveness is recognised immediately in profit or
loss (including ineffectiveness within the 80% to 125% window).
Categories of hedges

A fair value hedge is a hedge of the exposure to changes in fair value of a recognised asset or liability or a previously
unrecognised firm commitment or an identified portion of such an asset, liability or firm commitment that is attributable
to a particular risk and could affect profit or loss. [IAS 39.86(a)] The gain or loss from the change in fair value of the
hedging instrument is recognised immediately in profit or loss. At the same time the carrying amount of the hedged
item is adjusted for the corresponding gain or loss with respect to the hedged risk, which is also recognised immediately
in net profit or loss.

A cash flow hedge is a hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk
associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a
highly probable forecast transaction and (ii) could affect profit or loss.

If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, any
gain or loss on the hedging instrument that was previously recognised directly in equity is 'recycled' into profit or loss in
the same period(s) in which the financial asset or liability affects profit or loss.

*A hedge of a net investment in a foreign operation as defined in IAS 21 “The Effects of Changes in Foreign Exchange
Rates is accounted for similarly to a cash flow hedge.

*A hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or as a cash
flow hedge.

Problems:

11. On December 12, 2013, Davao Import, Inc. entered into a forward exchange contract to purchase 100,000
foreign currencies (FC) in 90 days to hedge a purchase of inventory in November, 2013 payable in March 2014.
The relevant exchange rates are as follows:
Forward Rate
Spot Rate (for March 12, 2014)
November 30,2013 P8.70 P8.90
December 12,2013 8.80 9.00
December 31,2013 9.20 9.30
At December 31, 2013, what amount of foreign exchange gain (loss) from this forward contract should be reported in
the statement of comprehensive income of Davao?
a. P(30,000) c. P40,000
b. P30,000 d. P(40,000)

12. Using the same data in item 11, at December 31,2013, what amount of forex gain (loss) should be reported in the
statement of comprehensive income from the adjustment of the accounts payable of 100,000 FC.
a. P50,000 c. P40,000
b. P(50,000) d. P(40,000)

13. On April 4, 2013, Malate Export, Inc. sold merchandise to Malaysia for 10,000 Ringgit. Payment is due on August 2,2013. Also on
April 4,2013, Malate entered into a forward exchange contract to sell 10,000 Ringgit on August 2, 2013. Exchange rates for
Ringgit are:
4/4/2013 6/30/2013 8/2/2013
Spot rate P14.80 P14,84 P14,82
Forward rate 14.77 14.83 14.82
What amount of forex gain (loss) from this forward contract should be included in
Malate's statement of comprehensive income on June 30, 2013?
a. P(6,000) c. P(4,000)
b. P 6,000 d. P 4,000
14. On October 1, 2013, R Corporation purchased goods from U.S based Corporation worth $93,750. Payment is due
120 days on January 30, 2014. In view of the transaction, R Corporation enters into a forward contract to buy
$93,750 from PNB in 120 days. The relevant exchange rates are as follows:

10/01/2013 12/31/2013 01/30/2014

Spot Rate P43 P47 P50
Forward Rate 44 46 50

Provide Answers for the following:

a. Forward Contract Receivable on December 31, 2013?

b. Net Foreign Exchange Loss on settlement date is?
c. Foreign Exchange Loss on the importing transaction on year end is?

15. Levin intends to sell Y400, 400 under a forward contract dated December 1. At what amount must Forward
Contract Receivable and Forward Contract Payable be presented on December 31?

Dates Forward Rates Spot Rates

December 1 P0.55 P0.53

December 31 P0.50 P0.49
March 22 P0.48 P0.46

a. Forward contract Receivable

b. Forward Contract Payable?
c. Forex Gain/ (loss) on December 31 with respect to the hedging instrument

16. Zest Company sod merchandise for 111,200 euros to a customer in France on November 02, 2022. Collection in
euros was due on January 31, 2023. On the same date to hedge this foreign currency exposure, Zest Company
entered into a futures contract to sell 111,200 to Metro bank for deliver on January 31, 2023.

Exchange rates for euros on different dates are as follows:

Nov. 2 Dec. 31 Jan. 31
Spot rate 81.9 80.7 80.1
30-day futures 82.3 80.4 83.9
60-day futures 81.8 80.3 82.6
90-day futures 80.6 81.6 83.4
120-day futures 80.1 81.4 82.8

a. What amount will affect profit or loss regarding the hedged item on the financial statement date in 2022?
a. P22,240 gain
b. P22,240 loss
c. P133,440 gain
d. P133,340 loss

b. What amount will affect profit or loss regarding the hedging instrument on the settlement date in 2023?
a. P66,720 gain
b. P66,720 loss
c. P33,360 gain
d. P11,120 gain
 c. As a result of all foregoing transactions, what amount will affect current earnings on the settlement date in
2023?
a. P33,360 gain
b. P33,360 loss
c. P11,120 loss
d. P11,120 gain

17. On October 31, 2013, P took delivery from an American firm of inventory costing $1,450,000.00 Payment is due on
January 31, 2014. At the same time, P paid P16,500 cash to acquire a 90-day call option for $1,450,000

October 31, 2013 December 31, 2013 January 31, 2014

Strike Price P12.60 P12.60 P12.60
Spot Rate 12.61 12.62 12.64
Forward Rate 12.72 12.77 12.78
Fair Value of Call Option ? 34,000 ?

Given the information above, compute for the following:

Foreign exchange gain or loss on option contract due to change in time value on December 31, 2013, and foreign
exchange gain or loss due to change in intrinsic value on January 31, 2014?
a. 3,000 gain : 29,000 gain
b. 10,500 loss : 14,500 gain
c. 10,500 loss : 29,000 gain
d. 3,000 gain : 14,500 gain

18. On January 1, 2013. L Inc. paid P9,800 to acquire a put option. This is in relation to the sale of merchandise worth
$65,000.00 (Strike Price = P4.965)

1/1/2013 3/31/2013 6/20/2013

Strike Price P4.934 P4.908 P4.75
Fair Value of Option P9,800 P11,400 P13,975

How much is the foreign currency gain/loss on the intrinsic portion on March 31, 2013?
a. 1,690
b. (1,690)
c. 1,600
d. (90)

19. GV Company anticipates the price cement will increase the coming months. Therefore, it decides to purchase a call
options on cement as a price-risk-hedging device to hedge the expected increase in prices on a forecasted purchase
of cement. On December 1, 2013 GV purchased call options for 1,200 sacks of cement at P165 per sack at premium
of P5 per sack, with a March 31, 2014, call date. The following is the pricing information for the term of the call:

Date Market price Fair Value of Option Contract

12/1/2013 P165 ?
12/31/2013 168 7,500
3/31/2014 172 ?

On March 31, 2014, GV exercised the option and acquired 1,300 sacks of cement. On May 15, 2014, GV sold all the
sacks of cement for P176 per sack. How much is the net income in 2014?
a. 13,600 c. 7,600
b. 9,700 d. 1,400