Recent political and economic events have focused on the pressing need for more uniformity in international accounting standards. Two organizations in the forefront of attempts to achieve such uniformity are the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
Currently, the International Accounting Standard Committee, parent of the 17-member IASB, headquartered in London, has a membership of accounting organizations of over 100 countries. The American Institute of Certified Public Accountants is the U.S. member of the IASC. International Accounting Standards issued by the IASB have no authoritative support unless they are adopted by the standard-setting organizations of IASB members' countries.
Through 2000, the IASB had issued about 40 International Accounting Standards (IASs) (now incorporated in International Financial Reporting Standards) dealing with a number of topics. In 1993, the IASB revised 11 of its IASs to establish benchmark (preferred) accounting treatments with permissible alternatives. Several IASs have dealt with topics in other chapters of the textbook; the standards in those pronouncements differ somewhat from U.S. generally accepted accounting principles.
In 2002, the FASB joined with the IASB in a convergence project, the goal of which was to compare the two Boards' existing standards and conform the two sets of standards into the highest quality solution.
In most countries of the world, the currencies of other countries are bought and sold as commodities or money-market instruments. The buying and selling of foreign currencies results in variations in exchange rates between the currencies of two countries. Spot rates apply to current exchanges of money; forward rates apply to foreign currency transactions to be completed on a future date.
FASB Statement No. 52, "Foreign Currency Translation," and FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," established accounting standards for transactions involving foreign currencies. These standards are incorporated in the discussion and illustrations in Chapter 11 of the textbook.
Multinational enterprises are business enterprises that carry on operations in more than one nation, through a network of branches, divisions, or subsidiaries. Multinational enterprises obtain raw material and capital in countries where such resources are plentiful, manufacture products where wages and other operating costs are lowest, and sell the products in countries that provide the most profitable markets.
Merchandise or loan transactions between a U.S. multinational enterprise and a foreign supplier, customer, or lender generally require journal entries for foreign currency transactions gains or losses, which result from the variations in exchange rates for foreign currencies. For example, if a U.S. enterprise purchased merchandise on May 1, 2005, from a South Korean supplier for 1 million won (W), on a date when the selling spot rate was W1 = $0.0014, and acquired a W1 million draft for transmittal to the South Korean supplier on May 31, 2005, when the selling spot rate was W1 = $0.0015, there would be a $100 foreign currency transaction loss. The $100 loss is the difference between the $1,500 required to acquire the W1 million draft on May 31, 2005, and the $1,400 trade account payable to the South Korean supplier recognized on May 1, 2005.
These amounts are recorded by the U.S. enterprise as follows:
2005
May 1
Inventories
1,400
Trade Accounts Payable
1,400
To record purchase from South Korean supplier for W1 million, translated at selling spot rate of W1 = $0.0014.
May 31
Trade Accounts Payable
1,400
Foreign Currency Transaction Losses
100
Cash
1,500
To record payment for W1 million draft to settle liability to South Korea supplier and recognition of foreign currency transaction loss.
The journal entries in paragraph 8 illustrate the two-transaction perspective for foreign currency transaction gains and losses. Under this concept, the purchase of merchandise from a foreign supplier is considered to be a separate and distinct transaction from the settlement of the liability to the foreign supplier. An opposing view, known as the one-transaction perspective, is that a foreign currency transaction gain or loss should be applied to correct the cost of merchandise purchased from the foreign supplier. The one-transaction perspective was rejected by the Financial Accounting Standards Board.
A U.S. multinational enterprise's sale of merchandise to a foreign customer, with payment to be received in the local currency of the customer, requires restatement of the local currency amount of the sale to U.S. dollars at the buying spot rate in effect on the date of sale. For example, if a U.S. enterprise sold merchandise costing $30,000 to a Greek customer for 10 million Greek drachmas (Drs), with the buying spot rate for the drachma $0.004648, the U.S. enterprise would debit Trade Accounts Receivable $46,480 (Drs10,000,000 x $0.004648 = $46,480) and credit Sales for the same amount. If the buying spot rate for the drachma increased by the date that the U.S. enterprise received Drs10 million from the Greek customer, the U.S. enterprise would realize a foreign currency transaction gain; a decrease in the buying spot rate for the drachma would produce a foreign currency transaction loss.
The purchase and sale transactions illustrated in paragraphs 8 and 10 demonstrate that increases in the selling spot rate between the dates of initiating and paying for a purchase denominated in a foreign currency generate foreign currency transaction losses; decreases in the selling spot rate produce foreign currency transaction gains. Conversely, increases in the buying spot rate between the dates of initiating and receiving payment for a sale denominated in a foreign currency result in foreign currency transaction gains; decreases in the buying spot rate create foreign currency transaction losses.
If financial statements are prepared between the dates of a foreign currency—denominated transaction and the payment of cash to settle the transaction, a U.S. multinational enterprise's payables (or receivables) are adjusted to reflect the end-of-period exchange rate. The resultant unrealized foreign currency transaction gain or loss is accounted for in the same manner as the realized foreign currency transaction loss illustrated in paragraph 8. Both realized and unrealized foreign currency transaction gains and losses are included in the measurement of net income for the accounting period in which the transaction gains and losses are recognized. Foreign currency transaction gains and losses are not extraordinary items.
A multinational enterprise may hedge its exposure to exchange rate fluctuations by acquiring or selling forward contracts. For example, a U.S. enterprise that has a liability payable in British pounds would acquire a forward contract for an appropriate number of British pounds to minimize the risk of having to use more dollars in the future to acquire British pounds.
In FASB Statement No. 133, the FASB established different accounting procedures for forward contracts, which are derivative instruments. Two of the five classes of forward contracts identified by the FASB are discussed and illustrated in Chapter 11 of the textbook; a third type is mentioned in Chapter 12 thereof.
IAS 21, "Accounting for the Effects of Changes in Foreign Exchange Rates," has provisions essentially the same as those of FASB Statement No. 52, except for the lack of coverage of forward contracts. IAS 39, "Financial Instruments: . . . ," deals with such contracts.
Both the FASB and the SEC require numerous quantitative and qualitative disclosures of foreign currency transaction gains and losses and forward contracts, as well as all other derivative instruments.
