Table of Contents Page
Acknowledgements
Abbreviations
List of Tables
1 Introduction
2 Management of Foreign Currency Risks
2.1 Currency Exposures
2.1.1 General Remarks
2.1.2 Translation Exposure
2.1.3 Transaction Exposure
2.1.4 Economic Exposure
2.2 Instruments of Foreign Currency Risk Management
2.2.1 General Remarks
2.2.2 Managing Translation Exposure
2.2.3 Managing Transaction Exposure
2.2.4 Managing Economic Exposure
3 Foreign Currency Translation according to IAS 21(revised 2004)
3.1 General Remarks
3.2 The Concept of the Functional Currency
3.2.1 Background
3.2.2 Factors determining the Functional Currency
3.3 Translating Foreign Currency Transactions into the Functional Currency
3.3.1 Monetary Items
3.3.2 Non-Monetary Items
3.3.3 Net Investments in Foreign Operations
3.3.4 Recognition of Exchange Differences
3.3.5 Accounting for Hedges of a net Investment in a Foreign Operation
3.4 The Presentation Currency
3.4.1 Allowed Presentation Currencies
3.4.2 Translation from the Functional Currency into the Presentation Currency
3.4.3 Translation of Foreign Operations
3.4.4 Recognition of Exchange Differences
3.4.4.1 Exchange Differences in Separate Financials Statements
3.4.4.2 Exchange Differences in Consolidated Financial Statements using a Foreign Currency Hedge
3.4.4.3 Exchange Differences arising from Intragroup Monetary Items
4 Foreign Currency Hedge Accounting according to IAS 39 in multinational groups
4.1 Introducing Hedge Accounting under IFRS
4.1.1 Overview
4.1.2 Derivative Financial Instruments
4.1.3 Hedges for Foreign Currency Risk
4.1.4 Qualifying Instruments for Hedge Accounting
4.1.5 Effectiveness Criteria
4.1.6 Hedging of Net Positions
4.2 Accounting for Fair Value Hedges
4.3 Accounting for Cash Flow Hedges
4.4 Exposure Draft ED-7 “Cash Flow Hedge Accounting of Forecast Intragroup Transactions”
4.4.1 Planned Amendments of IAS 39(revised 2003)
4.4.2 Reasons for the planned Amendments of IAS
4.4.3 Review on the proposed Amendments
5 Summaries
Appendix A: Case Study: Intragroup Foreign Currency Hedging shown on the Example of the Consolidated Financial Statements of a Chilean Company
A.1 Information for the Reader
A.2 The Company...
A.3 Significant Accounting Policies of the Company related to Hedge Accounting in Consolidated Financial Statements
A.4 Overview over Chilean Accounting Rule BT
A.5 Hedging Strategies and Functional Currencies
A.6 Net Investment Hedges
A.7 Differences between Chilean GAAP and IFRS
A.8 Disposal of a Subsidiary
A.9 Further Hedging Activities concerning Foreign Currency Risks
A.10 Assets and Liabilities denominated in Foreign Currencies
A.11 Conclusion
Bibliography
Abbreviations
Abbildung in dieser Leseprobe nicht enthalten
1 Introduction
Globalization is not just a buzzword. It is reality. Big multinational companies as well as small and medium sized companies operate in many foreign markets by importing and exporting goods or by having production plants in countries other than the home country. Acquisitions or mergers of companies that are located in other countries are daily business and shareholders of companies are located all over the world. While companies’ activities are international, the currencies in which business contracts are contracted and settled are still a national affair. Hence, due to international activities, companies hold many items that are denominated in foreign currencies.[1]
Fluctuating exchange rates may influence the companies economic situation, for example, provided that the order situation and the management are good, a company that pays two thirds of its bills in euros and generates two thirds of its revenues in US-dollars (US$) could, given constant exchanges rates, earn a profit. However, if the US$ becomes weaker against the euro during the fiscal year, the same company would possibly operate in the red, despite a good business situation. Thus, due to fluctuating exchange rates, companies face risks. These risks have to be systematized to be able to develop techniques, which can diminish risks arising from fluctuating exchange rates. To protect themselves against these kinds of risks or to limit them, companies have various possibilities; mainly these possibilities involve the use of financial instruments. Limitation or protection against risks arising from fluctuating exchange rates is known as foreign currency hedging.
Not any kind of hedging activity really limits risks. Depending on the kind of risk that shall be hedged, the respective hedging instruments and strategies have to be implemented. Fluctuating exchange rates result in several kinds of risks and thus, hedging foreign currency risks requires the use of several instruments and hedging strategies. Hence, the kinds of risks have to be identified before hedging strategies are developed. As this paper focuses accounting aspects of foreign currency translation and –hedging, hedging strategies are not discussed here.[2] Some hedging strategies suggest or require the use of currency options as the hedging instrument. The valuation of options requires comprehensive knowledge of capital market theory and option-pricing models. Hedges using options as the hedging instruments cannot be discussed here, as option pricing is not an accounting problem.[3]
For financial reporting purposes, all these items have to be translated to a single currency, for example, the currency of a company’s home country. Various translation methods have been created in the last years, but the main question when doing so is which exchange rate shall be used for the translation process.[4] Items could be translated into another currency by using the exchange rate of the transaction date, by using the exchange rate of the reporting-day (e.g. the balance sheet day), by using average exchange rates or any other kind of exchange rates. This leads to the question, whether currency translation shall be a process of translating one currency into another, or if it also is a method to remesurement. To answer this question, it has to be found out, which economical effects (on cash flow, income, balance sheet etc.) items that are denominated in foreign currency have on the company.
When translating an item using different exchange rates, exchange differences arise. These exchange differences could be treated in different ways. They could either be recognized in the income statement, although gains or losses arising from items denominated in foreign currencies might not be realized yet, or exchange differences could initially be realized in equity and be transferred to profit or loss when they are realized. As well as in the case mentioned above, the economical effects have to be regarded to make sure, that exchange differences are treated in a way, which insures fair presentation and decision usefulness of financial statements.[5]
Most groups include foreign subsidiaries in their financial statements. Thus, all financial statements have to be translated into one currency single currency in order to create consolidated financial statements, which contain useful information for the readers. Just if all of the group’s items that are included in the consolidated financial statement are presented in the same currency, items are presented on a reasonable base (i.e. the same currency). Translating financial statements from one currency into another can result in profits or losses, which affect the group’s net income, or the groups equity may change, depending on the fact, how arising exchange differences are treated. The net income and/or the equity of a company are important values for the capital markets and influence the company’s market capitalization, the price it has to pay for loan capital etc.
In order to make financial statements of companies comparable, the International Accounting Standards Board (IASB) issued International Accounting Standard (IAS) 21 “ The Effects of Changes in Foreign Exchange Rates” , which provides accounting rules for the currency translation of business transactions denominated in foreign currencies and the translation of financial statements.
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[1] Cp. Arbeitskreis „Rechnungslegungsvorschriften der EG-Kommission“ (1993), P. 746; Lachnit/Ammann (1998), P. 751.
[2] For implementation of hedging strategies cp. Chang/Wong (2003), P. 555-574; Hautsch/Inkmann (2003), P. 173-198.
[3] For option pricing and option pricing models cp., for example, Hiller (1996), P. 112-192; Linkwitz (1992), P. 80-120; Mehl (1991), P. 64-153; Lombard/Marteau (1990), P. 45-62.
[4] An overview of translation methods is provided by Langenbucher (1998), Mn. 1028-1076; Busse von Colbe/Ordelheide (1993), P. 133-146; Wiley et. al. (2003), P. 830-832; Küting/Weber (2001), P. 154-176; Lachnit/Ammann (1998), P. 754-759.
[5] Fair presentation is requiered by IAS 1.10.