Question

1-What is the concept underlying the two-transaction perspective in accounting for ­foreign currency transactions?

2-A company makes an export sale denominated in a foreign currency and allows the customer one month to pay. Under the two-transaction perspective, accrual approach, how does the company account for fluctuations in the exchange rate for the foreign currency?

3-What factors create a foreign exchange gain on a foreign currency transaction? What factors create a foreign exchange loss?

4-What does the word hedging mean? Why do companies hedge foreign exchange risk?

Answer 1

Answer: 1. In two transaction perspective, there is a transaction of export sale and after that collection of payment against that export sales is the subsequent transaction. Both the two transactions should be treated as separate transaction .The export transaction is recorded at the exchange rate on the date of export and collection amount is different. The difference of these transactions should be considered as foreign exchange gain or loss.

Answer: 2. In the case of export the export transaction is accounted on the conversion rate at the date of sales. The company allow 30 days credit. So the conversion rate on the date of sale and on the date of payment received is different. So the difference amount is treated as realised foreign exchange gain or loss. The company did not receive the payment till the last date of financial year then the company will convert the receivable on closing date of financials and the difference is unrealised foreign exchange gain or loss. The Exchange gain or loss transferred to income statement.

Answer: 3. Foreign exchange gain or losses are created due to two reasons:

1. Having foreign currency exposure : The company either have foreign currency receivable or payable
2. Change in Exchange Rate: The conversion rate changed on the date of transaction and on the date of payment.

In case of account receivables if there is an appreciation in foreign currency then it will result in exchange gain and loss ion case of accounts payable. If the foreign currency rate depreciated then it will result in foreign exchange loss in case of Account Receivables and foreign exchange gain in case of account payable.

Answer: 4. Hedging is the procedure through which the exchange fluctuation risk is reduced or eliminated. By use of hedging the company reduce it is possible foreign exchange loss.

The company hedge its foreign currency transaction to reduce potential losses. In addition hedge foreign currency transactions and commitments to introduce certainty into the future cash flows of foreign currency. In hedging a contract has been made to purchase or sale foreign currency at the rate on which contract has been made.