Foreigh exchange rate Fluctiation

• Appreciation (or strengthening) of a
currency:
•When the currency’s spot rate has
increased in value in terms of some other
currency.
• Depreciation (or weakening) of a
currency:
•When the currency’s spot rate has
decreased in value in terms of some
other currency.

 The transfer of funds or purchasing
power from one nation and currency to
another.
Demand for foreign currencies
-Import/expenditures abroad/investment abroad
Supply of foreign currencies
-Export/earnings from tourism/receipt of foreign
investments
 the credit function
 the facilities for hedging and speculation

1. Immediate users and suppliers of
foreign currencies-
importers/exporters/
tourists/investors
2. Clearinghouses-commercial bank
3. Foreign exchange brokers-interbank
/ wholesale market (95%)
4. The nation’s central bank-lender of
last resort

Internal operations are conducted an environment in which
there is no universal currency or common unit of exchange.
Consequently, business enterprises transacting with
dealers in other countries face two major problems;
a) Foreign Currency Conversion- means the physical
exchange of one country’s currency with another
country’s currency.
b) Foreign Currency Translation – means a change in
the monitory expression in the books of accounts.
Example- a Balance Sheet prepared in British Pounds
stated in Indian Rupees

Foreign exchange is the money of another country. It is
in a variety of firms such as paper money and coins, Bank draft
and other commercial papers.
A foreign exchange transaction is one where two parties agreed
to exchange one currency for another at a specified rate of
exchange.
Example; 1 US $ = Rs. 66
The foreign exchange market is the mechanism through
which the money of one country is exchanged for that of
another, the exchange rate between currencies is fixed and
foreign exchange transactions are completed in terms of its
physical location, the foreign currency market spans (spans
means extents across) the globe and exist wherever individuals
or institutions exchange the currencies of different countries
among each other. Therefore an exchange markets is vast in
terms of the volume of activity.
Example: In the late 1990’s it was estimated that daily
trading activity was about 1400 Billion US $ per day.
In terms of timing, foreign exchange transactions can

• Spot transaction-Spot rate
• The most common type of foreign exchange
transaction involves the payment and receipt of
the foreign exchange within two business days
after the day the transaction is agreed upon.
• The two-day period gives adequate time for the
parties to send instructions to debit and credit the
appropriate bank accounts at home and abroad.
The spot market involves the immediate purchase or
sale of foreign currency the settlement is immediate
in case of small transaction in retail markets and it
takes upto 2 days for larger transactions in the
wholesale markets.

In the forward market, participants contract today for the future delivery of
foreign currency.
For example; An Indian company might choose to buy 10,000 American
dollars 3 months forwards to settle an account payable (Bills payable) that is
due in 3 months to a supplier in the United State. By the exchange rate and
the forward contract is said today ( the day of contract ). The settlement of
the forward contract will occur at the maturity date in 3 months.
The Forward rates and Spot rates prevailing on particular day are
generally different, forward rate (fr) means the exchange rate of a future day
determined the date of contract. Spot rate (Sr) means the rate of exchange
prevailing on the rate of contract or on the date of settlement.
When the forward rate is higher than the Spot rate, the difference is forward
premium. When the forward rate is lower than the spot rate, the difference is
forward discount.
Example; a) 30 days forward rate is 1 US $ = Rs. 64
Spot rate is 1 US $ = Rs. 62
Forward Premium = Rs. 2
b) 30 days forward rate is 1 US $ = Rs. 64
Forward discount = -1

• A forward transaction involves an agreement today to buy or sell a specified amount
of a foreign currency at a specified future date at a rate agreed upon today.
• One month; Three months; six months
• Forward contracts can be renegotiated for one or more periods when they become
due.
FD (forward discount)
If the forward rate is below the present spot rate, the foreign currency is said to be at a
forward discount with respect to the domestic currency.
FP (forward premium)
If the forward rate is above the present spot rate, the foreign currency is said to be at a
forward premium with respect to the domestic currency.
When the forward rate is higher than the Spot rate, the difference is forward premium.
When the forward rate is lower than the spot rate, the difference is forward discount.
Example; a) 30 days forward rate is 1 US $ = Rs. 64
Forward Premium = Rs. 2
b) 30 days forward rate is 1 US $ = Rs. 64
Forward discount = -1

The currency option is a contract that
provides the right but not the obligation
to trade a foreign currency at a set
exchange rate on or before a given
date in the future.

A currency swap is a transaction that involves a
simultaneous purchase and sale of two different currencies.
The purchase is effective at once with the same back with
the same party at a price agreed upon today but to be
completed at a specified future date.
The following table illustrate how rates are reported
in the financial date.
Particulars 1 Pound equivalent
US $
1 US $ = UK
Pound
Britain Pounds-Spot 1.5875 0.6299
1 month forward 1.5880 0.6279

In this example, the first column of rates is a direct quote from US
perspective (and an indirect quote from the UK perspective). The
direct quote represents the price of one unit of the foreign currency
price in the domestic currency, thus, in the illustration above it costs
US $ 1.5875 to purchase one British Pounds in the Spot market.
The second column of a rates is direct quote from US
perspective (and a direct quote from the UK perspective). The
indirect quote represents how much of the foreign currency can be
purchased for one unit of Domestic currency. In the illustration above
1 US $ will purchase 0.6299 British Pound in spot market.
The illustration also provides forward rates for 1 month, 3
months and 6 months for the sake of simplicity, the illustration used a
single rate: however foreign currency price quotation are stated as
‘Bid rates’ and ‘Ask rates’. The Bid rate ( buy rate) represents the
price at which a financial institution is using to buy a currency, while
an ‘ask rate’ (sell rate) is the price at which it is using to sell a
currency. The difference between the Bid rate and ask rate is the
‘Spread’. It represents the greatest margin for the exchange trade.
Thus, if a US bank quoted a ‘Bid rate’ for British Pounds of 1.585 and
an ‘Ask rate’ of 1.5995, the spread would be 0.01 (1.5995-1.5895)

Exposure means the state of being exposed to something
harmful.
An unanticipated change in the exchange rate is termed
foreign exchange exposure. In other words, foreign
exchange exposure occurs when these is a an
unexpected change in the exchange rate. Sound financial
management requires that foreign exchange exposure be
monitored and managed so as to maximise the
profitability, cash flow and market value of the firm.
Foreign exchange exposure has been classified into 3
types
Translation or Accounting exposure
Transaction Exposure
Economic or Operating Exposure

It arises when foreign currency financial statements of
foreign subsidiaries must be restated into the parent
company country’s currency in order to prepare
consolidated financial statements.
The parent company (holding company) must
restated the financial statement of foreign subsidiaries
from their local currency into Indian rupees, these
amounts can be added in order to prepare rupees
denominated financial statements. This accounting
process is referred to as ‘Translation’ and hence, the
terms ‘translation exposure is defined as the potential for
an increase or decrease in the parent Net worth and
reported Net income, caused by a fluctuation in the
exchange rate since the previous periods

It relates to the sensitivity of the companies contractual cashflows
denominated in foreign currency to exchange rate changes as
measured in the company’s domestic currency. Transaction exposure
measure gains or losses that arise from the settlement of existing
financial claims and obligations that are set in a foreign currency.
Transaction exposure can arise from any of the following
a) Buying or selling on credit any goods or services whose prices are
contractually denominated in foreign currencies.
b) Borrowing or lending funds in a foreign currency
c) Engaging in contracts to buy or sell foreign currency at a future
date or
d) Other economic transactions to acquire assets or liabilities
denominated in foreign currencies.
A common example of transaction exposure arises when
a transaction to buy or sell goods or services on credit is
denominated in a foreign currency. The potential
fluctuations of exchange rates between the date of

Transaction exposure consists of 3 sub exposures;
I. Quotation exposure; it is the price changes from the time
the sell quotes to the time when buyer orders a goods is
called the period of the quotation exposure.
II. Backlog exposure; from the moment that the order is
placed to the point of shipment of invoicing is
considered the period of backlog exposure.
III. Billing Exposure; the lag between the point of shipment
and invoicing to the payment of the invoice is the period
of billing exposure
Though quotation exposure, backlog exposure and billing exposure
are all measurable, only the billing exposure is accounted for in financial
reporting.

It is also known as operating exposure. It can be defined
as the extend to which the value of the firm would be
affected by unexpected changes in currency exchange
rate. Economic exposure analyses the impact of future
change in exchange rates on a firm operations and its
competitive position compared to other firms.
The aim is to identify the significant steps that the
firm might take to enhance or preserve(retain) its value in
the face of unexpected currency rate changes.
Planning for economic exposure involves the entire
organization because it affects the interaction of strategies
over virtually every functional area of the company
including accounting, finance, marketing, personnel and
production.

A forward exchange contract is a contract wherein a buyer agrees to
buy a certain amount of foreign currency at a future date and at a
predetermined rate or price.
Conversely(opposite of the above statement), a forward
exchange contract is a contract where a seller agrees to sell a certain
sum of foreign currency at a future date at a rate agreed upon in
advance.
In a Forward exchange contract, the amount of the
transaction, the maturity date and the exchange rate are all
determined in advance, but no money changes hands until the
settlement date, moreover, one of the parties to the forward
exchange contract may not perform on the date of maturity, thus,
indicating towards the underlying risk of a forward contract but for the
estimation of advantages, forward exchange contracts are used as a
mechanism to minimise the exchange risk to exporters, importers,

Accounting treatment of forward contract has always invited controversies
as regards the treatment of
I. Forward premium or forward discount, and
II. Foreign exchange gain or loss on the forward variation
forward premium occurs when the forward rate is higher than the
Spot rate and Forward discount when the spot rate is higher than the
forward rate.
foreign exchange gain occurs when the forward rate on the date of
settlement is higher that the rate prevailing on the date of transaction.
foreign exchange loss occurs when the forward rate on the date of
settlement is lower than the rate prevailing on the date of transaction
forward premium or discount may be treated as the part of the loss
of the related item or alternatively written off against income over the life of
the forward contract.
The foreign exchange gain or loss on the forward contract may also
be recognised as current income or loss; or deferred as part of the base
of the related item. However, the actual practice varies from country to
country depending upon the accounting standard issued by the standard
setting body (SSB) to the effect. The related provisions issued by the
Accounting Standard Board (ASB) of India in March 1989 and revised in

On 1st April 2014, Hanuman Company Limited of
Bombay agreed to buy a machine costing $ 1000 from
Mellon and Company of USA. The machine was agreed
to be delivered on 13th April 2015 and the payment to be
made on delivery.
Hanuman company limited entered into a forward
exchange contract on 1st April 2014 to purchase $ 1000.
The forward rate prevalent on 1st April 2014 was Rs. 59
per US $. Hanuman company limited closes its books on
31st March every year. The exchange rate prevalent on
31st March 2015 was Rs. 59.80 per US $ and a same
rate is expected to prevail on 10th April 2015.
Show how these transactions will be recorded in
the books of Hanuman Company Limited under the
deferred system.

The most significant and controversial aspect of International
Accounting is the translation of foreign financial statements for
consolidation purpose with domestic financial statement. For this
purpose, a single currency framework is essential to facilitate the
grouping of similar financial data or figures.
Translation problems arise on account of the system of
fluctuating exchange rates prevailing in the market. The 2 major
issues that the accountants are faced with are the appropriate
exchange rate to be used in the translation process and the manner
in which the translation differences are to be accountable for.
Example; suppose that British branch of an Indian Company
acquired a machinery costing £ 10,000 on 1st April 2014, when the
rate of exchange was £1=Rs. 90. A year later that is on 31st march
2015, the branch still held the machinery and it is included in the
balance sheet of the branch at its Historical cost of £ 10,000. The
exchange rate on 31st March 2015 was £ 1 = Rs. 93. While
incorporating the financial statement of the british branch the parent
entity that is Indian company will have to face 2 problems;

1) What value should be placed on the machinery in
the consolidated Balance sheet.
Under historical cost accounting 2 possible
values are;
a) The first option could be to include the machinery
in terms of Rs. at the date of acquisition, by
translating the £ cost using the exchange rate of
the date of acquisition i.e £10,000*90=9,00,000
b) The second option could be the Rs. Equivalent of
the £ cost at the balance sheet date i.e £
10,000*93= Rs. 9,30,000
The rate of exchange prevailing at the end of
accounting period is know as closing rate of current
rate.

2) The second basic problem is; if the later figure
i.e Rs. 9,30,000 is taken into the consolidated
Balance Sheet, how should the difference between
their two figure Rs. 30,000 (i.e Rs. 9,30,000) be
dealt with.
An increase in the value of machinery to the
extra of Rs. 30,000 will have to be accounted for.
The problem is significant because, accounting of
Rs. 30,000 has an impact not only on the
consolidated Balance Sheet but also influence the
computation of profits. These problems are to be
dealt with in greater determination

Different countries have issued different
accounting standards in translation of Foreign
Financial Statements.
The different translation methods in practice may be
classified on the basis of the number of rates
employed in the process of translation.
The following different methods of translation are in
practice now.
There are two approaches to Foreign currency
Translation
1) Single Rate Methods/Approaches
2) Multiple Rate Method/Approaches

What is single/current rate approach
In this method the foreign currency figures are
restated to their domestic currency equivalents by
using one rate of exchange only. This one rate is the
closing rate/current rate. The rate of exchange
prevailing on the date of preparation of final account.
Hence, this method is also called current rate
method.
All foreign assets and liabilities translated at the
current rate
All revenues and expenses are translated by an
appropriately weighted average of current

Current assets and current liabilities
translated at the current rate.
Noncurrent assets and liabilities translated
at the historical rate.
Revenues and expenses ( excluding
depreciation and amortization) translated at
average rates.
Depreciation and amortization charges at
historical rates in effect when related assets
are acquired

Foreigh exchange rate Fluctiation

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Foreigh exchange rate Fluctiation