CPA
BOARD EXAMS
OUTLINES
by John Mahatma Agripa, CPA
#5
FOREIGN
EXCHANGE
TRANSACTIONS
Based on lectures and materials by Rodiel C. Ferrer, CPA, Ph.D. and
Brian Lim, CPA (CPAR)
Options are contracts that grant holders the right to either buy
(call) or sell (put) goods at the future date at a predetermined
price, called the strike/exercise price. This is recorded as an
investment in the balance sheet. The amount paid for an option is
referred to as the option premium
They may be classified as to the likeability of their exercise. If the
option is at the money (strike price equals current market prices),
the option is likely to be exercised, bearing no loss on the holder. If
the option is in the money, it is also likely to be exercised, bearing
gains on the holder. In a put option, this is when the strike price is
greater than market prices; in a call option, this is when the strike
price is less than market prices. If out of the money, the option is
likely not to be exercised, since it would bring losses to the holder
The option contact is the hedging instrument. However, it is not a
derivative like forward contracts, since it has its own cost (the
option premium). Also, it is not affected by changes in the forward
rate, since its value depends on its current fair value
The change in the fair value is the fair value is total gains/losses
on the hedging instrument, to be recorded on profit/loss (if fair
value hedge) or other comprehensive income (if cash flow hedge) if
the company uses non-split accounting
If problems mention that the effect of time value gains/losses are
excluded in the assessment of hedge effectiveness, the company
uses split accounting, wherein the fair value change is divided into
the effective and ineffective portions. Option contracts are usually
classified as cash flow hedges
The following format is used for split accounting:
Fair value of option
LESS: Intrinsic value
Time value
Date #1
xx
xx
xx
(difference)
Date #2
Total gains/losses
xx
xx
LESS: Intrinsic value g/l xx
xx
Time value g/l
xx
xx
xx
xx
xx
xx
xx
For instance, the domestic entity owns not a business but just a
single asset overseas thats measured at fair value, such as
investment property. That items value shall be its fair value
overseas at foreign currency, to be translated with the exchange
rate as of when the fair value was determined. No forex
gains/losses are recorded, but only unrealized gains/losses. This
is because forex gains/losses only emerge from monetary assets,
such as accounts receivable/payable
If the item is measured at cost, it remains to be measured at its
historical cost, using the exchange rate when purchased