Question

One of your friends has missed a couple of consolidations classes due to illness. She was reading through the professor’s PowerPoint slides and was confused as to why the appreciation of the Canadian dollar (relative to the US dollar) can result in a foreign exchange gain in one case and a foreign exchange loss in another case. Briefly describe what these cases are (i.e. temporal/current rate method) and why one case gives rise to a foreign exchange gain while the other gives rise to a foreign exchange loss.

Upon further reflection, she is also confused as to why in one instance, the foreign exchange gain/loss goes directly to the income statement whereas in the other case, the foreign exchange gain/loss is recorded in other comprehensive income. Briefly explain to her how this can be

Answer 1

Foreign Currency Exchange: It is the conversion of one currency into another currency. It requires when a company is operating in more than one country and it requires the preperation of financial statemnts of the subsidiary in other country into the currency of the parent company country.

1) why the appreciation of the Canadian dollar (relative to the US dollar) can result in a foreign exchange gain in one case and a foreign exchange loss in another case.

Assets: When there is an appreciation in the canadian dollar, there will be an increase in the value of the assets thus resulting the Foreign exchange gain.

Liabilities: When there is an appreciation in foreign canadian dollar, it increases the liabilities value and thus resulting in foreign exchange loss.

when there are more liabilities than Assets it ultimately results in Foreign exchange loss

2)Briefly describe what these cases are (i.e. temporal/current rate method)

Temporal Method: Temporal Method is also Called as Historical Method. It is used to convert the curency of the foreign subsidisry into the currency of the parent company at the historical exchange rate. It means it uses the exchange rate at the time of the transaction ocurred. The resulted gain or loss is showed in the parent company's net earnings.

Current Exchange Rate Method: It is used to convert the currency of the subsidisry company into the parent's currency by using the current exchange rate. It means the exchange rate on the day of preperation of the financial statements is used to prepare the financial statements into Parent company's currency.

3) why one case gives rise to a foreign exchange gain while the other gives rise to a foreign exchange loss.

The Excahnge rate athe the time of the transaction (Temporal method) and the exchngw rate at the time of preperation of financial statements will not be the same as it fluctuates. The exchange rate may be more at the time of transaction date and might have decreased at the time of preperation of financial statements or vice versa. So if we use one method, which has more exchange rate it shows Foreign exchange Gain while the other method whose exchange rate is decreased, shows the foreign exchange loss.

4) why in one instance, the foreign exchange gain/loss goes directly to the income statement whereas in the other case, the foreign exchange gain/loss is recorded in other comprehensive income.

Income Statement: The foreign exchange gain or losses arised on the realised transactions are recorded in the income statements.It is recorded if the transaction is settled at the end of the accounting period. For example. products are sold to the customers and the cash also received, It means it is realised.Foreign exchange or loss on such transasctions are recorded in the income statement.

Comprehensive Income: The foreign exchange or loss on onrealised transactions are recorded in comprehensive income . If the transaction is not settled at the end of the accounting period, it is recorded in comprehensive income. For example, The customer has not settled the payment by the end of the accounting period, gains or losses on hedge / derivative financial instruments or long term debt.