appendix d: foreign currency transactions instructor’s lecture
TRANSCRIPT
Appendix D: Foreign Currency Transactions
Instructor’s Lecture
Foreign Currency Transactions
When U.S. companies sell products or services to foreign companies, and they receive U.S. dollars, no special accounting problems are presented
Likewise, when U.S. companies buy products or services from foreign companies, and they pay in U.S. dollars, no special accounting problems are presented
Foreign Currency Transactions
However, if a U.S. company buys merchandise on account from a foreign company and the price is to be paid in the foreign currency (British pounds, Japanese yen, etc.), then the U.S. company may incur an exchange gain or loss.
Foreign Currency Transactions
Similarly, if a U.S. company sells merchandise on account to a foreign company, and payment is to be made by the foreign company in its own currency, then the U.S. company may incur an exchange gain or loss.
Foreign Currency Transactions
Exchange gains and losses may be realized
a sale on account, or a purchase on account is completed in one accounting period
unrealizeda sale on account, or a purchase on account
spans two accounting periods, necessitating an adjusting entry
Foreign Currency TransactionsRealized Gains and Losses:Purchases from Foreign Companies
Assume that a U.S. company purchases merchandise on account from a Costa Rican company for 600,000 colones on June 1. The price is quoted in colones, and the U.S. company must pay in colones. On June 1, the exchange rate is $0.003 per colone.
Foreign Currency TransactionsRealized Gains and Losses:
Purchases from Foreign Companies
June 1 Merchandise Inventory
A/P—Costa Rican Co.
Purchased merchandise on account (net 30) for 600,000 colones; exchange rate $0.003 per colone
1,800*
1,800
* $0.003 x 600,000 = $1,800
Foreign Currency TransactionsRealized Gains and Losses:
Purchases from Foreign CompaniesOn July 30, when the U.S. company makes the
payment on account, the exchange rate is $0.0035. Keep in mind that the price was negotiated in colones, so 600,000 colones is what the U.S. company needs. When the U.S. company goes to the bank to exchange dollars into colones, it now needs more dollars to purchase the same amount of colones. It needs $2,100 ($0.0035 x 600,000) to get 600,000 colones.
Foreign Currency TransactionsRealized Gains and Losses:
Purchases from Foreign Companies
July 30 A/P—Costa Rican Co.
Exchange Loss
Cash
1,800*
300**
2,100
* this amount is the balance of the A/P account
**Note that a debit of 300 is necessary to make the journal entry balance. “Exchange Loss” is an expense account.
Here is the entry on July 30:
Foreign Currency TransactionsRealized Gains and Losses:
Sales to Foreign Companies
Assume that a U.S. company sells merchandise on account to a Canadian company for 3,000 Canadian dollars on January 15. The price is quoted in Canadian dollars, and the U.S. company will receive Canadian dollars. On January 15, the exchange rate is $0.65 per Canadian dollar. The cost of merchandise sold was $1,150.
Foreign Currency TransactionsRealized Gains and Losses:
Sales to Foreign Companies
Jan. 15
15
A/R—Canadian Co.
Sales
Cost of Merchandise Sold
Merchandise Inv.
1,950*
1,150
1,950
1,150
* $0.65 x 3,000 = $1,950
Foreign Currency TransactionsRealized Gains and Losses:
Purchases from Foreign CompaniesOn February 16, when the U.S. company
receives the payment on account, the exchange rate is $0.73. Keep in mind that the price was negotiated in Canadian dollars, so 3,000 Canadian dollars is what the U.S. company will receive. When the U.S. company goes to the bank to exchange the Canadian dollars into U.S. dollars, how much will it receive?
Foreign Currency TransactionsRealized Gains and Losses:
Purchases from Foreign Companies
Feb. 16 Cash
A/R—Canadian Co.
Exchange Gain
2,190*
1,950**
240***
**this amount is the balance of the A/R account
***Note that a credit of 240 is necessary to make the journal entry balance. “Exchange Gain” is a revenue account.
Here is the entry on February 16:
* $0.73 x 3,000 = $1,950
Foreign Currency TransactionsSummary
Purchases:
exchange rate exchange loss
exchange rate exchange gain
Sales:
exchange rate exchange gain
exchange rate exchange loss
Foreign Currency TransactionsUnrealized Gains and Losses:
If financial statements must be prepared between the date of sale or purchase and the date cash is to be received or paid, an unrealized gain or loss may result.
Foreign Currency TransactionsUnrealized Gains and Losses:
For example, assume that a sale on account had been made to a British company on December 20 for 1,000 pounds. On that date, the exchange rate was $1.50 per British pound. The cost of merchandise sold was $1,000.
Foreign Currency TransactionsUnrealized Gains and Losses:
Dec. 20
20
A/R—British Co.
Sales
Cost of Merchandise Sold
Merchandise Inv.
1,500*
1,000
1,500
1,000
* $1.50 x13,000 = $1,500
Foreign Currency TransactionsUnrealized Gains and Losses:
The U.S. company uses a calendar year, so an adjusting entry must be made on December 31 for any unrealized gain or loss if the exchange rate is not $1.50 on December 31.
Keep in mind that payment will not be received until January 19.
Foreign Currency TransactionsUnrealized Gains and Losses:
Dec. 31 A/R—British Co.
Exchange Gain
50*
50**
If the exchange rate is $1.55 on December 31, the following entry records the unrealized exchange gain:
*($0.55-$0.50) x 1,000 = $50
Foreign Currency TransactionsUnrealized Gains and Losses:
The Accounts Receivable T-account in the general ledger, and the customer account in the A/R subsidiary ledger would look like this:
A/R
12/20 1,500
12/31 50
bal. 1,550
Foreign Currency TransactionsUnrealized Gains and Losses:
Jan. 19 Cash
Exchange Loss
A/R—British Co.
1,450*
100**
1,550***
***this amount is the balance of the A/R account
**Note that a debit of 100 is necessary to make the journal entry balance. “Exchange Loss” is an expense account.
If the exchange rate is $1.45 on January 19, the following entry records the receipt of cash on account from the sale:
* $1.45 x 1,000 = $1,450