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Appendix D: Foreign Currency Transactions Instructor’s Lecture.

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1 Appendix D: Foreign Currency Transactions Instructor’s Lecture

2 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

3 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.

4 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.

5 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 unrealized a sale on account, or a purchase on account spans two accounting periods, necessitating an adjusting entry

6 Foreign Currency Transactions Realized 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.

7 Foreign Currency Transactions Realized Gains and Losses: Purchases from Foreign Companies June 1Merchandise 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

8 Foreign Currency Transactions Realized Gains and Losses: Purchases from Foreign Companies On July 30, when the U.S. company makes the payment on account, the exchange rate is $ 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 $2,100 ($ x 600,000) to get 600,000 colones.

9 Foreign Currency Transactions Realized Gains and Losses: Purchases from Foreign Companies July 30A/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:

10 Foreign Currency Transactions Realized 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.

11 Foreign Currency Transactions Realized Gains and Losses: Sales to Foreign Companies Jan 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

12 Foreign Currency Transactions Realized Gains and Losses: Purchases from Foreign Companies On 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?

13 Foreign Currency Transactions Realized Gains and Losses: Purchases from Foreign Companies Feb. 16Cash 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

14 Foreign Currency Transactions Summary Purchases: exchange rate exchange loss exchange rate exchange gain Sales: exchange rate exchange gain exchange rate exchange loss

15 Foreign Currency Transactions Unrealized 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.

16 Foreign Currency Transactions Unrealized 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.

17 Foreign Currency Transactions Unrealized Gains and Losses: Dec 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

18 Foreign Currency Transactions Unrealized 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.

19 Foreign Currency Transactions Unrealized Gains and Losses: Dec. 31A/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

20 Foreign Currency Transactions Unrealized 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

21 Foreign Currency Transactions Unrealized Gains and Losses: Jan. 19Cash 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


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