Appendix D: Foreign Currency Transactions

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 inthe 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 • unrealized • a 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 * $0.003 x 600,000 = $1,800

Foreign Currency TransactionsRealized Gains and Losses:Purchases from Foreign Companies • On 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 Here is the entry on July 30: * 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.

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 toForeign Companies * $0.65 x 3,000 = $1,950

Foreign Currency TransactionsRealized 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?

Foreign Currency TransactionsRealized Gains and Losses:Purchases from Foreign Companies Here is the entry on February 16: * $0.73 x 3,000 = $1,950 **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.

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: * $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: 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: 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 **Note that a debit of 100 is necessary to make the journal entry balance. “Exchange Loss” is an expense account. ***this amount is the balance of the A/R account

Appendix D: Foreign Currency Transactions