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



unrealized



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

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.

Foreign Currency Transactions Realized 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 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 $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 Transactions Realized Gains and Losses:

Purchases

from Foreign Companies Here is the entry on July 30:

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.

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.

Foreign Currency Transactions Realized Gains and Losses:

Sales

to Foreign Companies

Jan. 15 A/R—Canadian Co.

Sales 1,950* 1,950 15 Cost of Merchandise Sold Merchandise Inv.

1,150 1,150

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

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?

Foreign Currency Transactions Realized Gains and Losses:

Purchases

from Foreign Companies Here is the entry on February 16:

Feb. 16 Cash A/R—Canadian Co.

Exchange Gain 2,190* 1,950** 240***

* $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 Transactions

Summary

Purchases: exchange rate exchange loss exchange rate exchange gain Sales: exchange rate exchange gain exchange rate exchange loss

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.

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.

Foreign Currency Transactions Unrealized Gains and Losses:

Dec. 20 A/R—British Co.

Sales 20 Cost of Merchandise Sold Merchandise Inv.

1,500* 1,500 1,000 1,000

* $1.50 x13,000 = $1,500

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.

Foreign Currency Transactions Unrealized Gains and Losses: If the exchange rate is $1.55 on December 31, the following entry records the

unrealized

exchange gain:

Dec. 31 A/R—British Co.

Exchange Gain 50* 50**

*($0.55-$0.50) x 1,000 = $50

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

Foreign Currency Transactions Unrealized 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:

Jan. 19 Cash Exchange Loss A/R—British Co.

1,450* 100** 1,550***

* $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