International accounting

Lecture 3
Foreign currency transactions
Dr maha rabei
 Scope of lecture
Accounting for foreign currency
transactions:
 Purchase and sale in foreign currencies.
 Recording foreign currency transactions.
 Two transactional versus one
transactional approach of recording
 Foreign currency transactions gains and
losses.
 Different problems covering the topic.
Check your understanding
Q1- From the viewpoint of a U.S. company, a
foreign currency transaction is a transaction:
 a. measured in a foreign currency.
 b. denominated in a foreign currency.
 c. measured in U.S. currency.
 d. denominated in U.S. currency.
Q2-The exchange rate quoted for future delivery of
foreign currency is the definition of a(n):
 a. direct exchange rate.
 b. indirect exchange rate.
 c. spot rate.
 d. forward exchange rate.
Q3-International accounting can be defined in terms of
which the following levels?
A) Supranational organizations
B) Company
C) Country
D) All of the above
Q4-A transaction loss would result from:

a. An increase in the exchange rate applicable to an asset

denominated in a foreign currency.
b. A decrease in the exchange rate applicable to a liability
denominated in a foreign currency.
c. The import of merchandise when the transaction is
denominated in a foreign currency.
d. A decrease in the exchange rate applicable to an asset
denominated in a foreign currency.
Q5- The factor used to convert from one country's
currency to another country's currency is called the:
 A) Interest rate.
 B) Cost of capital.
 C) Exchange rate.
 D) Strike price.
Q6- Foreign exchange risk arises when:
A) business transactions are denominated in foreign
currencies.
B) sales are made to customers in a foreign country.
C) goods or services are purchased from suppliers in a
foreign country.
D) accounting reports are prepared in a foreign
currency.
Q7- What is the term used to refer to creating one set
of financial accounting standards throughout the
world?
 A) GAAP
 B) Transfer pricing
 C) Consolidation
 D) Harmonization
Q8- Which of the following is an advantage of having a single
set of accounting standards used worldwide?

A)Reduce the accounting costs for multinational corporations

B)Increase the power of the FASB

C)Reduce the number of multinational corporations

D)Increase the diversity of accounting methods used by

multinational corporations
Q9-What does “multinationality” mean?
 A) How internationally widespread a company's
investment and business operations are
 B) The diversity of languages spoken at a
company's headquarters
 C) The number of stock exchanges where a
company's shares are listed
 D) None of the above
 1- Purchase of Merchandise from a
Foreign Supplier

 To illustrate a purchase of merchandise from a foreign

supplier, assume that on April 18, 2005, Worldwide
Corporation purchased merchandise from a
German supplier at a cost of 100,000 Euros.
 The April 18, 2005, selling spot rate was € = $ 1.05

 Because Worldwide was a customer of good credit

standing, the German supplier made the sale on
30-day open account.

So, it records the April 18, 2005,
purchase as follows:
 Foreign Currency Transaction
Gains and Losses
 During the period that the trade account payable to
the German supplier remains unpaid, the selling
spot rate for the euro may change.
 If the selling spot rate decreases (the Euro weakens
against the dollar), Worldwide will realize a
foreign currency transaction gain;
 If the selling spot rate increases (the Euro
strengthens against the dollar), Worldwide will
incur a foreign currency transaction loss.
 To illustrate….
 Assume that on April 30, 2005, the selling spot rate for the
euro was €1=$1.04 and Worldwide prepares financial
statements monthly.
 The accountant for Worldwide records the following journal
entry with respect to the trade account payable to the
German supplier:
 Assume further that the selling spot rate on
May 18, 2005, was €1=$1.02.
 The May 18, 2005, journal entry for World
wide's payment of the liability to the German
supplier is shown below:
2-Sale to foreign customer

Most companies’ first encounter with

international business occurs as sales to
foreign customers.
Often, the sale is made on credit and it is
agreed that the foreign customer will pay in
its own currency (e.g., Mexican pesos).
As a result…..
This gives rise to foreign exchange risk as the
value of the foreign currency is likely to change in
relation to the company’s home country currency
(e.g. U.S dollars).
 Assume that,
 On May 17, 2005, Worldwide Corporation, sold
merchandise acquired from a U.S. supplier for
$12,000 to a French customer for € 15,000, with
payment due June 16, 2005.
 On May 17, 2005, the buying spot rate for the euro
was € 1 =$1.01.
Worldwide prepares the following
journal entries on May 17, 2005:
 Assuming that the buying spot rate for the euro was
 €1= $0.99 (the euro weakened against the dollar).
 On May 31, 2005, when Worldwide prepared its
customary monthly financial statements, the
following journal entry is appropriate:
 If on June 16, 2005, the date when Worldwide
received a draft for € 15,000 from the French
customer, the euro had strengthened against the
dollar to a buying spot rate of €1= $0.995,
Worldwide’s journal entry would be as follows:
 Example on foreign transaction
 Suppose that on February 1, 2023, Maria Inc.,
a U.S. company, makes a sale and ships goods
to Jose, a Mexican customer, for $1,000,000
(U.S.).
 However, it is agreed that Jose will pay in
pesos on March 2, 2023.
The exchange (spot) rate as of February 1, 2023
is 18 pesos per U.S. dollar.
How many MXN pesos does Jose agree to
pay?
 Answer
Even though Jose agrees to pay 18,000,000
pesos ($1,000,000 x 18 pesos/U.S. $), Maria, Inc.
records the sale (in U.S. dollars) on February 1,
2023 as follows:
Dr. Accounts receivable (+) 1,000,000
Cr. Sales revenue (+) 1,000,000
SuppoSe that …
 On March 2, 2023, the spot rate for pesos is 19
pesos/U.S. $).
 Maria Inc. will receive 18,000,000 pesos, which are
now worth $ 947,368.
It will make the following journal entry:

Dr. Cash (+) $ 947,368

((18÷19)* 1,000,000)
Dr. Loss on foreign exchange $ 52,632
Cr. Accounts receivable $1,000,000
 PROBLEM
 On November 9, 2006, USA Corporation, a U.S. multinational
enterprise that prepares monthly financial statements, sold
merchandise costing $20,000 to a foreign customer on 30-day
open account for 50,000 local currency units (LCU).
 On December 9, 2006, USA received a draft for LCU50,000
from the foreign customer. Spot rates for the LCU during the
remainder of 2006 were as follows:

LCU1=
Date Buying Selling
Nov. 9 $0.80 $0.82
Nov. 30 0.84 0.87
Dec. 9 0.78 0.81
Prepare journal entries for USA Corporation's transactions with
the foreign customer.
ANSWER
 Two-Transaction Perspective and
One-Transaction Perspective
 The journal entries above reflect the two-transaction
perspective for interpreting a foreign trade transaction.

 One transaction was the purchase of the merchandise; the

second transaction was the acquisition of the foreign currency
required to pay the liability for the merchandise purchased.

 Supporters of the two-transaction perspective argue that an

importer’s or exporter’s assumption of a risk of fluctuations in
the exchange rate for a foreign currency is a financing
decision, not a merchandising decision.
 the one-transaction perspective, maintain that
World wide’s total foreign currency transaction
gain of $3,000(1,000+ 2,000) on its purchase from
the German supplier should be applied to reduce
the cost of the merchandise purchased.
 Under this approach, Worldwide would not prepare
a journal entry on April 30, 2005, but would
prepare the following journal entry on May 18,
2005 (assuming that all the merchandise purchased
on April 18 had been sold by May 18):

As follows;
• Supporters of the one-transaction perspective for foreign trade
activities consider the original amount recorded for a foreign
merchandise purchase as an estimate, subject to adjustment
when the exact cash outlay required for the purchase is
known.
• Thus, the one-transaction approach emphasize the cash-
payment aspect, rather than the bargained price aspect, of the
transaction.
Q10- Maria Company purchased equipment for 375,000
British pounds from a supplier in London on July 3, 2014.
Payment in British pounds is due on Sept. 3, 2014.
The exchange rates to purchase one pound is as follows:
July 3 August 31, (year end) September 3
Spot-rate 1.58 1.55 1.54
30-day rate 1.57 1.53 --
60-day rate 1.56 1.49 --
On its August 31, 2014, income statement, what amount
should Maria report as a foreign exchange transaction gain:
 a. $18,750.
 b. $3,750.
 c. $11,250..
 d. $0.
Q11- A foreign currency transaction loss occurs on an open-
account purchase from a foreign supplier denominated in local
currency units (LCU) of the foreign supplier's country if the:

A) Buying spot rate for the LCU decreases between the

purchase date and the payment date

B) Selling spot rate for the LCU decreases between the

purchase date and the payment date

C) Buying spot rate for the LCU increases between the

purchase date and the payment date
D)
E) Selling spot rate for the LCU increases between the
purchase date and the payment date..
Q12- Export Company had a trade account receivable from a
foreign customer stated in the local currency of the foreign
customer.
 The trade account receivable for 900,000 local currency
units (LCU) had been translated to $315,000 in Export's
December 31, 2005, balance sheet. On January 15, 2006,
the account receivable was collected in full when the
exchange rate was LCU1 = $0.33 1/3.
 The journal entry that Export prepares to record the
collection of this trade account receivable is:
A) Cash 300,000
Trade Accounts Receivable 300,000

B) Cash 300,000
Foreign Currency Transaction Gains and Losses 15,000
Trade Accounts Receivable 315,000

C) Cash 300,000
Foreign Currency Translation Adjustments 15,000
Trade Accounts Receivable 315,000

D) Cash 315,000
Trade Accounts Receivable 315,000