Chapter 15, Problem 6AP

a.

To determine

Prepare in general journal form the entries necessary to record the preceding events.

Explanation of Solution

Currency Exchange rate: Currency exchange rate is the cost incurred to purchase one unit of currency with another currency. In other words, currency exchange rate is the “price” of buying one unit of foreign currency (say, UK pounds (£)) stated in terms of domestic currency (say US dollars).

Prepare journal entries in the books of Company WC

Date	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
October 28	Inventory of Raw Materials $\left(\yen \text{180,000,000}\times \text{\$0}\text{.0105 per Japanese yen}\right)$		1,890,000
	Accounts payable – Company M			1,890,000
	(To record the purchase of 2,000 disk drives from Company M for ¥ 180,000,000 payable in 30 days when exchange rate is $0.0105 per yen )
November 09	Accounts receivable – Bank E $\left(\pounds 604,500\times \text{\$1}\text{.65 per British pound}\right)$		997,425
	Cost of goods sold		518,000
	Sales revenue			997,425
	Inventory of Finished goods			518,000
	(To record the sale and the cost of goods sold of 700 computers to Bank E, when current exchange rate is $1.65 per British pound)
November 27	Accounts payable – Company M		1,890,000
	Cash			1,836,000
	Gain on fluctuations in foreign exchange rates (1)			54,000
	(To record the payment of $1,836,000 to Company M and to recognize the gain or loss on fluctuations in  foreign exchanges)
December 02	Inventory of Raw Materials $\left(€1,200,000\times \text{\$0}\text{.7030 per Euro}\right)$		843,600
	Accounts payable – Company G			843,600
	(To record the purchase of 10,000 monitors from Company G for €1,200,000 payable in 60 days when exchange rate is $0.7030 per euro )
December 09	Cash		985,335
	Loss on fluctuations in foreign exchange rates (2)		12,090
	Accounts receivable – Bank E			997,425
	(To record the collection of £604,500 from Bank E  when exchange rate was $1.63 per British pound)
December 11	Accounts receivable – Company C $\left(\text{SFr}\text{. 23,750,000}\times \text{\$0}\text{.6000 per Swiss franc}\right)$		14,250,000
	Cost of goods sold		7,400,000
	Sales revenue			14,250,000
	Inventory of Finished goods			7,400,000
	(To record the sale and cost of goods sold of 10,000 computers to Company C when current exchange rate is $0.600 per Swiss franc)

Table (1)

Explanation for journal entries:

October 28: To record the purchase of 2,000 disk drives from Company M for ¥ 180,000,000 payable in 30 days when exchange rate is $0.0105 per Japanese Yen:

Inventory of raw materials is an asset. The value is increased due to the credit purchases. Therefore, inventory of raw materials account is debited with $1,890,000.

Accounts Payable is a liability and it is increased due to the purchases made on credit. Therefore, credit Accounts Payable account with $1,890,000.

November 09: To record the sale and the cost of goods sold of 700 computers to Bank E:

Accounts receivable is an asset account. The value is increased due to the credit sales of $997,425. Thus, it is debited.

Cost of goods sold is a component of retained earnings and it is decreased by $518,000. Thus, it is debited.

Sales revenue is a component of stockholders’ equity that increases the stockholders’ equity by $997,425. Thus, it is credited.

Inventory of finished goods is an asset and it is decreased by $518,000. Thus, it is credited.

November 27: To record the payment of $1,836,000 to Company M and to recognize the gain or loss on fluctuations in foreign exchanges:

Accounts Payable is a liability and it decreases by $1,890,000. Thus, it is debited.

Cash is an asset. The payment to accounts payable (liability) decreases the cash by $1,836,000 and hence, it is credited.

Gain on fluctuations in foreign exchange rates is a component of retained earnings and it is increased by $54,000. Thus, it is credited.

December 02: To record the purchase of 10,000 monitors from Company G for € 1,200,000 payable in 60 days when exchange rate is $0.7030 per Euro:

Inventory of raw materials is an asset. The value is increased due to the credit purchases. Therefore, inventory of raw materials account is debited with $843,600.

Accounts Payable is a liability and it is increased due to the purchases made on credit. Therefore, credit Accounts Payable account with $843,600.

December 09: To record the collection of £604,500 from Bank E when exchange rate was $1.63 per British pound:

Cash is an asset. The collections from accounts receivable (asset) increases the cash by $985,335 and hence, it is debited.

Loss on fluctuations in foreign exchange rates is a component of retained earnings and it is decreased by $12,090. Thus, it is debited.

Accounts receivable is an asset. Collections from accounts receivable (asset) decreases the accounts receivable by $997,425. Thus, it is credited.

December 11: To record the sale and cost of goods sold of 10,000 computers to Company C:

Accounts receivable is an asset account. The value is increased due to the credit sales of $14,250,000. Thus, it is debited.

Cost of goods sold is a component of retained earnings and it is decreased by $7,400,000. Thus, it is debited.

Sales revenue is a component of stockholders’ equity that increases the stockholders’ equity by $14,250,000. Thus, it is credited.

Inventory of finished goods is an asset and it is decreased by $7,400,000. Thus, it is credited.

Working note:

Compute the gain or loss on fluctuation in foreign exchange rate on November 27.

$\begin{array}{c}\begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\left(\begin{array}{l}\text{Purchases from}\\ \text{ Company M}\end{array}\right)-\left(\begin{array}{l}\text{Cash paid to }\\ \text{Company M}\end{array}\right)\\ \begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\$1,890,000-\$1,836,000\\ \begin{array}{l}\text{Gain on Fluctuations in }\\ \text{foreign exchange}\end{array}]=\$54,000\end{array}$ (1)

Compute the gain or loss on fluctuation in foreign exchange rate on December 09.

$\begin{array}{c}\begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\left(\begin{array}{l}\text{Sales to }\\ \text{Bank E}\end{array}\right)-\left(\begin{array}{l}\text{Cash collected }\\ \text{from Bank E}\end{array}\right)\\ \begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\$997,425-\left[\begin{array}{l}\pounds 604,500\times \$1.63\\ \text{per British pound}\end{array}\right]\\ =\$997,425-\$985,335\\ \begin{array}{l}\text{Loss on Fluctuations in }\\ \text{foreign exchange}\end{array}]\text{=\$12,090}\end{array}$ (2)

b.

To determine

Prepare the adjusting entries needed at December 31 for the €1,200,000 account payable to Company G and the SFr. 23,750,000 account receivable from Company C. Year-end exchange rates, $0.7000 per euro and $0.5980 per Swiss franc.

Explanation of Solution

Currency Exchange rate: Currency exchange rate is the cost incurred to purchase one unit of currency with another currency. In other words, currency exchange rate is the “price” of buying one unit of foreign currency (say, UK pounds (£)) stated in terms of domestic currency (say US dollars).

Prepare journal entries to record the adjusting entries.

Date	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
December 31	Accounts payable – Company G		3,600
	Gain on fluctuations in foreign exchange rates (Refer Table (3))			3,600
	(To record the adjusting entries at the end of the year)
December 31	Loss on fluctuations in foreign exchange rates (Refer Table (4))		47,500
	Accounts receivable – Company C			47,500
	(To record the adjusting entries at the end of the year)

Table (2)

Explanation for journal entries:

December 31: To adjust balance of €1,200,000 account payable at the end of the year:

Accounts Payable is a liability and it decreases by $3,600. Thus, it is debited.

Gain on fluctuations in foreign exchange rates is a component of retained earnings and it is increased by $3,600. Thus, it is credited.

December 31: To adjust balance of SFr. 23,750,000 account receivable at the end of the year:

Loss on fluctuations in foreign exchange rates is a component of retained earnings and it is decreased by $47,500. Thus, it is debited.

Accounts Receivable is an asset and it decreases by $47,500. Thus, it is credited.

Working Notes:

Compute the adjusted balance of account payable – Company G at the year end.

Particulars	Amount
Original account balance	$843,600
Adjusted balance as on December 31$\left(€\text{1,200,000}\times \text{\$0}\text{.7000 per Euro}\right)$	($840,000)
Required balance for adjustment (gain)	$3,600

Table (3)

Compute the adjusted balance of account receivable at the year end.

Particulars	Amount
Original account balance	$14,250,000
Adjusted balance as on December 31$\left(\text{SFr}\text{. 23,750,000}\times \text{\$0}\text{.5980 per Swiss franc}\right)$	($14,202,500)
Required balance for adjustment (loss)	$47,500

Table (4)

c.

To determine

Compute (to the nearest dollar) the unit sales price of computers in U.S. dollars in either the November 9 or December 11 sales transaction.

Explanation of Solution

Currency Exchange rate: Currency exchange rate is the cost incurred to purchase one unit of currency with another currency. In other words, currency exchange rate is the “price” of buying one unit of foreign currency (say, UK pounds (£)) stated in terms of domestic currency (say US dollars).

Compute the unit sales price of computers in U.S. dollars.

Computation of unit sales price on November 09
Particulars	Amount
Sales price, 700 units, in British pounds	£604,500
Sales price, 700 units, in U.S. dollars $\left(\pounds 604,500\times \$1.65\text{ per pound}\right)$	$997,425
Sales price per unit $\left(\$997,425÷700\text{ units}\right)$	$1,425
Computation of unit sales price on November 11
Sales price, 10,000 units, in Swiss francs	SFr. 23,750,000
Sales price in U.S. dollars $\left(\text{SFr}\text{. }23,750,000\times \$.6000\text{ per Swiss franc}\right)$	$14,250,000
Sales price per unit $\left(\$14,250,000÷10,000\text{ units}\right)$	$1,425

Table (5)

Hence, the sales price of computers in U.S. dollars on November 09 and on November 11 is $1,425 per unit.

d.

To determine

Compute the exchange rate of Japanese Yen (¥) in US dollars ($) as on November 27.

Explanation of Solution

Currency Exchange rate: Currency exchange rate is the cost incurred to purchase one unit of currency with another currency. In other words, currency exchange rate is the “price” of buying one unit of foreign currency (say, UK pounds (£)) stated in terms of domestic currency (say US dollars).

Compute the exchange rate of Japanese Yen (¥) in US dollars on November 27.

$\begin{array}{c}\text{Exchange rate in US dollars}=\frac{\text{Amount paid to Company M in dollars}}{\text{Value of goods purchased in terms of }\yen }\\ =\frac{\$1,836,000}{\yen 180\text{,000,000}}\\ =\text{\$0}\text{.012 per Japanese Yen (}\yen )\end{array}$

The exchange rate as on November 27 is $0.12784 per Japanese Yen (¥).

e.

To determine

Explain the manner by which Company WC could have hedged its position to reduce the risk of loss from exchange rate fluctuations on (1) foreign payable and (2) its foreign receivables.

Explanation of Solution

Hedging: This is a mechanism that is used to eliminate or minimize the risk of loss that is associated with the fluctuations in foreign exchange market. It is a strategy to offset the losses against the gains on the fluctuations of foreign exchange.

Company WC could have hedged to reduce the risk of loss from exchange rate fluctuations in the following ways:

(1) Foreign payable: Company WC could have hedged its position in foreign accounts payable by acquiring an equivalent amount of future contracts in these currencies that would mature at the same time when the liabilities would be paid. Such contracts are essentially receivables in foreign contracts. The losses or gains on the future contract can be used to offset the gain or losses on the foreign payable.

(2) Foreign receivable: Company WC’ position in its foreign receivables could be hedged by selling the future contracts. From the perspective of seller of a future contract, such contracts are a liability to pay off the fixed amount of foreign currency at a future date. Thus, Company WC would be creating foreign payables to offset its foreign receivables.