Chapter 15, Problem 6BP

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 FG

Date	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
October 25	Inventory of Raw Materials $\left(\yen \text{120,000,000}\times \text{\$0}\text{.01 per Japanese yen}\right)$		1,200,000
	Accounts payable – Company S			1,200,000
	(To record the purchase of 15,000 parts from Company S for ¥ 120,000,000 payable in 30 days when exchange rate is $0.01 per yen )
November 15	Accounts receivable – Company BE $\left(\pounds 200,000\times \text{\$1}\text{.60 per British pound}\right)$		320,000
	Cost of goods sold		160,000
	Sales revenue			320,000
	Inventory of Finished goods			160,000
	(To record the sale and the cost of goods sold of 500 consoles to Company BE, when current exchange rate is $1.60 per British pound)
November 24	Accounts payable – Company S		1,200,000
	Cash			1,150,000
	Gain on fluctuations in foreign exchange rates (1)			50,000
	(To record the payment of $1,150,000 to Company S and to recognize the gain or loss on fluctuations in  foreign exchanges)
December 04	Inventory of Raw Materials $\left(\text{SFr}\text{. 8}0,000\times \text{\$0}\text{.70 per Swiss Franc}\right)$		56,000
	Accounts payable – Company SP			56,000
	(To record the purchase of 5,000 black cases from Company SP for SFr. 80,000 payable in 60 days when exchange rate is $0.70 per Swiss Franc )
December 15	Cash		310,000
	Loss on fluctuations in foreign exchange rates (2)		10,000
	Accounts receivable – Bank E			320,000
	(To record the collection of £200,000 from Company BE  when exchange rate was $1.55 per British pound)
December 21	Accounts receivable – Company S $\left(\text{NOK}\text{. 40,000,000}\times \text{\$0}\text{.20 per Norwegian Krone}\right)$		8,000,000
	Cost of goods sold		5,000,000
	Sales revenue			8,000,000
	Inventory of Finished goods			5,000,000
	(To record the sale and cost of goods sold of 6,000 consoles for NOK 40,000,000to Company S when current exchange rate is $0.20 per Norwegian Krone (NOK))

Table (1)

Explanation for journal entries:

October 25: To record the purchase of 15,000 parts from Company M for ¥ 120,000,000 payable in 30 days when exchange rate is $0.01 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 $1,200,000.

Accounts Payable is a liability and it is increased due to the purchases made on credit. Therefore, credit Accounts Payable account with $1,200,000.

November 15: To record the sale and the cost of goods sold of 500 consoles to Company BE, when current exchange rate is $1.60 per British pound:

Accounts receivable is an asset account. The value is increased due to the credit sales of $320,000. Thus, it is debited.

Cost of goods sold is a component of retained earnings and it is decreased by $160,000. Thus, it is debited.

Sales revenue is a component of stockholders’ equity that increases the stockholders’ equity by $320,000. Thus, it is credited.

Inventory of finished goods is an asset and it is decreased by $160,000. Thus, it is credited.

November 24: To record the payment of $1,150,000 to Company S and to recognize the gain or loss on fluctuations in foreign exchanges:

Accounts Payable is a liability and it decreases by $1,200,000. Thus, it is debited.

Cash is an asset. The payment to accounts payable (liability) decreases the cash by $1,150,000 and hence, it is credited.

Gain on fluctuations in foreign exchange rates is a component of retained earnings and it is increased by $50,000. Thus, it is credited.

December 04: To record the purchase of 5,000 black cases from Company SP for SFr. 80,000 payable in 60 days when exchange rate is $0.70 per Swiss Franc:

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 $56,000.

Accounts Payable is a liability and it is increased due to the purchases made on credit. Therefore, credit Accounts Payable account with $56,000.

December 15: To record the collection of £200,000 from Company BE when exchange rate was $1.55 per British pound:

Cash is an asset. The collections from accounts receivable (asset) increases the cash by $310,000 and hence, it is debited.

Loss on fluctuations in foreign exchange rates is a component of retained earnings and it is decreased by $10,000. Thus, it is debited.

Accounts receivable is an asset. Collections from accounts receivable (asset) decreases the accounts receivable by $320,000. Thus, it is credited.

December 11: To record the sale and cost of goods sold of 6,000 consoles for NOK 40, 000,000 to Company S when current exchange rate is $0.20 per Norwegian Krone (NOK):

Accounts receivable is an asset account. The value is increased due to the credit sales of $8,000,000. Thus, it is debited.

Cost of goods sold is a component of retained earnings and it is decreased by $5,000,000. Thus, it is debited.

Sales revenue is a component of stockholders’ equity that increases the stockholders’ equity by $8,000,000. Thus, it is credited.

Inventory of finished goods is an asset and it is decreased by $5,000,000. Thus, it is credited.

Working note:

Compute the gain or loss on fluctuation in foreign exchange rate on November 24.

$\begin{array}{c}\begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\left(\begin{array}{l}\text{Purchases from}\\ \text{ Company S}\end{array}\right)-\left(\begin{array}{l}\text{Cash paid to }\\ \text{Company S}\end{array}\right)\\ \begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\$1,200,000-\$1,150,000\\ \begin{array}{l}\text{Gain on Fluctuations in }\\ \text{foreign exchange}\end{array}]=\$50,000\end{array}$ (1)

Compute the gain or loss on fluctuation in foreign exchange rate on December 15.

$\begin{array}{c}\begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\left(\begin{array}{l}\text{Sales to }\\ \text{Company BV}\end{array}\right)-\left(\begin{array}{l}\text{Cash collected }\\ \text{from Company BV}\end{array}\right)\\ \begin{array}{l}\text{Loss or Gain on Fluctuations}\\ \text{ in foreign exchange}\end{array}]=\$320,000-\left[\begin{array}{l}\pounds 200,000\times \$1.55\\ \text{per British pound}\end{array}\right]\\ =\$320,000-\$310,000\\ \begin{array}{l}\text{Loss on Fluctuations in }\\ \text{foreign exchange}\end{array}]\text{=\$10,000}\end{array}$ (2)

b.

To determine

Prepare the adjusting entries needed at December 31 for the SFr. 80,000 account payable to Company SP and the NOK 40,000,000 account receivable from Company S. Year-end exchange rates, $0.68 per Swiss franc and $0.18 per Norwegian Krone.

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 SP		1,600
	Gain on fluctuations in foreign exchange rates (Refer Table (3))			1,600
	(To record the adjusting entries at the end of the year)
December 31	Loss on fluctuations in foreign exchange rates (Refer Table (4))		800,000
	Accounts receivable – Company C			800,000
	(To record the adjusting entries at the end of the year)

Table (2)

Explanation for journal entries:

December 31: To adjust balance of SFr. 80,000 account payable at the end of the year:

Accounts Payable is a liability and it decreases by $1,600. Thus, it is debited.

Gain on fluctuations in foreign exchange rates is a component of retained earnings and it is increased by $1,600. Thus, it is credited.

December 31: To adjust balance of NOK 40,000,000 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 $800,000. Thus, it is debited.

Accounts Receivable is an asset and it decreases by $800,000. Thus, it is credited.

Working Notes:

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

Particulars	Amount
Original account balance	$56,000
Adjusted balance as on December 31$\left(\text{SFr}\text{. 80,000}\times \text{\$0}\text{.68 per Swiss franc}\right)$	($54,400)
Required balance for adjustment (gain)	$3,600

Table (3)

Compute the adjusted balance of account receivable – Company S at the year end.

Particulars	Amount
Original account balance	$8,000,000
Adjusted balance as on December 31$\left(\text{NOK 40,000,000}\times \text{\$0}\text{.18 per Norwegian Krone}\right)$	($7,200,000)
Required balance for adjustment (loss)	$800,000

Table (4)

c.

To determine

Compute (to the nearest dollar) the unit sales price of computers in U.S. dollars in either the November 15 or December 21 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, 500 units, in British pounds	£200,000
Sales price, 500 units, in U.S. dollars $\left(\pounds 200,000\times \$1.60\text{ per pound}\right)$	$320,000
Sales price per unit $\left(\$320,000÷500\text{ units}\right)$	$640
Computation of unit sales price on November 11
Sales price, 6,000 units, in Swiss francs	NOK 40,000,000
Sales price in U.S. dollars $\left(\text{NOK}\text{. 40,000,000}\times \text{\$0}\text{.20 per Norwegian Krone}\right)$	$8,000,000
Sales price per unit $\left(\$8,000,000÷6,000\text{ units}\right)$	$1,333

Table (5)

Hence, the sales price of consoles in U.S. dollars on November 09 and on November 11 is $640 per unit and $1,333 per unit respectively.

d.

To determine

Compute the exchange rate of Japanese Yen (¥) in US dollars ($) as on November 24.

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 24.

$\begin{array}{c}\text{Exchange rate in US dollars}=\frac{\text{Amount paid to Company S in dollars}}{\text{Value of goods purchased in terms of }\yen }\\ =\frac{\$1,150,000}{\yen 120\text{,000,000}}\\ =\text{\$0}\text{.00958 per Japanese Yen (}\yen )\end{array}$

The exchange rate as on November 24 is $0.00958 per Japanese Yen (¥).

e.

To determine

Explain the manner by which Company FG 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 FG could have hedged to reduce the risk of loss from exchange rate fluctuations in the following ways:

(1) Foreign payable: Company FG 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 FG’s 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 FG would be creating foreign payables to offset its foreign receivables.