Question

Assume that your company purchases inventories from a Mexican supplier on December 15. The invoice specifies that payment is to be made on March 15 in Mexican Pesos in an amount of 150,000 Pesos. Your company operates on a calendar year basis.

Assume the following exchange rates and dates:

December 15……………..$0.04:1 Peso

December 31……………..$0.05:1 Peso

March 15…………………..$0.06:1 Peso

The journal entries are as follows:

Date	Account	Dr	Cr
15-Dec	Inventory	6,000
	Accounts Payable		6,000
	To record purchase of inventory
31-Dec	Foreign Currency Transaction Loss	1,500
	Accounts Payable		1,500
	To record increase in accounts payable
15-Mar	Accounts Payable	7,500
	Foreign Currency Transaction Loss	1,500
	Cash		9,000
	To record payment of accounts payable

Submission Requirements:

Answer the following:

• Describe the rationale for each entry, utilizing GAAP standards when possible.

Answer 1

Foreign Exchange Accounting:

Financial Accounting Standard Board (FASB) prescribes accounting and reporting requirements for Foreign currency transactions under ASC Topic 830.

Overall understanding:

Before going in for understanding each entry specifically, we shall take an overall view of the scenario to understand accounting treatment in a better manner. US Company has purchased inventories from a Mexican supplier for which 150,000 pesos need to be paid. This purchase transaction occurs on December 15. This acquisition of inventory will be recognized in Books of account with rate prevailing on December 15. At the end of the Financial Period on December 31, Foreign exposure of liability is recognized. US Company will need to account for an increase in liability due to an increase of $0.01 in the foreign exchange rate. Such exchange loss arising out of fluctuation of currency rate will be recognized in net income. Going further on March 15, when actual payment is made, liability needs to be raised by $1,500 to give the effect of the increase in currency rate by $0.01. Currency rate has increased from $0.04 to $0.06 for which Foreign exchange loss of $0.01 is booked in the previous year ending on December 31 and the remaining loss of $0.01 is recognized in the current year. This rationale can be understood from the following chart too:

Forex Loss =$0.01 Transfered to Income Statement of Year Ending on Dec. 31 Forex Loss =$0.01 Transfered to Income Statement of Current Year $0.04 $0.05 $0.06 Dec. 15 Dec. 31 March 15

At the time of Purchase:

Date Account 15-Dec Inventory 6,000 Accounts Payable 6,000 To record purchase of inventory

Asset and liability are remeasured in reporting currency using the exchange rate prevailing on the Transaction date. Accounts Payable (Liabilities) are recorded for $6,000 ($0.04 X Peso 150,000).

At Balance Sheet Date:

31-Dec Foreign Currency Transaction Loss 1,500 Accounts Payable 1,500 To record increase in accounts payable

At the date of the original transaction, the Liability of Accounts Payable could be settled using $6,000. But on December 31, Exchange rates have increased and US company will have to use $7,500 ($0.05 X Peso 150,000) to meet such liability. This increase of $1,500 in Accounts payable is due to Foreign exchange fluctuation. Hence such Forex loss shall be recorded and reflected in the Income statement of Period ending on December 31.

At the time of Payment:

15-Mar Accounts Payable 7,500 Foreign Currency Transaction Loss 1,500 Cash 9,000 To record payment of accounts payable

At the date of actual settlement of liability, Company has to spend $9,000 ($0.06 X Peso 150,000) which is $1,500 more than the balance of Accounts payable (Balance of Accounts payable is $7,500 = $6,000 + $1,500). Reson for such excess payment is again foreign exchange fluctuation. Hence such Forex loss is recorded in present year as previous year's books are closed already.