Question

Globalization is a continuous process whereby managers become aware of the impact of international activities on their companies. This process takes place in stages that include exporting, licensing joint ventures, wholly owned subsidiaries, and global sourcing. Each stage has implications for the type of accounting information reported.

Striking Furs imports furs from Canada. In the space provided below, prepare journal entries to record the following events.

• Dec. 11, 2017: Purchased furs from Capable Trappers, Ltd., a Canadian corporation, at a price of 25,000 Canadian dollars, due in 60 days. The current exchange rate is $0.85 U.S. dollars per Canadian dollar. (Striking uses the perpetual inventory method; debit the Inventory account.)
• Dec. 31, 2017: Striking made a year-end adjusting entry relating to the account payable to Capable Trappers. The exchange rate at year-end is $0.89 U.S. dollars per Canadian dollar.
• Feb. 9, 2018: Issued a check for $21,750 (U.S. dollars) to National Bank in full settlement of the liability to Capable Trappers, Ltd. The exchange rate at this date is $0.87 U.S. dollars per Canadian dollar.

2. Explain ways in which Striking Furs can protect itself against the losses that would arise from a sudden increase in the foreign exchange rate.

Answer 1

1. Journal entries are as below:

Debit (US $) Credit (US $) Dr.Cr. Account title Explanation Date December 11, 2017 Dr Inventory 21,250 21,250 Canadian dollar 25000 * $0.85 Accounts Payable Cr |(To record purchase of fur at Canadian Dollar 25000 @ equivalent US $ 0.85) Foreign currency exchange loss Accounts payable December 31, 2017 Dr 1,000 1,000 Canadian dollar 25000 *( $0.85 - $ 0.89) Cr (To restate accounts payable at year end exchange rate) February 9, 2018 Dr Accounts Payable Canadian dollar 25000 *$0.89 22,250 Foreign currency exchange gain 500 Canadian dollar 25000 *( $0.89 - $ 0.87) 21,750 Canadian dollar 25000 *$0.87 Cr Cash Cr (To record payment to vendor and related forex gain or loss)

2. Hedge is the best way for an entity to protect itself against foreign currency exchange losses. There are two ways of Hedging - Forward contract and Options. Under forward contract, an entity can enter into an agreement with a financial institution for specified exchange rate of future date (i.e.) if there exists any future payable or receivable, the company agrees an exchange rate with the financial institution today itself for the said date. On the said date, irrespective of the exchange rate (spot rate), financial institution has to honor the payment or receipt for the forward contract rate. Under Options, there exists an additional facility for the company to choose either to exercise the option or not. So, if exchange rate is favorable, company can choose not to exercise the option and vice versa. Thus forward contract and options are two different types of hedge derivatives, through which company can protect itself from foreign currency exchange losses.