Saturday, February 9, 2013

Sales and Purchases Listed in a Foreign Currency

When a U.S. company makes a credit sale to an international customer, accounting for the sale and the account receivable is straightforward if sales terms require the international customer’s payment in U.S. dollars. If sale terms require (or allow) payment in a foreign currency, however, the U.S. company must account for the sale and the account receivable in a different manner.

Sales in a Foreign Currency  To illustrate, consider the case of the U.S.-based manufacturer Boston Company, which makes credit sales to London Outfitters, a British retail company. A sale occurs on December 12, 2010, for a price of £10,000 with payment due on February 10, 2011. Boston Company keeps its accounting records in U.S. dollars. To record the sale, Boston Company must translate the sales price from pounds to dollars. This is done using the exchange rate on the date of the sale. Assuming the exchange rate on December 12, 2010, is $1.80, Boston records this sale as follows.

 



When Boston Company prepares its annual financial statements on December 31, 2010, the current exchange rate is $1.84. Thus, the current dollar value of Boston Company’s receivable is $18,400 (£10,000 × $1.84£). This amount is $400 higher than the amount recorded on December 12. Accounting principles require a receivable to be reported in the balance sheet at its current dollar value. Thus, Boston Company must make the following entry to record the increase in the dollar value of this receivable at year-end.

 


Point: Foreign exchange gains are credits, and foreign exchange losses are debits.

On February 10, 2011, Boston Company receives London Outfitters’ payment of £10,000. It immediately exchanges the pounds for U.S. dollars. On this date, the exchange rate for pounds is $1.78. Thus, Boston Company receives only $17,800 (£10,000 × $1.78£). It records the cash receipt and the loss associated with the decline in the exchange rate as follows.

 


Gains and losses from foreign exchange transactions are accumulated in the Foreign Exchange Gain (or Loss) account. After year-end adjustments, the balance in the Foreign Exchange Gain (or Loss) account is reported on the income statement and closed to the Income Summary account.

Example: Assume that a U.S. company makes a credit purchase from a British company for £10,000 when the exchange rate is $1.62. At the balance sheet date, this rate is $1.72. Does this imply a gain or loss for the U.S. company? Answer: A loss.

Purchases in a Foreign Currency  Accounting for credit purchases from an international seller is similar to the case of a credit sale to an international customer. In particular, if the U.S. company is required to make payment in a foreign currency, the account payable must be translated into dollars before the U.S. company can record it. If the exchange rate is different when preparing financial statements and when paying for the purchase, the U.S. company must recognize a foreign exchange gain or loss at those dates. To illustrate, assume NC Imports, a U.S. company, purchases products costing ₠20,000 (euros) from Hamburg Brewing on January 15, when the exchange rate is $1.20 per euro. NC records this transaction as follows.

 



NC Imports makes payment in full on February 14 when the exchange rate is $1.25 per euro, which is recorded as follows.

 


Decision Insight
Global Greenback What do changes in foreign exchange rates mean? A decline in the price of the U.S. dollar against other currencies usually yields increased international sales for U.S. companies, without hiking prices or cutting costs, and puts them on a stronger competitive footing abroad. At home, they can raise prices without fear that foreign rivals will undercut them.

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