Basics of accounting for foreign currency transactions

2. Accounts receivable denominated in foreign currencies

We’ll continue with our example of a manufacturer of machine parts located in the United States. On December 1, 201X, the company receives a $50,000 order from an automobile factory in Germany for parts costing the manufacturer $35,000 to produce. The manufacturer allows the purchase to be made in euros and gives the German factory until December 20 to pay for the order. On December 1, one euro is worth $1.25. On December 20, the buyer pays 40,000 euros. One euro is now worth $1.29.

The initial journal entries for the sale are basically the same as any other sale. Note, however, that we need to indicate that the sale is denominated in a foreign currency. The manufacturer keeps all amounts in U.S. dollars, not euros.

Account Names

Debits

Credits

Cost of Goods Sold

35,000

 

     Finished Goods Inventory

 

35,000

     

Accounts Receivable

50,000*

 

     Sales Revenue

 

50,000

(*) $50,000 = 40,000 euros x $1.25

Because the German buyer has one month to pay, the manufacturer is exposed to any fluctuation in the exchange rate between euros and U.S. dollars. When the account is settled on December 20, we make a second entry that shows the effect of the rate change. Instead of crediting or debiting Sales Revenue, we use an account called Gain (or Loss) On Foreign Currency Transaction to show that the change in income is a result of a separate decision to grant foreign trade credit.

Account Names

Debits

Credits

Cash

51,600*

 

     Accounts Receivable

 

50,000**

     Gain on Foreign Currency Transaction

 

1,600***

(*) $51,600 = 40,000 euros x $1.29

(**) $50,000 = 40,000 euros x $1.25

(***) $1,600 = 40,000 euros x $0.04 or $51,600 - $50,000

In this situation, the manufacturer received an extra $1,600 because the value of the euro increased compared to the U.S. dollar from December 1 to December 20.

If instead the euro is only worth $1.20 on December 20, cash received would be less than the receivable amount, so we would debit Loss On Foreign Currency Transaction to balance the amounts.

If a company carries a foreign currency receivable on its balance sheet at the end of a reporting period, it needs to adjust the carrying amount of the receivable to better match gains and losses with the proper reporting period. Let’s say that our manufacturer gives the German buyer until January 31 to pay, and the spot rate for euros at that time is $1.27. The spot rate on December 31 is still $1.29. This time, an additional entry is required to completely account for the sale.

Account Names

Debits

Credits

December 31

   

Accounts Receivable

1,600*

 

     Gain on Foreign Currency Transaction

 

1,600

     

January 31

   

Cash

50,800**

 

Loss on Foreign Currency Transaction

800***

 

     Accounts Receivable

 

51,600****

(*) $1,600 = 40,000 euros x $0.04, where $0.04 = $1.29 - $1.25

(**) $50,000 = 40,000 euros x $1.27 (@ January 31 spot rate)

(***) $800 = 40,000 euros x $0.02, where $0.02 = $1.29 - $1.27

(****) $51,600 = 40,000 euros x $1.29 (@ December 31 spot rate)

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