Exchange Rate Adjustments
Response to the following problem:
Given the international economy in which many firms operate, it is not unusual for companies to have transactions with companies in foreign countries. Relatedly, it is becoming common for some of those transactions to be denominated in a foreign currency. That is, if a company in the United States makes a purchase from a company in Japan, it is possible that the U.S. company will have to pay Japanese yen when the invoice comes due.
For example, suppose American, Inc., purchased inventory from Japan, Inc., on December 15, 2008. Japan, Inc., expects to receive 1,000,000 Japanese yen in 30 days. To record a journal entry for this purchase, you would need to know what 1,000,000 yen are worth today. Suppose that on December 15, 2008, one yen is worth $0.07 (this is called an exchange rate). What journal entry would be made on American, Inc.'s books?
Since exchange rates change every day, the amount of U.S. dollars to be paid on January 15, 2009, will likely be different than the originally recorded $70,000. In addition, to correctly state the liability on December 31, 2008, an adjustment will be required. Suppose that at year-end, one Japanese yen is worth $0.08. What adjusting entry would be made to reflect this change in exchange rates as of December 31, 2008?
(Hint: The accounts being adjusted with this journal entry will be the accounts payable account and an exchange gain or loss.)
When the invoice is paid on January 15, 2009, it is likely that the number of U.S. dollars required to purchase 1,000,000 Japanese yen will again have changed. Suppose exchange rates have increased to $0.09. Provide the journal entry to pay the invoice.