CHAPTER 6 FOREIGN CURRENCY TRANSACTIONS AND HEDGING FOREIGN EXCHANGE RISK
FOREIGN CURRENCY TRANSACTIONS Export sales and import purchases are international transactions. When two parties from different countries enter into a transaction, they must decide which of the two countries' currencies to use to settle the transaction. For example, if a U.S. computer manufacturer sells to a customer in Japan, the parties must decide whether the transaction will be denominated (i.e., whether payment will be made) in U.S. dollars or Japanese yen. In some cases, a third country's currency might be used to denominate the transaction.
FOREIGN CURRENCY TRANSACTIONS Assume that a U.S. exporter (Eximco) sells goods to a Spanish customer with payment to be made in euros. In this situation, Eximco has entered into a foreign currency transaction. It must restate the euro amount that actually will be received into U.S. dollars to account for this transaction. This is because Eximco keeps its books and prepares financial statements in U.S. dollars. Although the Spanish importer has entered into an international transaction, it does not have a foreign currency transaction (payment will be made in its home currency) and no restatement is necessary.
• Assume that as is customary in its industry, Eximco does not require immediate payment and allows its Spanish customer three months to pay for its pur chases. By doing this, Eximco runs the risk that from the date of the sale is made until the date of payment, the euro might decrease in value (depreciate) against the US. dollar and the actual number of U.S. dollars generated from the sale will be less than expected. In this situation Eximco is said to have an exposure to foreign exchange risk.
Accounting Issue • The major issue in accounting for foreign currency transactions is how to deal with the change in the domestic currency value of the sales revenue and account receivable resulting from the export when the foreign currency changes in value. The corollary issue is how to deal with the change in the domestic currency value of the foreign currency account payable and goods being acquired in an import purchase.
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- Spring '16
- Accounting, United States dollar, foreign exchange loss