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Prepare accounting entries relating to foreign currency transactions Contents Key to resources 2 Introduction 3 Accounting standard for foreign currency 3 Import and export of goods 3 Receiving a loan and repayment 8 Import of non-current assets 10 Hedging 12 Translation of the financial statements of foreign operations 13 Summary 13 Feedback to questions 12.7, 12.8 and 12.11 14 This learning guide is based on the following resource: Textbook Woodford WL and Mills AD (2005) Company Accounting, LexisNexis Butterworths, Chatswood, NSW Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 1 Key to resources Key Resource 1 Chapter 12, Overview, p 442 2 Chapter 12, table indicating effect of movements in exchange rates on amounts receivable or payable in a foreign currency, p 443 3 Chapter 12, self-assessment question 12A, p 443 4 Chapter 12: 5 example 1, p 444 example 2, p 445 Chapter 12, questions 12.1 and 12.2, p 446 For feedback to these questions, go back to where you were in this guide. 6 Chapter 12, Unrealised exchange gains/losses, p 446 7 Chapter 12, example 3, p 448 8 Chapter 12, self-assessment question 12B (example is for periodic inventory), p 447 9 Chapter 12, question 12.7, p 449 Feedback is provided at the end of this learning guide. 10 Chapter 12, question no 12.8, p 449 Feedback is provided at the end of this learning guide. 11 Chapter 12: table indicating effect of movements in exchange rates on amounts receivable or payable in a foreign currency, p 443 example 4 (realised exchange loss), p 450 12 Chapter 12, example 5 (unrealised exchange gain and realised exchange loss), p 451 13 Chapter 12, self-assessment 12C, p 453 14 Chapter 12, question 12.11, p 452 Feedback is provided at the end of this learning guide. 15 Chapter 12, example 6, p 453 16 Chapter 12, question 12.13, p 454 For feedback, return to where you were in this learning guide. 17 Chapter 12, example 8 (purchase of a non-current asset), p 458 18 Chapter 12, question 12.19, p 458 For feedback, return to where you were in this learning guide. 19 2 Chapter 12, Hedging, p 442 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Introduction In this guide the focus is on foreign currency transactions, as stipulated under AASB 121. Accounting standard for foreign currency Go to Resource 1 Note: The Key to resources is provided at the front of this learning guide. The applicable accounting standard for foreign currency transactions is AASB 121. Areas of study under the guidelines of this standard are: import of goods export of trading goods loan raising and repayment discussion of hedge transactions issues associated with the translation of financial statements. Note the last two paragraphs in the Overview. Exchange rates fluctuate on a daily basis and as a result exchange gains/losses will need to be recorded in the books of account. Import and export of goods Now go to Resource 2 Carefully study the effect of movements of foreign currency against the Australian dollar. Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 3 Movements under the heading of ‘Amounts receivable’ refer to sales of goods on credit. Movement under the heading of ‘Amounts payable’ refer to purchases on credit. Now go to Resource 3 This will help you to check your understanding. Import of trading goods: realised exchange gains or losses Now go to Resource 4 Example 1 (where JK Ltd buys goods for resale from BC Ltd) is for periodic inventory and therefore the debit is to purchases account. If the perpetual inventory system is used, the debit would be to inventory account. Note especially that the recording of the purchase and the payment all occurred within the financial year. This gives rise to a realised exchange gain (in this case)—that is, the Australian dollars needed to settle the outstanding account in full was less than the original purchase price. Compare example 1 with example 2. In example 2, the recording of the purchase and the payment all occurred within the same financial year but in this case the Australian dollars needed to settle the outstanding account in full was more than the original purchase price. This results in a realised exchange loss. At the end of the financial year, realised exchange gains and losses are transferred to the profit and loss account. Now go to Resource 5 This will help you to check your understanding. Feedback to questions12.1 and 12.2 from the textbook are provided below. 4 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Feedback to questions Question 12.1 TX Ltd General journal Date Details Debit 20x0 Sep 15 $ Purchases Credit $ 50 000.00 Accounts payable – AB Company Ltd 50 000.00 Recording purchase of $NZ50 000 @ $A1.00 = $NZ1.00 Nov 1 Accounts payable – AB Company Ltd 4 545.46 Realised exchange gain 4 545.46 Recording exchange gain on payment date when $A1.00 = $NZ1.10 (50 000 – 45 454.54) Accounts payable – AB Company Ltd 45 454.54 Bank 45 454.54 Payment to creditor 20x1 Jun 30 Realised exchange gain 4 545.46 Profit and loss 4 545.46 Balance transferred Solution (above) is from Company Accounting, Woodford & Mills, LexisNexis Butterworths, 2005. Reproduced with permission. Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 5 Question 12.2 GL Ltd General journal Date Details Debit 20x2 Feb 1 $ Purchases Credit $ 60 000.00 Accounts payable – RN Ltd 60 000.00 Recording purchase of $F60 000 @ $A1.00 = $F1.00 Jun 1 Realised exchange loss 606.06 Accounts payable – RN Ltd 606.06 Recording exchange loss on payment date when $A1.00 = F0.99 (60 606.06 – 60 000) Accounts payable – RN Ltd 60 606.06 Bank 60 606.06 Payment to creditor Jun 30 Profit and loss 606.06 Realised exchange loss 606.06 Balance transferred Solution (above) is from Company Accounting, Woodford & Mills, LexisNexis Butterworths, 2005. Reproduced with permission. Import of trading goods: unrealised exchange gains or losses Now go to Resource 6 If the outstanding amount owing to the accounts payable has not been paid by balance date, it is recalculated with the exchange rate applicable at balance date. Any difference between the exchange rate applicable at the date of purchase and the exchange rate applicable at balance date will be an unrealised gain or loss. 6 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Unrealised exchange gains or losses are also transferred to profit and loss account. Now go to Resource 7 Note that Example 3 is for periodic inventory. For perpetual inventory, a further journal entry would be required for the cost of goods sold. This entry is not affected by foreign currency fluctuations and is not shown. Now go to Resource 8 This will help you to check your understanding. Now go to Resource 9 Feedback to question 12.7 is provided at the end of this guide. Now go to Resource 10 Export of goods: realised exchange gains or losses Go to Resource 11 Note that example 4 shows a realised exchange loss. The sale and the receipt of the money for the outstanding account all occurred within the financial year. The Australian dollar gained strength against the foreign currency and there will be fewer Australian dollars Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 7 received to settle the balance owing. Realised exchange gains or losses are transferred to profit and loss. Export of goods: unrealised exchange gains or losses If the amount owing by an accounts receivable has not been received by balance date then the amount owing is recalculated using the exchange rate applicable at balance date. Any gain or loss as a result will be unrealised. Unrealised exchange gains or losses are transferred to profit and loss at balance date. Go to Resource 12 Go to Resource 13 Test your understanding to date by answering self-assessment question 12C. Go to Resource 14 Note: Feedback to question 12.11 is provided at the end of this learning guide. Receiving a loan and repayment Now go to Resource 15 Note that the loan was received and repaid within the same financial year. Therefore the exchange difference (a loss in this case) was realised. 8 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Note also the need to calculate the interest paid on the loan converted to Australian dollars and to transfer both the realised exchange difference and the interest to profit and loss. Now go to Resource 16 This will help you to check your understanding. Feedback to question 12.13 General journal Date Details Debit $ 20x8 Jul 1 Credit Bank $ 694 444 Loan from YK Ltd 694 444 Recording receipt of loan for $US500 000 when $A1 = $US0.72 (500 000 0.72) 20x9 Jun 30 Interest expense 65 217 Bank 65 217 Recording interest payment for year (9/100 × 500 000 = 45 000 0.69) Realised exchange loss 30 194 Loan from YK Ltd 30 194 Recording exchange loss where $A1 = $US0.69 (724 638 – 694 444) Loan from YK Ltd 724 638 Bank 724 638 Recording repayment of $US500 000 loan when $A1 = $US0.69 Profit and loss 95 411 Interest expense 65 217 Realised exchange loss 30 194 Balance transferred Solution (above) is from Company Accounting, Woodford & Mills, LexisNexis Butterworths, 2005. Reproduced with permission. Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 9 Import of non-current assets Now go to Resource 17 You will have noted in Example 8 that the process for the purchase of a noncurrent asset is similar to the purchase of trading goods. The exception is if the asset has to be constructed overseas and is deemed to be a qualifying asset. Exchange rate differences will form part of the cost of the asset up until the time its construction is complete even though the amount owing remains unpaid. After construction is complete, exchange rate differences are written off to profit and loss as for the import of goods. Note: The accounting entries for a qualifying asset are beyond our scope. Now go to Resource 18 This will help you to check your understanding. Feedback to the textbook question follows. 10 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Feedback to question 12.19 (a) DD Ltd General journal Date Details Debit 20x5 Aug 15 $ Purchases Credit $ 82 819.38 Accounts payable – Interpel Corporation 82 819.38 Recording purchase of $S94 000 @ $A1.00 = $S1.1350 Dec 15 Realised exchange loss 6 237.94 Accounts payable – Interpel Corporation 6 237.94 Recording realised exchange loss at payment date when $A1.00 = $S1.0555 Accounts payable – Interpel Corporation 89 057.32 Bank 89 057.32 Payment to creditor 20x6 Jun 30 Profit and loss Realised exchange loss 6 237.94 6 237.94 Balance transferred Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 11 (b) Date Details 20x5 Aug 15 Equipment Debit Credit $ $ 82 819.38 Accounts payable – Interpel Corporation 82 819.38 Recording non-current asset purchase of $S94 000 @ $A1.00 = $S1.1350 Dec 15 Realised exchange loss 6 237.94 Accounts payable – Interpel Corporation 6 237.94 Recording exchange loss on payment date when $A1.00 = $1.0555 Accounts payable – Interpel Corporation 89 057.32 Bank 89 057.32 Payment to creditor 20x6 Jun 30 Profit and loss 6 237.94 Realised exchange loss 6 237.94 Balance transferred Solution (above) is from Company Accounting, Woodford & Mills, LexisNexis Butterworths, 2005. Reproduced with permission. Hedging Now go to Resource 19 Note that the operative standard for hedging is AASB 139. (For our purposes, the study of hedging is limited to the material in the textbook.) 12 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Translation of the financial statements of foreign operations If a company has a foreign operation, the financial statements of that operation need to be changed from the foreign currency to Australian dollars. This process is known as ‘translating’. Paragraph 39 of AASB 121 generally covers the process. Here are the main principles: Assets and liabilities are translated at the closing exchange rate at the date of the balance sheet. Income and expenses are translated at exchange rates at the date of the transaction. Resulting exchange differences from the above are recognised as a separate component in equity, eg foreign currency translation reserve, and not transferred to profit and loss. You are not required to translate financial statements as part of your studies and study is limited to the above material. Summary In this learning guide on the preparation of foreign currency transactions, our coverage included the accounting standard that governs foreign currency transactions (AASB121) and the guidelines under this standard relating to the import and export of goods, loans and repayments as well as the process of translating. Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 13 Feedback to questions 12.7, 12.8 and 12.11 The following solutions are from Company Accounting, Woodford & Mills, LexisNexis Butterworths, 2005. Reproduced with permission. Question 12.7 feedback EW Ltd Worksheet – Amounts ‘owing’ on relevant dates: Krone $A 1 April 20x5 1 200 000 250 548.07 30 April 20x5 1 200 000 248 678.89 1 June 20x5 1 200 000 250 783.69 (a) General journal Date Details Debit 20x5 Apr 1 $ Purchases Credit $ 250 548.07 Accounts payable – EN Corporation 250 548.07 Recording purchase of Krone 1 200 000 @ $A1.00 = Krone 4.7895 Apr 30 Accounts payable – EN Corporation 1 869.18 Unrealised exchange gain 1 869.18 Recording unrealised exchange gain at balance date @ $A1.00 = Krone 4.8255 (250 548.07 – 248 678.89) Unrealised exchange gain 1 869.18 Profit and loss 1 869.18 Balance transferred Jun 1 Realised exchange loss 2 104.80 Accounts payable – EN Corporation 2 104.80 Recording realised exchange loss at payment date when $A1.00 = Krone 4.7850 (250 783.69 – 248 678.89) Accounts payable – EN Corporation Bank 14 250 783.69 250 783.69 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 Payment to creditor 20x6 Apr 30 Profit and loss 2 104.80 Realised exchange loss 2 104.80 Balance transferred (b) Unrealised exchange gain 20x5 Apr 30 20x5 Profit and loss 1 869.18 Apr 30 Accounts payable – EN Corporation 1 869.18 Realised exchange loss 20x5 Jun 1 20x6 Accounts payable – EN Corporation 2 104.80 Apr 30 Profit and loss 2 104.80 Accounts payable – EN Corporation 20x5 Apr 30 20x5 Unrealised exchange gain Balance c/d 1 869.18 Apr 1 Purchases 250 548.07 248 678.89 250 548.07 Jun 1 Bank 250 783.69 250 548.07 May 1 Balance b/d 248 678.89 Jun 1 Realised exchange loss 250 783.69 2 104.80 250 783.69 Question 12.8 feedback Worksheet – amounts ‘owing’ on relevant dates: $US $A 15 August 20x4 15 000 20 833 31 December 20x4 15 000 20 548 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 15 15 January 20x5 16 15 000 21 429 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 General journal Date Details Debit 20x4 Aug 15 $ Purchases Credit $ 20 833 Accounts payable – EB Ltd 20 833 Recording purchase of $US15 000 when $A1 = $US0.72 Dec 31 Accounts payable – EB Ltd 285 Unrealised exchange gain 285 Recording unrealised exchange gain at balance date when $A1 = $US0.73 (20 833 – 20 548) Unrealised exchange gain 285 Profit and loss 285 Balance transferred 20X5 Jan 15 Realised exchange loss 881 Accounts payable – EB Ltd 881 Recording realised exchange loss where $A1 = $US0.73 (21 429 – 20 548) Accounts payable – EB Ltd 21 429 Bank 21 429 Payment to creditor (15 000 0.70) Dec 31 Profit and loss Realised exchange loss 881 881 Balance transferred Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699 17 Question 12.11 feedback Thear Ltd General journal Date Details Debit 20x6 May 1 $ Accounts receivable – Islander Ltd Credit $ 400 000.00 Sales 400 000.00 Recording sales of $A400 000 ($F430 000) @ $A1.00 = $F1.075 Jun 30 Unrealised exchange loss 1 851.87 Accounts receivable – Islander Ltd [see Note] 1 851.87 Recording unrealised exchange loss at balance date on $F430 000 when $A1.00 = $F1.080 (430 000 1.08 = 398 148.13) Profit and loss 1 851.87 Unrealised exchange loss 1 851.87 Balance transferred Aug 15 Realised exchange loss 1 834.77 Accounts receivable – Islander Ltd 1 834.77 Recording realised exchange loss at payment date on $F430 000 when $A1.00 = $F1.085 (398 148.13 – 396 313.36) Bank 396 313.36 Accounts receivable 396 313.36 Receipt of payment (430 000 1.085 = 396 313.36) 20x7 Jun 30 Profit and loss 1 834.77 Realised exchange loss 1 834.77 Balance transferred Note: The credit could be transferred to an exchange loss allowance and deducted from accounts receivable in the balance sheet. 18 Prepare accounting entries relating to foreign currency transactions © NSW DET 2006, 2006/053/12/2006 LRR 4699