Where to exchange currency in boston
Foreign Currency Transactions | Advanced Accounting | CPA Exam FAR
hello and welcome to this session this
is Professor Farhad in this session
we're going to be doing accounting for
foreign currency transaction this topic
is covered in advanced accounting as
well as international accounting and
it's surely covered on the CPA exam the
fourth section if you want additional
lectures about these topics please go to
forehead lectures comm now before I
proceed I would like to make a quick
announcement please connect with me I
really like to know my viewers
I'd like to connect with them on a
personal level so you could connect with
me on LinkedIn I have a Facebook I have
a Facebook page for my website obviously
if you're watching this on youtube
please subscribe to my youtube and
connect with me on my Twitter account so
let's start to take a look at foreign
currency transaction and what do they
entail so it's a very important concept
and you need to learn about it okay what
are the problems with recording and
reporting foreign currency transactions
here's what's gonna happen we have a US
company buying goods and services from
Germany and here's what's gonna happen
they're buying the goods and services
from Germany the German company they
want to be paid in Euros the US company
they'll have to record their
transactions in u.s. dollar
okay so transaction in a foreign
currency must be translated so now we're
gonna be doing what we're gonna be
translating it means Express them at a
dollar amount because we are you
eccentric I am u.s. centric we're always
assuming we are the concurrence in US
currency before they can be aggregated
with domestic transaction so any
transaction will have to be translated
and if you are buying or if you are
selling you might have a receivable or a
payable so if you are buying from a
foreign from a Germany you're gonna have
it payable if you are selling to a
German company are gonna have a
receivable so you're gonna have payable
and receivable that are denominated in
foreign currency okay
but when we report them they're going to
be reported in US dollar and if you
don't know this there's gonna be changes
and the value of the currency therefore
we might have again and we might have a
losses which we will talk about
in this session now also company might
use hatching strategy with derivatives
to minimize the impact of exchange rate
why because exchange rate could go up
could go down depending if you have a
receivable or a payable I'll explain
this you might be hurt or you might
benefit but you don't want to take that
chance you're not in the business of of
playing the foreign foreign foreign
currency market you are in the business
of selling your product making sure you
are paid and making sure you are paid
enough money to compensate you so that's
why you might use hedging strategies
which we would look at in the next
session so the hedging strategy just
hold on it for now
basic terminology you need to be aware
of when we are dealing with foreign
currency translation is something called
the direct exchange rate and the
indirect exchange rate they're basically
the same thing depending on how the
information is given to you you need to
know the difference so what is a direct
exchange rate okay it's the unit of
domestic currency and again we are the
u.s. domestic currency that can be
converted into one unit of foreign
currency for example we could say the
direct rate is valid 50 one-dollar 51
pennies for one british pound simply put
you need dollar one dollar and 51
pennies to buy one british pound or you
might say for example for a euro dollar
30 for a euro so you need one dollar and
30 cent for the euro won one dollar and
thirty US sent to buy one euro
this is the direct exchange how much
your currency buys in another currency
okay for example you might you might
need only point zero zero ten to buy one
yen okay or on the other hand we can
express the currency in the indirect
exchange rate what's the indirect
exchange rate it's how much before you
need foreign currency to buy US dollar
it all you have to do is take the direct
rate and divide it by one point five one
seven so simply put what you need to do
is if you take one divided by
one point five one seven it means you
need sixty five British pound to buy a
US dollar so simply put you will need to
buy but you need sixty five British
pound to buy a dollar now for the Euro
let's do the same thing for the year or
how much Euros do you need well let's
find out one divided one point three you
need seventy six euros to buy US dollar
well for for the yen one divided by
point zero zero one I just made up this
are point zero zero one you need 1,000
yen so you need for the yen so if you
are a Japanese individual you need to
have 1,000 yen to buy one US dollar this
is the indirect rate the US will say we
need point zero zero one to buy a yen
which is less than a penny okay so make
sure you know the difference between
direct and indirect and I will try to
hopefully make it easier for you and we
look at the problem other terminology
you need to be aware of is the spot rate
what is the spot rate the spot rate is
the rate today how much today or at this
moment for that matter because the
exchange rate change this changes
constantly how much it you will need to
how much you can exchange your currency
into a foreign currency rate at which
currencies can be exchanged today or
this moment then you have to know what
is a forward or future or future it
what's the forward rate it's the rate at
which currencies can be exchanged at
some future date for example today's
date is what today is November the 16th
today is November the 16th so this is
the sorry this is the spot rate November
the 60 now I can look up the forward
rate for the currency for example let's
assume the Euro today is dollar 30 I
want to know on December 16th or
December 16th a month from now how much
can i buy euro while they might say you
can buy the euro at dollar 25 you might
be able to buy the euro at dollar 35
this is the forward rate so if you know
you're gonna have to come up you have to
pay something in Europe
you want to pay your German supplier an
euro today the rate is number 30 but you
don't have to pay them until a month
from today well you cannot you don't
want to wait until month from today
because a month from today the euro
could be dollar fifty for the euro could
be ninety pennies who knows so you don't
take that chance you might buy something
in the forward market to lock in your
rate $1 $25 thirty five whatever the
rate is you can lock it so it's the rate
that you can lock basically you will pay
a fee and as a result someone will
guarantee that on that date if you want
buy the currency you can pay for example
dollar twenty eight and we'll guarantee
you will deliver German sorry not German
euros to you for that rate so this is
what the forward rate is and what kind
of work problems with that forward
exchange rate this is what I'm talking
about now contract to exchange
currencies of different countries on a
stipulated future date and a specified
rate this is called the future rate so
how much do we agree to exchange the
rate so someone will say pay me $100
today as a fee and I will sell you the
Euro for dollar 28 December the 60 so
basically they are guaranteeing it it's
the risk you just you're gonna pay them
a fee okay that's their job now what is
what is a floating rate floating rate
means the rate between currencies always
fluctuate and that's why we have to
learn about this chapter so relationship
between major currencies is determined
by supply and the main factor political
risk economic risk so on and so forth
okay increase risk the companies doing
business with a foreign company so what
happened is this when you buy when you
buy goods and services from a foreign
company and you have to pay them in
their currency you might be taking a
risk
why let's assume you have a payable of
100,000 yen for payable 100,000 yen all
right what does that mean it means
that's assume a month from today you
have to you have to pay this money today
today what happened is this today when
the transaction took place you owed the
Japanese company 100,000 yen well you
can buy the yen at point zero zero for
three so this is the spot rate on the
transaction date the spot rate so right
now you think well today if I pay them
today or what I have to come up with is
four hundred and thirty-four
dollars okay now let's fast forward when
the settlement date came the settlement
means when the day you need to pay them
want to settle the transaction guess
what now you need point zero zero six
towba to pay to pay them to 100,000 yen
so 100,000 yen times point zero zero six
you need six hundred and twenty five
dollars you might be saying or what's
the big deal between 434 and 625 well if
you add zeroes to these amounts then the
risk is substantial so that's why you
have the risk when you buy Japanese
product you have the risk because you're
gonna have to pay them in Japanese yen
and Japanese yen between now and the
settlement date could become cheaper
which is good or it becomes more
expensive which is not good so again
this let's assume just kind of just tell
you this also works in your favor so
let's assume on the settlement date the
rate is point zero zero three zero just
to make it easy
then only what you have to pay is three
hundred dollars so you thought you're
gonna pay for thirty four now you pay
only three hundred dollars but again
that sort of you are taking and you're
not in the business of foreign currency
risk you're in the business of buying
material building your product selling
your product okay so transaction are
normally measured and recorded in the
terms of the currency in which they are
reported in which the reporting entity
prepare its financial statement once
again we are talking US dollar for our
purposes so the reporting currency is
usually the currency where the company
is located again US dollar for our
purposes you're reporting currency could
be different if you're in Canada it's
the Canadian dollar transaction between
a US firm and a foreign company okay
company negotiate whether settlement is
to be used to be paid in US dollar or
Ana foreign currency so if it's in u.s.
dollars there is not really a lot of
risk but if it's in a foreign currency
then you are taking risk if settled by
foreign currency US firm measured the
receivable or the table and dollar we
have to measure them in dollar but the
transaction is denominated in foreign
currency so when we say you're gonna
have to pay one hundred thousand yen
well we don't record on our books one
hundred thousand
we converted 100,000 yen at point zero
four and we say it's 400.000 of four
hundred dollars okay so it's denominated
and the foreign currency that it's
recorded in US dollar so foreign
currency transaction requires payment or
receipts and a foreign currency okay
so US firm exposed to risk to
unfavorable changes an exchange rate now
just one that you know it could be
unfavorable or it could be favorable but
the the what we are discussing here is
the risk and risk we're gonna assume
unfavorable now how does it work
if the direct exchange increases what
does that mean
okay or it means the foreign currency
weakened if the direct exchange
increases let's assume downward 32 by a
euro okay this was the spot rate now
let's assume you have a payable we have
an accounts payable and you purchase one
hundred thousand worth of euros right
now you need one hundred and thirty
thousand dollar let's assume the foreign
currency unit is strengthened what does
that mean it means now you need dollar
forty to buy a euro
okay $100,000 times 140 now your payable
is 140,000 well it means more dollars
needed to acquire the foreign currency
what happened is this the foreign
currency strengthened you need more
instead of 130 you need dollar 40 now
what happened is you have to come up
with more dollars what does that mean it
means you are at a loss you are at a
loss now let me give you the other
scenario the other scenario is if the
foreign if the opposite happened well
let's let's look at the others let's
look at the other scenario if
direct exchange decreases if the direct
exchange decreases so simply put now so
the euro now is dollar 25 and you have
to come up with 100,000 euro so you need
125,000 it means the foreign currency
weakened well guess what now you need
fewer dollars to acquire the foreign
currency
therefore you are at a gain you are at
again so remember but this relationship
is the opposite if you have a receivable
if you have an account receivable if you
have an account receivable you want the
US dollar to weaken if you have a
receivable in foreign currency you want
the US dollar to weaken why because when
you receive the German at the euros if
the US dollar is cheaper you can buy
more US dollar so the opposite would
account receivable if you have a
receivable you want your home currency
to go down if you have a payable you
have you you want you want your home
currency to go up to strengthen it means
the other currency to go down okay so if
your currency strengthened and you have
a payable you want that you want a page
you want strong currency if you have a
payable what dates are we are we need to
be aware of okay
translate an account in denominated in
foreign currency we have to be concerned
with three dates sometime it's two dates
sometimes it's three first is the
transaction date the date the
transaction takes place two is the
balance sheet date balance sheet date
means if the transaction took place and
it's not gonna be settle until the next
period then what's gonna happen you have
to prepare the balance sheet so you have
to worry about the balance sheet day but
we have to do on the balance sheet date
then we have the settlement date the
date that you have to pay pay the money
this is the settlement date three
different dates and this is as
complicated as it gets so what you have
to do and in those states increases or
decreases generally reported there's a
foreign currency transaction or gain
sometime prefer to exchange gain or
exchange loss know that it goes on the
income statement so any gains and losses
and a foreign currency goes on the
income statement this is important this
is important gains and losses from
foreign currency goes on the income
statement in other words they don't go
on the balance sheet and other
comprehensive income they go on the
income statement so let's take a look at
an example to see what we are doing here
okay on this de some dude in December of
the current here tella tax system a
company based in Seattle entered into
the following transactions old so we're
gonna have a receivable seven office
computer store can't be located in
Columbia for eight million five hundred
forty-one thousand pesos on the state
the spot rate is three sixty five pesos
per US dollar so simply put we should
goods to Columbia as a result the
Columbian will have to pay us but
they're gonna pay us in pesos you pick
their back cannot mexican Colombian
pesos and we know as of today as of
today the each three hundred and sixty
five pesos will buy a US dollar this is
the indirect exchange this is the
indirect if you are not comfortable with
the indirect exchange convert the
indirect exchange into a direct exchange
by taking one divided by three sixty
five which is point zero zero two seven
so each each point zero zero two seven
US dollar will buy your pesos or in
other words three hundred and sixty five
pesos will buy a US dollar okay it's the
same thing so how do we record the
transaction well guess what first we
have to record the transaction in us
that we have a receivable so we'll take
the amount of the pesos which is eight
million five hundred and forty forty-one
pesos and we're gonna divide it by 365
365 pesos and as a result we're gonna
have a receivable of twenty-three
thousand four hundred dollars once again
we divided because we are giving how
much pesos can bias in US dollar okay so
we have a receiver of twenty three
thousand four hundred in sales of twenty
three thousand four hundred this is
called the transaction date on the
transaction date we use the spot rate
and the spot rate was each three hundred
and sixty five pesos
by you a US dollar or point zero zero
seven US dollar we'll get you a pesos
the Colombian pesos now let's take a
look at the transaction on December 31st
because this is the balance sheet
prepare the journal entry to adjust the
account as of December 31st now what I
want you to do just I want you to create
a receivable create a receivable the T
accounts receivable which is I'm just
gonna put it right here receivable
account receivable and we have in that
receivable twenty three thousand four
hundred twenty three four hundred so on
the side on a ship or a piece of paper
right 23400 now assume on December 31st
the direct exchange was point zero zero
two six eight so could you tell me what
happened now today Colombian pesos we
used to need point zero zero two seven
okay now all what we need is point zero
zero two six what happened to the US
dollar the US dollar strengthened
strengthen get this is stronger the US
dollar is stronger is this good for us
or bad for us this is bad why is it bad
well because we have a receivable it
means now if we get the money we buy
less US dollar because the the dollar
strengthened therefore therefore what's
gonna happen is this I shouldn't have
raised s but I will do it again
so remember we have a receivable of
twenty three four hundred now we
remeasured receivable well that's an
error so now we have eight million five
hundred and forty-one thousand if we
converted at the date at December 31st
straight now our Siebel is worth twenty
two thousand eight forty but it was
worth twenty three thousand four hundred
what does that mean it means we lost the
receivable lost value of five hundred
dollars time e to the t account here
account receivable we had twenty three
four hundred now what we're gonna have
to reduce it to reduce by five hundred
and ten now the receivable is twenty-two
8:19 now therefore we have to reduce the
receivable so we credit the receivable
510 and we debit transaction loss which
is an income account it goes on the
income statement
now the receivable is twenty two
thousand eight hundred and ninety we're
not done yet
we haven't settled the transaction we're
gonna wait until the settlement date but
or what we know now as of December 31st
we have a loss let's look at the
settlement date the settlement date was
January tenth assume that the direct
exchange rate at the settlement date is
0.32 what happened now well here's what
happened the rate started at point zero
zero two seven then it became the direct
exchange became point zero zero two six
two six eight so the US dollar
strengthened then by the settlement date
the US dollar weakened now we need point
zero zero three to the US dollar
weakened the US dollar weakened now if
you want the indirect exchange in case
you are wondering what's the indirect
exchange just take one divided by point
zero zero three two it means now 300 you
need three hundred and twelve pesos to
buy a dollar okay so the pesos increased
in value it means we weakened and we
like this why do we like this because we
like this because we have an account
receivable we want the US currency to go
down it means we need more US dollar to
buy a pesos
it means the pesos will buy you more US
dollar we receive in pesos we want the
US dollar to go then we want the US
dollar to go down
okay now let's compute how much do we
need well by the settlement date whence
everything is settled let's let's
compute what we need we have eight
million five hundred and forty-one
thousand pesos now we're gonna settle
them means we're gonna have to pay it
pay it at point zero zero three two
simply put I'm sorry we're gonna we're
gonna convert them at point zero zero
three two we are going to receive twenty
seven thousand three hundred and thirty
one dollars hold on a second the last
time the receivable was worth twenty two
thousand eight ninety by the time they
paid us
the pesos really went up and we did very
well so this is the US dollar so we're
gonna be receiving once you receive the
pesos we converted at point zero zero
three two because the US dollar weakened
it bought us more US dollar account
receivable is twenty two thousand eight
ninety that's the last time we computed
the receivable twenty two thousand eight
ninety we remove it and we have again a
4441 and this game goes through income
so we have again notice because you have
a receivable you wanted the US dollar to
weakened first it went it strengthened
first its strengthened at the settlement
date you had the loss by the ten days
later the US dollar weakened something
happened from December 31st of January
tenth which is good for us the US dollar
weakened the pesos went up
therefore you had a large gain and this
is really the large gain four thousand
four hundred now bear in mind you know
overall you had the gain of four
thousand four hundred but remember this
is not the net gain if you want to know
the net gain four thousand four hundred
minus minus the five hundred and ten
dollars remember you had a you had a
loss earlier you had a loss so the
difference between them is then AB gain
on the transaction been obtained now
let's take a look at another on the
other side of the entry now we did the
receiver let's do a payable because it's
good to look at both to see how this
work during December of the current year
ten attacks company a company in Seattle
Washington enter into the following
transaction now we purchased computer
chips from a Taiwan company so we're
gonna have payable in a foreign currency
dominated table that's worth half a
million Taiwanese yen the direct
exchange on this date the direct
exchange was point zero three nine one
okay simply put we sold them I'm sorry
we bought from them half a million worth
of Taiwanese dollar now they want to
receive Taiwanese dollars they don't
they're not interested in u.s. dollar
therefore today if we take half a
million times point zero three nine one
so how much are we responsible for so
half a million times point zero three
nine one we are responsible for 19,500
we have a table of nineteen thousand
five hundred so this is the direct
exchange so you need three pennies three
point nine one tends to buy so simply
put here what we're saying you need
point zero point zero three nine one if
you want to know the indirect exchange
take one divided by point zero three
nine one so so you need 10.10 point nine
eight to buy a dollar ten point nine
eight ten one is to buy analogous if
you're interested in that so on the set
on the transaction date on the
transaction date we record the payable
either debit purchases or debit
inventory depending on the inventory
system we are using on this date anyhow
we debit week we have an Accounts
Payable dominated in a foreign currency
of nineteen thousand five hundred and
fifty again what I suggest you do wish
to create a tea account called accounts
payable and park in there 19550 in this
took place on December 12 on December
31st the Taiwan is great okay now if we
want to if we want to buy Taiwanese
dollar we need three point point zero
three five one well what was the prior
year the Priory eight plus point zero
three nine one now the rate or what we
need is point zero three five one we
need less we need less US dollar what
does that mean we are at again now in
this situation the US dollar is stronger
and that's good why because we have a
payable we have a payable we want to
have a strong US dollar why because with
a strong US dollar we need less US
dollar to buy Taiwanese dollar okay so
let's see how it works so now half a
million times point zero three point
zero three five
we only need point zero three five one
two by the Taiwanese dollar so we need
to come up with seventeen thousand five
fifty the balance in the payable was
nineteen thousand five hundred and fifty
when we initially took the transaction
on December the 12th guess what we have
two thousand we are responsible $2,000
less so now what's gonna happen
you'll debit the payable two thousand
now you are responsible for seventeen
thousand five fifty and unfortunately
that's not the settlement date that's
the balance sheet day so now we adjusted
how it works to make sure we show the
risk of the foreign currency transaction
or in this in this situation the reward
we have again remember this game goes to
income so now our net income went up by
$2,000 as a result of this transaction
that's very good but not yet not yet we
still gonna have to wait until the
settlement date now now maybe we should
do it now and settle it today and send
them the money okay but we're gonna have
to wait okay
On January 10th that's when the
settlement they took place the exchange
rate was points three point zero three
nine eight what was the prior yet the
last time we did it was point zero three
five one oh boy
now the US Dollars friend the US dollar
weakened we need now point zero three
nine eight to buy a a a a Taiwanese
dollar so we have half a million of
those we are responsible for point zero
three nine eight let's do the math see
how much do we need half a million times
point zero three nine eight
we need 19900 we need 19900 to settle
huh yet to settle because we have a
payable and the last time we thought our
payable was seventeen thousand five
hundred okay last time we did the
measure of the transaction well simply
put so we need to come up with cash
19900 our payable is seventeen thousand
five fifty now we have a transaction
loss of two thousand three hundred and
fifty now that's not too bad
well what's the net transaction what's
the net foreign currency transaction we
had a gain of 2000 a loss of 2350 yes
overall we had the loss of 350 overall
okay compared to the initial first
transaction okay so we have a loss but
it's only 350 you just make sure you
remember that any foreign currency
transaction gain or losses are included
in net income or included net income and
we have two transaction approach for
this the sale or purchases if you'd as a
transaction separate from the financing
arrangement okay
therefore the dollar amount recorded in
sales or purchases is determined by the
exchange rate on the transaction date
you know we can do we can have the
adjustment of the foreign currency
denominated and receivable or payable
recorded directly that the transaction
gain or loss recorded the net income
okay so it's just basically simply put
all and all gains and losses goes into
net income from foreign currency
translation we have a receivable might
go up or civil might go down a table
might go up a table might go down the
offsetting
entry either again or a loss and the
foreign currency and the gain or a loss
once again goes into a net income now
why I keep emphasizing this point
because when you get when you look at
when we look at the translating
financial statement well we have to know
if it goes into net income or OCI other
comprehensive income so that's why I'm
emphasizing this point if you have any
questions any comments by all means
email me and please visit my website for
more lectures if you happen to visit the
website a please consider donating if
you're studying for your CPA exam as
always study hard
it's worth it
