Lesson 4

Sales Revenues
Definition: The amount of assets received on the sale of goods or
services to customers. Those assets typically come in the
form of cash or accounts receivable.

Lesson 4 Revenue Recognition Principle: Revenues are to be recognized in

the period earned and not necessarily when cash is
received from customers.
Sales and Receivables
When are revenues earned?
When are revenues earned on sales that offer customers a full refund
for up to a year if they aren't completely satisfied with the product?

What about a fitness center's revenues on the sale of a two-year

membership contract?

1 2

Under current accounting standards, revenues are to be recorded when
earned, and revenues are earned when both of the following have
occurred:
1. The acts associated with the providing of goods or services have
been substantially completed.
2. The collection of cash or other assets from the customer is
reasonably assured.
This means a company has to actually finish doing something that
legally obligates a financially capable customer to pay now or in the
future.
With the sale of goods, this usually takes place when product
ownership actually transfers to the customer, which is usually when
the customer takes physical possession of the goods.
When merchandise is shipped to a customer, whether
revenues are recognized at the time of shipment or at the time
of subsequent customer receipt, will depend on the contract
terms of shipment.
FOB destination ("free on board" delivery): Ownership
doesn't transfer and revenues are deferred until the
goods are actually received by the customer.
FOB shipping point: Ownership transfers and revenues are
recognized when goods are loaded for shipment from
the company's dock.

3 4

Consignment Sales
Supplier Merchandiser Customer
(Consignor) (Consignee)

Traveling to Customer

12/31/X7
Sales Revenues 1/3/X8
FOB FOB
Shipping Point ? Destination

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4-1
 Consignment Sales Consignment Sales
Supplier Merchandiser Customer Supplier Merchandiser Customer
(Consignor) (Consignee) (Consignor) (Consignee)
For
Sale!

No legal ownership No legal ownership

No obligation No obligation

No sales revenues are recognized until

the sale is made to the final customer.

7 8

Long-Term Construction or Service Contracts

Companies that are involved in consulting or other service

contracts, or major projects involving the construction of When should revenues be recognized
bridges, dams and other facilities that take a number of on sales that guarantee customer
years to complete, may be allowed to recognize a portion of
the total contract revenue at the end of each year based on a
satisfaction for up to a year?
percentage of the completed work, as long as:
Is revenue earned and recorded at, during
1. The percentage of completion can be reasonably or one year following the date of sale?
estimated.

2. Collection of the revenues recognized can be

reasonably assured.

9 10

It depends! What about a fitness center's revenues on a

two-year membership contract?
For companies that can estimate returns with reasonable Should that revenue be recognized at the time:
accuracy, then revenues are typically recognized upon Contract is signed?
sale and any end-of-the-year estimate of future returns Payment is received?
on current period sales are deducted through a year-end Equal amounts over the 24-month contract?
adjusting entry.
Generally speaking revenues should be recognized over
If, however, reasonable estimates of returns aren't the period services are rendered regardless of the timing
possible, then simply deferring revenue recognition of cash receipts.
until the end of the one-year guarantee period is If the customer pays $480 up front for a 24-month
appropriate. membership, then

$480 24 months = $20/month

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4-2

What if the fitness company really needs to increase revenues
in the current period and decides to designate $240 of the $480
received as an upfront sign up fee?
Can $240 be immediately recognized as revenues?
NO
Such fees can be recognized as revenues upfront only if an
identifiable service that can be sold separately has been
rendered at the time.
Example: If a fitness center separately offers customers an initial
fitness evaluation and personal weight loss seminar for
$240 and that service is included in the $480 deal, then
$240 of the $480 can be recognized as revenues up front
at the time the evaluation and seminar are provided, with
the remaining $240 spread out evenly over the 24-month
period.
Revenues are recognized when services are provided.
13
Problem 4-1
C. An appliance company sells a TV for $500 along with a $50 service
contract for any parts and labor on repairs not covered under the
manufacturer's warranty for two years from the date of sale. Cash
amounting to $550 was received at the time of sale. How much
revenue do you think should be recognized on this transaction and
when?
D. Should revenues on goods shipped to a customer "FOB
destination" be recognized as revenue on the date of shipment or
the date delivered to the customer? Why?
E. If a wholesale distributor makes sales to a retail merchandiser on
account agreeing that payment is not required until the product is
subsequently sold to a customer, should sales revenues be
recorded at the time of shipment to the retailer?
15
Problem 4-1 - Answer
C. The $500 received on the TV sale should be recognized as revenue
at the time of sale, but the $50 received on the service contract
should be recognized over the two-year term of the contract. If
service repairs typically occur equally over the two-year period
following sale then an equal monthly recognition would probably
be appropriate. If, on the other hand, prior experience indicates
that most service repairs are performed in the last few months of
such contracts, then it may be more appropriate to defer
recognition until those final months.
D. Revenues on goods shipped to a customer "FOB destination"
should be recognized as revenue on the date the goods are
delivered to the customer. FOB destination means that
ownership has not transferred and the sale is not complete until
delivery has been made.
E. The answer is no! This is similar to a consignment. Even if legal
ownership of a product is transferred, if an agreement exists that
payment is not required unless a subsequent event takes place,
then revenues are not earned until that event occurs. In this case,
goods or services were provided but collection of the sales price is
contingent on a future event and not reasonably assured.
17
4-3
Problem 4-1
Revenue Recognition
Describe the two key criteria for revenue recognition and then respond
to the following:
A. A dam construction company has a contract to build a dam for
$200 million over a three-year period. Collections under the
contract are scheduled at the end of each year based on the
percentage completed with 10% withheld until 30 days following
the full and satisfactory completion of the dam. At the end of the
first year, the project stands at 30% completion and $54 million is
collected under the contract. How much revenue do you think
should be recognized in the first year?
B. A CPA firm agrees to prepare an office supply company's tax
return over the next three years in exchange for a copy machine
received today that retails for $1,500. How much, if any, revenue
should the CPA firm recognize upon receipt of the copy machine?
14
Problem 4-1 - Answer
Revenue Recognition
The two criteria for revenue recognition are:
1. The providing of goods or services is substantially complete.
2. Collection from the customer is reasonably assured.
A. Assuming the 30% estimate of the percentage of completion has
been dependably determined at the end of the first year, the
maximum amount of revenue to be recognized is $60 million.
Whether the $60 million, $54 million of cash actually received to
date, or some lesser amount is actually recognized will depend on
the specific terms of the contract and the confidence of
management and the company's independent auditors regarding
the contractor's ability to complete the contract according to its
terms and the customer's likelihood of future payment.
B. No revenue should be recognized until services have been
performed. Upon receipt of the copier, the firm has a liability
equal to the value received, or $1,500. When the first of the three
tax returns has been completed, then 1/3 of the value of the asset
received should be recognized as revenue.
16
Sales of Goods or Services on Account
Accounts Receivable XXX
Sales Revenues XXX
18
 Problem 4-2 Problem 4-2

Review of Accounting for Uncollectible Accounts Receivable

Review of Accounting for Uncollectible Accounts Receivable
An aging of Jordan, Inc.'s $85,300 of accounts receivable as of 12/31/X7
An aging of Jordan, Inc.'s $85,300 of accounts receivable as of 12/31/X7 and Jordan's estimate of future uncollectibility of those accounts is
and Jordan's estimate of future uncollectibility of those accounts is reflected below:
reflected below: Estimate of
Estimate of Days Past Due Amount Uncollectibility
Days Past Due Amount Uncollectibility
Current $40,300 3%
Current $40,300 3%
1 - 30 days $25,400 6%
1 - 30 days $25,400 6%
31 - 60 days $16,300 20%
31 - 60 days $16,300 20%
61 + days $ 3,300 70%
61 + days $ 3,300 70%
$85,300
$85,300
B. What journal entry would be made in the subsequent year, 20X8,
A. Prepare the 12/31/X7 adjusting entry for uncollectible accounts if Jordan writes-off accounts receivable amounting to $7,500?
receivable under the allowance method assuming Jordan has a What is the net effect of this entry on the company's financial
$1,402 debit balance in their Allowance for Uncollectible Accounts statements? Why isn't this write-off recorded as an expense?
Receivable account before any adjustment. Why is the amount of
uncollectible accounts (bad debt) expense different than the C. What is the direct write-off method of accounting for uncollectible
estimate of uncollectible accounts? accounts receivable and why is it an unacceptable accounting
method for financial reporting purposes?
19 20

Problem 4-2 - Answer Problem 4-2 - Answer

Review of Accounting for Uncollectible Accounts Receivable
Estimate of
Days Past Due Amount Uncollectibility
B. What journal entry would be made in the subsequent year, 20X8,
if Jordan writes-off accounts receivable amounting to $7,500?
Current $40,300 3% = $ 1,209
1 - 30 days $25,400 6% = $ 1,524
31 - 60 days $16,300 20% = $ 3,260 Allowance for Uncollectible A/R 7,500
61 + days $ 3,300 70% = $ 2,310 Accounts Receivable 7,500
$85,300 $ 8,303
A. Adjusting entry at 12/31/X7: What is the net effect of this entry on the company's financial
Uncollectible Accounts Expense 9,705 statements? Why isn't this write-off recorded as an expense?
Allowance for Uncollectible A/R 9,705
Answer: There is no net effect on the company's financial statements as
Allowance for Uncollectible Accounts Receivable
a result of this entry. The reduction in assets is offset by the reduction in
XXX 12/31/X6 the contra-asset. All this entry did was clean up the company's books by
Write-offs XXX removing the "bad" accounts receivable. The reason this write-off is not
'X6 underestimation 1,402 recorded as an expense is that these bad debts were effectively part of the
9,705 Adjustment $8,303 estimate of uncollectibles in 20X7 and included in the expense
8,303 12/31/X7 recorded at that time. In fact, that 20X7 expense was actually
Why is the amount of uncollectible accounts (bad debt) expense overstated given that only $7,500 of those receivables ultimately proved
different (higher) than the estimate of uncollectible accounts? to be uncollectible. This overstatement will have to be compensated for
in the adjustment to record bad debt expense in 20X8 by understating the
Answer: It must be higher in order to compensate for the prior year's estimated expense.
$1,402 underestimation of expense.

21 22

Problem 4-2 - Answer

C. What is the direct write-off method of accounting for
uncollectible accounts receivable and why is it an unacceptable
accounting method for financial reporting purposes?
Answer: The direct write-off method of accounting for uncollectible A/R
calls for bad debts to be expensed in the period written-off. This
approach is unacceptable because it violates the matching principle,
which requires bad debt expenses to be recorded in the same period as
the credit sales, which gave rise to the ultimately uncollectible
receivables. That's why the allowance method must be used and relies
on estimates of future uncollectibility.
The allowance method of accounting for uncollectible accounts
receivable relies on estimates of uncollectibility in determining and
recording a company's current bad debt expense.
Most companies come up with this estimate based on a percentage
of ending accounts receivable. In fact, the receivables are usually
aged based on how long they've been outstanding with higher
percentages of estimated uncollectibility applied to older accounts.
An alternative approach that's sometimes used in making this
estimate is based on a percentage of sales revenues as opposed to
ending A/R. This method is especially helpful when preparing
interim monthly or quarterly financial statements.

23 24

4-4
 Example: Barlow, Inc.'s prior experience indicates that on Assume Barlow's balance in the allowance account at the beginning of the
average, about 2% of all the company's net credit sales end up year totaled $15,500 as a result of the prior year's recording of uncollectible
being uncollectible. The company's January net credit sales accounts receivable using the 2% of net credit sales estimate.
totaled $90,794. In this case, what would be the company's entry
to record Bad Debt Expense for the month of January? Also assume that actual accounts written off during the current year totaled
$26,404.
2% X $90,794 = $1,816, rounded.
Allowance for Uncollectible Accounts Receivable
Bad Debt Expense 1,816 15,500 Beg. Balance
Allowance for Uncollectible A/R 1,816 18,926 Bad Debt Expense
Accounts Written-Off 26,404
If total net credit sales for the year amounted to $946,306, then the 8,022 Ending Balance
total recorded bad debt expense for the year would be: 13,978 Adjustment
22,000 Ending Balance
2% X $946,306 = $18,926.
What if actual bad debts from this year's net credit sales exceeds Assume an aging produces a $22,000 estimate of uncollectible accounts
the 2% estimate? receivable.
In that case, the allowance for uncollectible accounts receivable will Adjustment entry:
get progressively smaller in amount over time and an adjustment will Bad Debt Expense 13,978
have to be made to correct the error in estimation. Allowance for Uncollectible A/R 13,978

25 26

Problem 4-3 Problem 4-3 - Answer

Percentage of Sales Method of Estimating Uncollectible Accounts Receivable

Percentage of Sales Method of Estimating Uncollectible Accounts Receivable
1/31/X6 adjusting entry to record January's bad debt expense:
Ames Manufacturing wants to prepare monthly financial statements Bad Debt Expense 29,250*
and chooses to estimate monthly bad debt expense using 6% of net Allowance for Uncollectible A/R 29,250
credit sales. Given the following information as of 1/31/X6, prepare the * .06 X $487,500 = $29,250
appropriate 1/31/X6 adjusting entry to record January's bad debt
expense: Answer: When using the percentage of sales method of estimating
uncollectible accounts receivable, the entry is based on the percentage
Dr (CR) calculation, as noted above, regardless of the existing balance in the
Accounts Receivable $125,432 allowance for uncollectible A/R.
Net Credit Sales Revenues ($487,500)
Bad Debt Expense 0 Question: When using this method of estimating and accounting for
Allowance for Uncollectible A/R ($8,762) uncollectible accounts receivable, what does it mean if the Allowance for
Uncollectible A/R gets progressively larger over time?
Questions: When using this method of estimating and accounting for Answer: A progressively increasing balance in the Allowance for
uncollectible accounts receivable, what does it mean if the Allowance for Uncollectible A/R could be the result of:
Uncollectible A/R gets progressively larger over time? What should be 1. Overestimation of bad debt expense over time.
done if such an increase is attributable to prior period overestimation of 2. Actual increasing uncollectible accounts as a result of increasing
bad debt expense? credit sales, liberalization of credit policies, poor collection efforts, or
a declining general economy, among other things.
27 28

Problem 4-3 - Answer

Question: What should be done if such an increase is attributable to

prior period overestimation of bad debt expense?
A company's criteria in accepting or rejecting credit
Answer: At the end of the year, an aging of accounts receivable should
customers will ultimately have a significant impact on
probably be performed to evaluate the ending balance in the allowance the amount of its bad debt expense.
for uncollectible accounts receivable with an adjustment made if over or
understated. Any over-recording of bad debt expense for the year will
result in an overstated allowance account which should be adjusted Another factor in the amount of a company's bad debt
down with a corresponding decrease in bad debt expense. expense will be the effectiveness of its collection efforts.

29 30

4-5
 1/14/X8 1/14/X8
For value received, Robert Jones agrees to pay to the order of For value received, Robert Jones agrees to pay to the order of
Barlow, Inc. -------------------------------------------------$4,000.00 Barlow, Inc. -------------------------------------------------$4,000.00
four thousand and no/100 dollars, on or before 5/14/X8, with interest four thousand and no/100 dollars, on or before 5/14/X8, with interest
from the date hereof at a simple annual rate of 18%, all due at from the date hereof at a simple annual rate of 18%, all due at
maturity. maturity.
Robert Jones Robert Jones
Signature of maker Signature of maker
Entry to covert an account receivable to a note.
Adjusting entry at 1/31/X8 to record earned interest for the month:
Note Receivable 4,000
Accounts Receivable 4,000 $4,000 X .18 X 17/365 = $34
Entry to record a sale made in receipt of a note. Interest Receivable 34
Interest Revenue 34
Note Receivable XXX
Sales Revenues XXX
Entry upon collection:
Cost of Goods Sold XXX
Inventory XXX Cash 34
Interest Receivable 34
Notes receivable arising from the sales of goods or services are
traditionally referred to as "trade" notes receivable.

31 32

If a company is desperate for cash, one option is the immediate and Factoring A/R and Discounting Notes Receivable
outright sale of receivables for cash.

Assume a friend of yours has a valid receivable from a company like Example: Barlow, Inc. factors, without recourse, $20,000 of
IBM for $1,000. Given the legal enforceability of the receivable and accounts receivable for $13,000 cash. Assume that Barlow's
IBM's ability to pay its debts, would you consider buying the receivable previously recorded allowance for uncollectible accounts
from your friend? receivable on the factored accounts totaled $2,000.
What price?
Entry to record factoring of A/R:
Say $900
Cash 13,000
$100 / $900 = 11% return on a 30-day investment Allowance for Uncollectible A/R 2,000
Annualized return = 11% X 12 months = 133% Loss on Factoring of A/R 5,000
Accounts Receivable 20,000
In other words, if I could do that same deal every month using the same
$900 my total return for the year would be $100 per month or $1,200 for
the year on an investment of $900.

$1,200 / $900 = 133% annualized return

33 34

Problem 4-4

Factoring A/R and Discounting Notes Receivable

Factoring and Discounting of Receivables

Example: Barlow has a $10,000 note receivable from a customer. Respond to each of the following:
Assuming Barlow discounts the note to its bank without recourse
A. Messick, Inc. factors $10,000 of accounts receivable due in 20 days
for $8,000:
to a financing company for $9,000 cash, without recourse. A $500
allowance for uncollectible accounts on the $10,000 of receivables
Cash 8,000
has been previously recorded and the following journal entry was
Loss on Discounting of N/R 2,000
Note Receivable 10,000 made to record the factoring:
Cash 9,000
Allowance for Uncollectible A/R 500
Loss on Factoring 500
Accounts Receivable 10,000
Determine Messick's cost of factoring these A/R in terms of an
annualized effective interest rate on the funds received.

35 36

4-6
 Problem 4-4 Problem 4-4 - Answer

Factoring and Discounting of Receivables Factoring and Discounting of Receivables

A. Cost of factoring A/R in terms of an annualized effective interest rate
B. Immediately following receipt of a $20,000, 10%, 60-day note
receivable on the sale of merchandise to a customer, Messick
discounts the note to a local bank for $18,000, without recourse.
This discounting was recorded with the following entry:
Cash 18,000
Loss on Discounting of N/R 2,000
Note Receivable 20,000
Determine Messick's effective cost of discounting this note
receivable in terms of an annualized interest rate on the funds
received.
C. Why would Messick do these deals when the effective interest
costs are so high? What, if any, financing options might be
available to Messick in lieu of these arrangements?
37
on the funds received:
Answer: Messick has already recognized $500 expense for bad debts on the
$10,000 of A/R. Assuming that is an accurate amount, in other words, $500 is
truly uncollectible, then the cost of factoring is the $500 difference between the
$9,500 net realizable value of the A/R and the cash received upon factoring.
This cost could have been avoided if Messick had simply waited an
additional 20 days. The cost of getting the $9,000 of immediate cash, stated
as an interest percentage is determined by taking the cost of $500 and
dividing it by the amount of $9,000 cash received. The resulting 5.56% is a
percentage cost over 20 days. This cost can be stated in annual terms by
dividing the 5.56% by 20 days and then multiplying by 365 for a 101%
annual interest cost. In other words, the cost of this factoring of receivables
was effectively the same as if Messick had borrowed $9,000 for twenty days
at an annual interest rate of 101%.
$500
= 5.56% cost for 20 days
$9,000
5.55%
= .278% cost per day
20 days
365 days X .277% = 101% annualized interest cost
38

Problem 4-4 - Answer Problem 4-4 - Answer

B. Effective cost of discounting the note receivable in terms of an
annualized interest rate on the funds received:
Answer: The sale of the note for $18,000 of immediate cash means Messick will
forgo not only $2,000 of principal on the note but also 10% interest on $20,000
for 60 days. That interest amounts to $329 ($20,000 x .10 x 60/365). The total
cost of this discounting is $2,329 over a 60-day period. The effective cost
stated in terms of an annual interest rate comes to 78.7% as noted below:
C. Why would Messick do these deals when the effective interest costs are
so high?
Answer: Messick is apparently desparate for cash or doesn't understand the
effective cost of these transactions.
What, if any, financing options might be available to Messick in lieu of
these arrangements?

$2,329 Answer: Selling accounts and notes receivable can usually be accomplished at a
= 12.94% cost for 60 days much lower cost if done with recourse. Recourse allows the buyer of the
$18,000
receivables or note to look to the seller for payment in the event of collection
12.94% problems. Another option might be to simply borrow money from a bank or
= .216% cost per day other lending institution. Even credit card debt at a rate of 18% would be a far
60 days
cheaper financing option than the sale of these two assets. If Messick is unable
365 days X .216% = 78.7% Annualized interest cost to qualify for an unsecured loan, then the providing of collateral in the form of
real estate or some other assets might be required. Even the A/R and note may be
In other words, the cost of the discounting of the note was effectively the same acceptable collateral for a loan.
as if Messick had borrowed $18,000 for 60 days at an annual interest rate of
almost 79%.

39 40

Example: Assume that on 12/15/X7, a U.S. company makes a credit sale of

Sales Denominated in a Foreign Currency merchandise costing $2,000 to a customer in Japan at a price of 480,000
Japanese yen when 1 yen is trading for $.008
Since accounting standards in the U.S require financial statement reporting in
U.S. dollars,
Accounts Receivable 3,840*
Most foreign sales are denominated, or made, in U.S. Sales Revenues 3,840
dollars. This means the price is set and then paid in * 480,000 yen X $.008 = $3,840

dollars and the accounting for sales revenues, A/R and Cost of Goods Sold 2,000
Inventory 2,000
the ultimate collection of cash would be the same as it is
Assume that at the end of the year, 12/31/X7, the yen has strengthened against
for any sale made in the United States. the dollar such that 1 yen is now worth $.009.
Current value of the A/R: 480,000 yen X $.009 = $4,320
Sometimes, however, these sales are denominated in a (Under GAAP, any asset held in a foreign currency must be adjusted and reflected
in the financial statements at its current dollar value based on the prevailing
foreign currency. When that happens, the accounting can exchange rate at the end of the period.)
become a bit more complicated. Adjusting Entry at 12/31/X7:
Accounts Receivable 480
Foreign Exchange Gain 480

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4-7
Assume that on 1/15/X8 the company finally receives the 480,000 yen due on There's a significant financial risk involved when entering
account when the value of the yen has plunged to $.007. into transactions denominated in a foreign currency.
480,000 Yen X $.007 = $3,360
Ways to avoid that risk:
Entry at 1/15/X8:
Cash 3,360 1. Simply refuse to do business in anything other than U.S dollars.
Foreign Exchange Loss 960 That effectively shifts the risk of loss to the customer.
Accounts Receivable 4,320
Example: Assume the customer in Japan agreed to buy the
merchandise at the original $3,840 price payable in U.S.
dollars rather than yen.
Date of purchase: 480,000 yen at exchange rate of $.008
Date of payment: 548,571 yen at exchange rate of $.007
68,571 yen loss
2. Locking in the currency price at the date of sale through a
forward contract with a foreign currency broker. This is
commonly referred to as a derivative contract.

43 44

Problem 4-5 Problem 4-5 - Answer

Foreign Currency Transaction Foreign Currency Transaction
A. 1/12/X2: Barker makes a credit sale of merchandise costing $6,000
Barker Marketing sells lighting fixtures to customers around the world. to a customer in Italy at a price of 10,000 euros when one
A. Prepare the appropriate journal entries to record the following euro trades for $1.07.
transactions: Accounts Receivable 10,700*
Sales Revenues 10,700
1/12/X2: Barker makes a credit sale of merchandise costing $6,000
to a customer in Italy at a price of 10,000 euros when one Cost of Goods Sold 6,000
euro trades for $1.07. Inventory 6,000
* 10,000 euros X $1.07 = $10,700
2/10/X2: Barker then collects the 10,000 euros from its Italian
2/10/X2: Barker then collects the 10,000 euros from its Italian
customer. Assume the euro has strengthened such that
customer. Assume the euro has strengthened such that
one euro now trades for $1.10.
one euro now trades for $1.10.
B. What would the 2/10/X2 entry have been assuming an exchange rate Cash 11,000
$1.03 to the euro? Gain on Foreign Exchange 300
Accounts Receivable 10,700
C. Questions: Assuming the euro exchange rate to the dollar went from
$1.07 at the date of sale to $1.10 at the date of collection, did the B. What would the 2/10/X2 entry have been assuming an exchange rate
dollar get stronger or weaker against the euro and what was the $1.03 to the euro?
ultimate effect on Barker and his customer? Do you think U.S Cash 10,300
companies are glad to see a stronger dollar relative to foreign Loss on Foreign Exchange 400
currencies? Accounts Receivable 10,700

45 46

Problem 4-5 - Answer Problem 4-5 - Answer

C. Questions: Assuming the euro exchange rate to the dollar went
from $1.07 at the date of sale to $1.10 at the date of collection, did
the dollar get stronger or weaker against the euro and what was the
ultimate effect on Barker and his customer?
Answer: This increasing exchange rate implies a stronger euro. At the time of
payment, one euro buys more dollars than it used to. A stronger euro means a
weaker dollar against the euro.
As the euro strengthens, all of Barker's assets denominated in euros, including
A/R and cash held in euros, increase in value and any change in value on
foreign currency denominated assets are reported in the company's financial
statements, in this case, as a foreign exchange gain.
As far as the customer is concerned, if we assume their financial statements are
prepared in euros for financial reporting in their own country's equity markets,
the stronger euro has no effect on their outstanding payables denominated in
euros. On their books, 10,000 euros were owed at the time of the merchandise
purchase and 10,000 euros were subsequently paid. On the other hand, if the
Italian Company prepared financial statements in U.S. dollars, then a payable,
initially recorded at $10,700 (10,000 euros X $1.07) would be paid off with
euros worth $11,000 (10,000 euros X $1.10) and a $300 loss would be
recognized given the payoff of the obligation with more valuable euros.
Do you think U.S companies are glad to see a stronger dollar
relative to foreign currencies?
Answer: It depends. Companies that buy and sell goods and operate their business
exclusively in the United States are unaffected by changing exchange rates.
Companies that buy goods or services from other countries would in theory like a
stronger dollar if it allowed them to buy more for their dollar. However, that isn't
automatically the case. Many foreign suppliers will effectively increase prices to
compensate for their weaker currency. This can be done by simply setting and
maintaining prices in U.S. dollars, or, by actually increasing prices charged in their
own currency.
In selling goods to foreign customers, a stronger dollar may result in lower sales
volume if those customers can no longer afford to buy U.S. products given their
weaker currency. As a result, companies may be forced to effectively cut prices in
order to maintain sales. This can be done by cutting selling prices stated in U.S.
dollars or by simply setting and maintaining prices in the foreign currency. Selling
a product at a price of 10,000 euros means a lower effective price if the value of the
euro goes down.
The only sure result of a stronger dollar for a U.S company is that existing assets,
like receivables, denominated in a foreign currency decrease in value with a
stronger dollar and existing liabilities denominated in a foreign currency are
effectively reduced because they can be paid off with fewer dollars.

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