ACC-311 Chapter 7: Review Notes and Practice Problems

Review Notes
During the study of this chapter, students should focus on understanding the following:

1. Understand concepts related to foreign currency, exchange rates, and foreign exchange
risk.
2. Account for foreign currency transactions using the two- transaction perspective, accrual
approach.
3. Account for foreign currency borrowings.

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25 LO 7-2

Peerless Corporation (a U.S.-based company) made a sale to a foreign customer on September

15, for 100,000 crowns. It received payment on October 15. The following exchange rates for 1
crown apply:

Date U.S. Dollar per

Crown
September 15 $0.60
September 30 0.66
October 15 0.62

Prepare all journal entries for Peerless Corporation in connection with this export sale, assuming
that the company closes its books on September 30 to prepare interim financial statements.

Date Dr Cr
September 15 Accounts Receivable [100,000 x $0.60] 60,000
Sales 60,000

Date Dr Cr
September 30 Accounts Receivable 6,000
Foreign Exchange Gain or Loss 6,000
[100,000 x ($0.66 – $0.60)]

Date Dr Cr
October 15 Foreign Exchange Gain or Loss Foreign 4,000
Accounts Receivable (crowns) 4,000
[100,000 x ($0.62 – $0.66)]

Date Dr Cr
October 15 Cash 62,000
Accounts Receivable (crowns) 62,000
100,000 x $0.62

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26 LO 7-2On December 15, 2020, Lisbeth Inc. (a U.S.-based company) purchases
merchandise inventory from a foreign supplier for 50,000 schillings. Lisbeth agrees to pay in 45
days, after it sells the merchandise. Lisbeth makes sales rather quickly and pays the entire
obligation on January 25, 2021. Currency exchange rates for 1 schilling are as follows:

Date U.S. Dollar per Schilling

December 15, 2020 $0.28

December 31, 2020 0.30
January 25, 2021 0.33
January 31, 2021 0.34

Prepare all journal entries for Lisbeth Company in connection with this purchase and payment.

12/15/20 Inventory 14,000

Accounts Payable (schillings) [50,000 x $0.28] 14,000
12/31/20 Foreign Exchange Gain or Loss 1,000
Accounts Payable (schillings) [50,000 x ($0.30 – $0.28)] 1,000
1/25/21 Foreign Exchange Gain or Loss 1,500
Accounts Payable (schillings) [50,000 x ($0.33 – $0.30)] 1,500
Accounts Payable (schillings) 16,500
Cash 16,500

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30 LO 7-3

On September 30, 2020, Peace Frog International (PFI) (a U.S.-based company) negotiated a
two-years, 1,000,000 Chinese yuan loan from a Chinese bank at an interest rate of 2% per year.
The company makes interest payments annually on September 30 and will repay the principal
on September 30, 2022. PFI prepares U.S. dollar financial statements and has a December 31
year-end. Relevant exchange rates are as follows:

Date U.S. Dollar per Chinese Yuan (CNY)

September 30, 2020 $0.100
December 31, 2020 0.105
September 30, 2021 0.120
December 31, 2021 0.125
September 30, 2022 0.150

a. Prepare all journal entries related to this foreign currency borrowing.

b. Taking the exchange rate effect on the cost of borrowing into consideration, determine
the effective interest rate in U.S. dollars on the loan in each of the three years 2020,
2021, and 2022.

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a. 9/30/20 Cash 100,000
Note Payable (CNY) [1,000,000 x $0.10] 100,000
(To record the note and conversion of CNY 1 million into U.S.$ at the spot rate.)

12/31/20 Interest Expense 525

Interest Payable (CNY) 525
[1,000,000 x 2% x 3/12 = CNY 5,000 x $0.105 spot rate]
(To accrue interest for the period 9/30 – 12/31/20.)

Foreign Exchange Gain or Loss 5,000

Note Payable (CNY) [CNY 1 mn x ($0.105 – $0.10)] 5,000
(To revalue the note payable at the spot rate of $.105 and record a foreign
exchange loss.)

9/30/21 Interest Expense [CNY 15,000 x $0.12] 1,800

Interest Payable (CNY) 525
Foreign Exchange Gain or Loss [CNY 5,000 x ($0.12 – $0.105)] 75
Cash [CNY 20,000 x $0.12] 2,400
(To record the first annual interest payment, record interest expense for the
period 1/1 – 9/30/21, and record a foreign exchange loss on the interest payable
accrued at 12/31/20.)

12/31/21 Interest Expense 625

Interest Payable (CNY) [CNY 5,000 x $0.125] 625
(To accrue interest for the period 9/30 – 12/31/21.)

12/31/21 Foreign Exchange Gain or Loss 20,000

Note Payable (CNY) [CNY 1 mn x ($0.125 – $0.105)] 20,000
(To revalue the note payable at the spot rate of
$0.125 and record a foreign exchange loss.)

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9/30/22 Interest Expense [CNY 15,000 x $.15] 2,250
Interest Payable (CNY) 625
Foreign Exchange Gain or Loss [CNY 5,000 x ($0.15 – $0.125)] 125
Cash [CNY 20,000 x $0.15] 3,000
(To record the second annual interest payment, record interest expense for the
period 1/1 – 9/30/22, and record a foreign exchange loss on the interest
payable accrued at 12/31/21.)

Note Payable (CNY) 125,000

Foreign Exchange Gain or Loss 25,000
Cash [CNY 1 mn x $0.15] 150,000
(To record payment of the CNY 1 million note.)

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b. The effective interest rate on the loan can be determined by summing the total interest
expense and foreign exchange losses related to the loan and comparing this with the amount
borrowed:

2020
Interest expense $525
Foreign exchange loss 5,000
Total $5,525 / $100,000 = 5.525% for 3 months
5.525% x 12/3 = 22.1% for 12 months
2021
Interest expense $2,425
Foreign exchange loss 20,075
Total $22,500 / $100,000 = 22.5% for 12 months
2022
Interest expense $2,250
Foreign exchange loss 25,125
Total $27,375 / $100,000 = 27.38% for 9 months
27.38% x 12/9 = 36.5% for 12 months

Because of appreciation in the value of the Chinese yuan, the effective annual interest cost
ranges from 22.1% – 36.5%.

Alternatively, the average effective interest rate on this loan can be calculated by comparing
the cash inflows in U.S.$ and cash outflows in U.S.$ as follows:

Cash outflows:
Interest ($2,400 + $3,000) $ 5,400
Principal 150,000
$155,400
Cash inflow:
Borrowing $(100,000)
Net cash outflow $ 55,400 on a loan that originally generated
$100,000

Ignoring compounding, this results in an average effective interest rate of approximately

27.7% per year [($55,400 / $100,000) = 55.4% over two years.
55.4% / 2 years = 27.7% per year].