Global Trading Transactions

Many firms buy goods from foreign suppliers and/or sell goods to foreign customers. The terms of the transaction will stipulate how payment is to occur and the currency for making that settlement. If the currency is a "foreign currency," then some additional thought must be given to the associated bookkeeping. Fortunately, this issue is not so complicated and can be easily illustrated with a few examples.

Suppose Bentley's Bike Shop purchases bicycles from Giro Cycle of Switzerland. On July 1, 20X6, Bentley purchased 10 bikes, agreeing to pay 20,000 Swiss francs within 60 days. Bentley is in Cleveland, Ohio, and the U.S. dollar is its primary currency. On July 1, Bentley will record the purchase with the following accounts:

But, what amounts should be debited and credited? If 20,000 were used, the accounts would cease to be logical. The total Inventory balance would be illogical since it would include this item, and all other transactions in other currencies, thereby becoming a meaningless hodge-podge of currency units. Total Accounts Payable would become unintelligible as well. Therefore, Bentley needs to measure the transaction in dollars. On July 1, assume that the current exchange rate (i.e., the "spot rate") is $0.75 U.S. dollars to acquire 1 Swiss franc. The correct entry would be:

By the August 29 settlement date, assume that the dollar has weakened and the spot rate is $0.80. Bentley will have to pay a bank $16,000 (20,000 X $0.80) to buy the 20,000 francs needed to settle the obligation. The following entry shows that the difference between the initially recorded payable ($15,000) and the cash settlement amount ($16,000) is to be recorded as a foreign currency transaction loss:

If the exchange rate had gone the other way to $0.70 by the August 29 settlement date, a foreign currency transaction gain (credit) would have been needed to balance the difference between the $15,000 payable and $14,000 ($0.70 X 20,000) required cash disbursement.

In the preceding example, the foreign currency payable was created and settled within the same accounting period. It is important to know that foreign currency payables and receivables that exist at the close of an accounting period must also be adjusted to reflect the spot on the balance sheet date. The following sale transaction will illustrate this important point.

Suppose Vigeland Corporation sold goods to one of its customers in England, agreeing to accept payment of 100,000 British pounds in 90 days. On the date of sale, December 1, 20X1, the spot rate for the pound was $1.75. Vigeland prepared financial statements at its year end on December 31, 20X1, at which time the spot rate for the pound was $1.90. As expected, the foreign currency receivable was collected on February 28, 20X2; Vigeland immediately converted the 100,000 pounds to dollars at the then current exchange rate of $1.70. The following illustrates the sale, year-end adjustment of the foreign currency receivable, and subsequent collection:

Some companies may wish to avoid foreign currency exchange risks like those illustrated above. The simplest way to avoid such exposure is to convince your trading partner to make or take payment in your home currency. In the alternative, there are various financial agreements that can be structured with banks or others to transfer away this risk (but, forego the opportunity for gains as well). As you might imagine, such hedging transactions can grow quite complex. Great care must be taken to record and monitor these activities, and advanced accounting courses are apt to devote substantial time to this subject.