CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A U.S. company, whose functional currency is the USD, acquires a machine from a German supplier on December 1, Year 1, for 100,000 Euros. Payment is due on March 1, Year 2. The exchange rates are as follows: December 1, Year 1: $1.10 = 1 Euro; December 31, Year 1: $1.15 = 1 Euro; March 1, Year 2: $1.12 = 1 Euro. What amount of foreign exchange gain or loss should the company recognize in its Year 1 income statement related to this transaction?
- A$2,000 loss
- B$5,000 loss
- C$2,000 gain
- D$5,000 gain
Show answer & explanationAnswer & explanation
Correct answer: B. $5,000 loss
At December 31, Year 1, the company must revalue its foreign currency payable to the current exchange rate. The initial liability was 100,000 Euros * $1.10/Euro = $110,000. At year-end, the liability is 100,000 Euros * $1.15/Euro = $115,000. This increase in the U.S. dollar equivalent of a foreign currency payable results in a foreign exchange loss of $5,000.
Why the other options are wrong
- A. This amount represents the loss recognized at settlement, but not the year-end revaluation loss.
- C. This amount represents the gain if the Euro had weakened, or the gain recognized at settlement, but not the year-end revaluation loss.
- D. This would be a gain, but the revaluation of a payable when the foreign currency strengthens against the dollar results in a loss.
Foreign Currency Transaction Gains/Losses
Gains or losses arising from changes in exchange rates between the transaction date and the settlement date for transactions denominated in a foreign currency.
- Recognized in net income in the period the exchange rate changes.
- Monetary assets and liabilities denominated in foreign currency are revalued at each balance sheet date.
- Non-monetary assets and liabilities are generally not revalued after initial recognition.
Memory trick: Fluctuating Euros mean gains or losses for your books.