The Effects of Changes in Foreign Exchange Rates: Solutions To Quiz 2

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Chapter 10
The Effects of Changes in Foreign Exchange Rates

ANSWERS TO QUIZ 1:
1. D 6. A
2. C 7. C
3. D 8. D
4. A 9. B
5. D 10. C

SOLUTIONS TO QUIZ 2:

1. Solution:
Nov. 29,
No entry
20x1
Dec. 1, Machine (€20,000 x P58) 1,160,000
20x1 Accounts payable 1,160,000
to record the purchase of machine on an FOB shipping point
term
Dec. 15, Accounts payable 20,000
20x1 Foreign exchange gain* 20,000
to recognize FOREX gain on the exchange difference

*Accounts payable – Dec. 15, 20x1 (€20,000 x P57) P1,140,000


Accounts payable – Dec. 1, 20x1 (€20,000 x P58) 1,160,000
Decrease in accounts payable – FOREX gain P 20,000

Dec. 31, Foreign exchange loss* 60,000


20x1 Accounts payable 60,000
to recognize FOREX loss on the exchange difference

* Accounts payable – Dec. 31, 20x1 (€20,000 x P60) P1,200,000


Accounts payable – Dec. 15, 20x1 (€20,000 x P57) 1,140,000
Increase in accounts payable – FOREX loss P 60,000

Total net foreign exchange loss recognized in 20x1 is P40,000 (60,000 loss – 20,000 gain).

Jan. 3, 20x2 Accounts payable 1,200,000


Foreign exchange loss (squeeze) 20,000
Cash in bank (€20,000 x P61) 1,220,000
to record the settlement of the purchase transaction

The foreign exchange loss of P20,000 is recognized in profit or loss in 20x2.

2. A see solutions below

3. C see solutions below

4. A see solutions below


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 Translation:

in pesos rates in yens

Total assets ₱10M ¥4 (CR) ¥40M

Total liabilities ₱5M ¥4 (CR) ¥20M


Share capital 2M ¥2 (HR) 4M
Retained earnings 3M (see below) 9M
Exchange differences - (squeeze) 7M
Total liabilities and equity ₱10M ¥40M

Income ₱7M ¥3 (AR) ¥21M


Expenses (4M) ¥3 (AR) (12M)
Profit ₱3M ¥3 (AR) ¥9M

Translated total assets 40M – translated total liabilities 20M = translated total equity 20M

 Retained earnings is translated as follows:


in pesos rate in yens
Retained earnings, beginning 0 (not applicable) 0 (a)
Profit 3M 3 9M
Retained earnings, end. 3M 9M

(a)
Entity A has nobeginning retained earnings because it has just started operations during the year. In the
case of a non-newly formed entity, the amount to be included here would be the translated retained
earnings from the preceding year.

 After translating all the amounts, the exchange difference is simply “squeezed” as the balancing
figure between ‘total assets’ and ‘total liabilities and equity.’ This is computed as follows: (¥40M
total assets – ¥20 total liabilities – ¥4M share capital – ¥9 retained earnings) = ¥7 exchange difference –
gain (credit).

The exchange difference can also be reconciled as follows:

1) Translation of opening net assets


Equity, Jan. 1 - at opening rate (₱2M x ¥2) ¥4M
Equity, Jan. 1 - at closing rate (₱2M x ¥4) 8M
Increase in opening net assets – gain 4M
(a)
Cumulative translation gain, Jan. 1 0

2) Translation of changes in net assets during the period:


Profit or loss:
Profit - at average rate (₱3M x ¥3) 9M
Profit - at closing rate (₱3M x ¥4) 12M
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Increase in profit – gain 3M

Exchange difference - gain ¥7M


(a)
See explanation on retained earnings above.

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