Question

On September 30, 2020, Peace Frog International (PFI) (a U.S.-based company) negotiated a two-year, 2,800,000 Chinese yuan loan from a Chinese bank at an interest rate of 4 percent 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	$	0.170
December 31, 2020		0.175
September 30, 2021		0.190
December 31, 2021		0.195
September 30, 2022		0.220

1. Prepare all journal entries related to this foreign currency borrowing.
2. 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.

Answer 1

Answer a

On Sep 30 2020

( 2,800,000 loan is taken at 4% interest for 2 yrs) (2,800,000 * 0.170)

On Dec 31 2020

Interest expense $4,900

Accrued interest $4,900

(Interest for 3 months accounted at 4% using closing rate of exchange at 0.175)

(2,800,000 * 4% * 3/12 * 0.175) = 4,900

On Dec 31 2020

Foreign exchange loss $14,000

Loan payable $14,000

(Foreign exchange loss on translation of loan amount using exchange rate at 31st December)

(2,800,000 * 0.145)

On Sep 30 2021

Interest Expense $16,380

Accrued Interest $4,900

Cash $21,280

(Interest for the first year paid at 4% using exchnage rate on payment)

[(2,800,000 * 4% * 0.190) - 4,900 ]

On Dec 31 2021

Interest Expense $5,460

Accrued interest $5,460

(Interest for the period of Oct - Dec accounted using exchange rate @ Dec 31 2021)

(2,800,000 * 4% * 3/12 * 0.195)

On Dec 31 2021

Foreign exchange loss $56,000

Loan Payable $56,000

(Foreign exchange loss on translation of loan payable amount using year end rate of 0.195 is now recognised)

(2,800,000 x 0.195 - 490,000) = 56,000

On Sep 30 2022

Interest expense $19,180

Accrued interest $5,460

Cash $24,640

(Interest for 2nd year paid using the exchange rate)

[(2,800,000 * 4% * 0.220) - 5,460)

On Sep 30 2022

Foreign exchange loss $70,000

Loan payable $70,000

(Exchange loss recorded based on the exchange rate existing at the time of repayment)

[ 2,800,000 * 0.220 - 546,000 ]

On Sep 30 2022

Loan payable $616,000

Cash $616,000

(loan of 2,800,000 repaid using exchange rate of 0.220)

Answer b

Effective cost of borrowing is calculated below

For 2020 = 14,000 + 4,900 = $18,900

For 2021 = 21,280 + 56,000 + 5,460 - 4,900 = $77,840

For 2020 = 24,640 + 70,000 - 5,460 = $89,180

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