Question

On September 30, 2015, Ericson Company negotiated a 2-year, 1,000,000 dudek loan from a foreign bank at an interest rate of 2 percent per year. It makes interest payments annually on September 30 and will repay the principal on September 30, 2017. Ericson prepares U.S.-dollar financial statements and has a December 31 year-end.

a.Prepare all journal entries related to this foreign currency borrowing assuming the following exchange rates for 1 dudek:

September 30, 2015	$0.100
December 31, 2015	0.105
September 30, 2016	0.120
December 31, 2016	0.125
September 30, 2017	0.150

b.Determine the effective cost of borrowing in dollars in each of the three years 2015, 2016, and 2017.

Answer 1

a.	.Prepare all journal entries related to this foreign currency borrowing
	assuming the following exchange rates for 1 dudek:
9/30/2015	Cash	$100,000
	Notes payable (dudek) [$1000000 * $.10]		$100,000
	(to record the note and conversion of 1 million dudeks into $ at spot rate)
12/31/2015	Interest expense	$525
	interest payable (dudek)		$525
	[1000000 * 2% * 3/12 = 5000 dudeks * $.105 spot rate]
	(to accrue interest for the period 9/30 - 12/31/15)
	Foreign exchange loss	$5,000
	notes payable (dudek) [ 1 m* ($.105 - $.10)]		$5,000
	(to revalue the notes payable at the spot rate of $.105 and record a foreign exchange loss)
9/30/2016	Interest expense [15000 dudeks * $.12]	$1,800
	Interest payable (dudeks)	525
	Foreign exchange loss [ 5000 dudeks* ($.12 - $.105)]	75
	Cash [20000 dudeks* $.12]		$2,400
	(to record the first annual interest payment, record interest expense for the period 1/1 - 9/30/16 and record a foreign exchange loss on the interest payable accrued at 12/31/15)
12/31/2016	Interest expense	$625
	Interest payable (dudek) [5000 dudeks *$.125]		$625
	(to accrue interest for the period 9/30 - 12/31/16)
	Foreign exchange loss	$20,000
	Notes payable (dudek) [ 1m* ($.125 - $.105)]		$20,000
	(to revalue the notes payable at the spot rate of $.125 and record a foreign exchange loss)
9/30/2017	interest expense [15000 dudeks * $.15]	$2,250
	interest payable (dudeks)	625
	foreign exchange loss [5000 dudeks * ($.15 - $.125)]	125
	Cash [20000 dudeks*$.15]		$3,000
	(to record the second annual interest payment, record interest expense for the period 1/1 - 9/30/17 and record a foreign exchange loss on the interest payable accrued at 12/31/16)
	Notes payable (dudek)	$125,000
	Foreign exchange loss	25000
	cash [ 1m dudeks * $.15]		$150,000
	(to record payment of the 1 million dudek note)
b	the effective cost of borrowing can be determined by considering the total interest expense
	and the foreign exchange losses related to the loan
	and comparing this with the amount borrowed
	2015
	interest expense	$525
	foreign exchange loss	5000
	total	$5525 / $100000 = 5.525 for 3 months
		= 22.1 for 12 months
	2016
	interest expense	$2,425
	foreign exchange loss	20075
	total	$22500 / $100000 = 22.5% for 12 months
	2017
	interest expense	$2,250
	foreign exchange loss	25125
	total	$27375 / $100000 = 27.38% for 9 months
		= 36.5% for 12 months
	Because of appreciation in the value of the dudek, the effective annual borrowing cost
	range from 22.1% - 36.5%