Question

Wolfe computer is a U.S company that manufacture portable personal computer. Many of the components for the computer are purchased abroad. And the finished products is sold in foreign countries as well as in the United States. Among the recent transaction of Wolfe are the following:

OCT.28 : Purchased from Mitsutonka, a Japanese company, 20,000 disk drives. The purchase price was ¥180,000,000, payable in 30 days. Current exchange rate, $0.0105 per yen. (Wolfe uses the perpetual inventory method; debit the Inventory of Raw Materials account.)

NOV. 9: Sold 700 personal computers to the Bank of England for £604,500 due in 30 days. The cost of the computers, to be debited to the Cost of Goods Sold account, was $518,000. Current exchange rate, $1.65 per British pound. (Use one compound journal entry to record the sale and the cost of goods sold. In recording the cost of goods sold, credit Inventory of Finished Goods.)

NOV.27: Issued a check to Inland Bank for $1,836,000 in full payment of account payable to Mitsutonka.

DEC. 2 : Purchased 10,000 gray-scale monitors from German Optical for €1,200,000, payable in 60 days. Current exchange rate, $0.7030 per euro. (Debit Inventory of Raw Materials.)

DEC.9: Collected dollar-equivalent of £604,500 from the Bank of England. Current exchange rate, $1.63 per British pound.

DEC.11: Sold 10,000 personal computers to Computique, a Swiss retail chain, for SFr23,750,000, due in 30 days. Current exchange rate, $0.6000 per Swiss franc. The cost of the computers, to be debited to Cost of Goods Sold and credited to Inventory of Finished Goods, is $7,400,000.

Required:

a. Prepare in general journal form the entries necessary to record the preceding transactions.

b. Prepare the adjusting entries needed at December 31 for the €1,200,000 account payable to German Optical and the SFr23,750,000 account receivable from Computique. Year-end exchange rates, $0.7000 per euro and $0.5980 per Swiss franc. (Use a separate journal entry to adjust each account balance.)

c. Compute the unit sales price of computers in U.S. dollars in either the November 9 or December 11 sales transaction. (The sales price is the same in each transaction.)

d. Compute the exchange rate for the yen, stated in U.S. dollars, on November 27.

e. explain how Wolfe Computer could have hedged its position to reduce the risk of loss from exchange rate fluctuation on (1) its foreign payables and (2) its foreign receivable

Answer 1

a) & b) General Journal Entries as well as adjustment entries for 31st Dec.

Date	Particulars	Debit	Credit
28/10	Inventory of Raw Material - Dr	1,890,000
	To Accounts Payable Account (180,000,000 * 0.0105)		1,890,000
	(Being purchase from Mitsutonka recorded)
09/11	Accounts Receivable Account - Dr (604,500 * 1.65)	997,425
	To Inventory of Finished Goods Account		518,000
	To Net Income from Sale		479,425
	(Being sale to Bank of England recorded)
27/11	Accounts Payable Account - Dr	1,890,000
	To Bank Account		1,836,000
	To Gain/Loss on Foreign Exchange		54,000
	(Being account of Mitsutonka settled)
02/12	Inventory of Raw Material Account - Dr	843,600
	To Accounts Payable Account (0.7030 * 1,200,000)		843,600
	(Being purchase from German Opticals recorded)
09/12	Bank Account - Dr (1.63 * 604,500)	985,335
	Gain/Loss on Forex Acc. - Dr	12,090
	To Accounts Receivable Account		997,425
	(Being account settled by Bank of London)
11/12	Accounts Receivable Account - Dr (23,750,000 * 0.6)	14,250,000
	To Inventory of Finished Goods Account		7,400,000
	To Net Income from Sale		6,850,000
	(Being Sale to Computique recorded)
31/12	Account Payable Account - Dr (.7030-.7000)*1,200,000	3,600
	To Gain / Loss on Foreign Exchange		3,600
	(Being adjustment made for changes in forex rate at year end)
31/12	Gain / Loss on Foreign Exchange - Dr	47,500
	To Accounts Receivable Account		47,500
	(Being adjustment made for changes in forex rate at year end)

c) Computation of Sales price per unit

Sale of 10,000 units at $14,250,000 (23,750,000 * 0.6). Therefore price per unit = $1,425 (14,250,000 / 10,000 units)

d) Exchange rate for transaction on Nov 27.

On Nov 27, $1,836,000 = 180,000,000 Yen.

Therefore in $ terms, $ per yen = 1,836,000 / 180,000,000

which is equal to 0.0102 $ per yen.

e) There are various ways through which an organization can hedge its foreign currency exposure. Few of them are as always -

(i) Hedging using forwards - The organization can enter into a forward contract with its bank today itself where the rate of exchange is predetermined today itself thereby reducing the forex risk,

(ii) Billing in Home Currency - Another method of hedging is billing all foreign transactions in home currency, i.e in dollars in the given case, thereby shifting the entire forex risk on the opposite party. However this may lead to a business risk i.e. loss of customer, incase a competitor allows the opposite.

(iii) Hedging using Options - By paying a small premium, the organization receives a right to buy a currency at a pre-determined strike price, This hedges the risk by allowing the organization to exercise such right in case where the price goes against it at the same allows it to lapse such right, if the price is in its favor.

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