On October 1, 20x0, the Alexander Company, a U.S. based manufacturer, purchased

Question

On October 1, 20x0, the Alexander Company, a U.S. based manufacturer, purchased merchandise inventory from a French company for 25,000 euro. Terms of the purchase require the company to repay in euro on or before February 1, 20x1. Alexander Company has a December 31st fiscal year-end. The related dollar/euro exchange rates are: Assuming the buyer pays for the purchase on February 1, 20x1, show or explain how Alexander Company would account for the related transaction at: inception of the transaction, December 31, 20x1, and February 1, 20x1. Describe the foreign currency risk for Alexander Company associated with entering into foreign currency purchase transaction. Explain how they might reduce the foreign currency risk associated with the foreign currency purchase Show or explain how the Alexander Company accounts for the instrument used to reduce their foreign currency risk. Describe the foreign currency risk for the French seller associated with entering into the transaction with Alexander Company and explain how they might reduce that foreign currency risk.

Explanation / Answer

(A) (1) Inception of the transaction

Purchase A/c_______________Dr. $50000 (25000 x $2)   

To Account Payable A/c $50000 (Being Merchandise Purchased)

(2) On December 31, 2000

Account Payable A/c_________________Dr. $2500 (2.00 - 1.90)25000

To Foreign Exchange Gain A/c______________ $2500 (Being foreign exchange occured)

(3) On February 1, 2001

Foreign Exchange Loss A/c___________Dr. $7500 (2.20-1.90)x25000

To Account Payable A/c_________________ $7500 (Being Foreign Exchange Loss occurred)

Account Payable A/c_________________Dr. $55000

To Cash A/c _______ $55000 (Being amount paid)

(B) Foreign Exchange Risk For Alexander Company asociated : (2.20 - 2.00) x 25000 = $5000

(C) Foreign Exchange Risk can be reduced by taking entering into a Forward Conract Risk can be reduced to (2.20 - 2.09) x 25000 = $2750

(E) The foreign currency risk for the Frenxh seller associated with appreciation of $ dollar and depreciation of Euro. And it can be reduced or nullified by taking a forward contract to hedge the above mentioned transaction

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