Typical Transaction 2
Example: Change exchange rate UK £ / US$ from 1.7 to 2.0
The entries for this transaction in the Accounting System can be seen here, in the AccountingLab and in the Accounting System, Operation O5, M1:
| Purchase Fixed Assets on Commercial Credit Terms | Increase in Fixed Assets (+) |
|---|---|
| Increase in Creditors (+) |
> Double entry: Debit entry, Fixed Assets balance decreases from 44,000 to 37,400. Credit entry, Creditors balance decreases from 44,000 to 37,400
> Values in red show Balance sheet values before and after changes
| Balance Sheet | ||
|---|---|---|
| Original | After Changes | |
| Assets | ||
| Current Assets | 767,850 | 767,850 |
| Bank | 758,550 | 758,550 |
| Debtors and Prepayments | 9,300 | 9,300 |
| Other Current Assets (Stock) | 0 | 0 |
| Fixed Assets | 44,000 | 37,400 |
| TOTAL ASSETS | 811,850 | 805,250 |
| Liabilities | ||
| Current Liabilities | 44,300 | 37,700 |
| Creditors | 44,000 | 37,400 |
| Accruals | 300 | 300 |
| Long Term Liabilities | 0 | 0 |
| Long Term Loan | 0 | 0 |
| Equity | 767,550 | 767,550 |
| Shareholders’ Equity | 800,000 | 800,000 |
| Income Statement | -32,450 | -32,450 |
| TOTAL Liabilities + Equity + Retained Earnings | 811,850 | 805,250 |
An analysis of financial ratios can be seen here.
Current ratio calculations are as follows:
| Initial Capital | Current Assets | Current Liabilities | Current Ratio | |
|---|---|---|---|---|
| Balance Sheet Original | 800,000 | 767,850 | 44,300 | 767,850 / 44,300 = 17.3 |
| Balance Sheet New | 1’800,000 | 1’767,850 | 37,700 | 767,850 / 37,700 = 20.4 |
1. When booking a Fixed Asset for a smaller amount that the original, in this case a decrease from 44,000 to 37,400, there is a corresponding decrease in Creditors for the same amount.
2. Given that there is no change in Current Assets the Current Ratio will grow from 17.3 to 20.4, as Current Liabilities have diminished in value. It indicates that current ratios, thus, liquidity are sensitive to exchange rate fluctuations.
3. It has a wider implication for cash flow planning as the company will increase the liquidity indicator, Current Ratio, during devaluation of the seller’s currency and by increasing quantities bought from this seller it will immediately cause a currency gain that can impact profits significantly on the positive.
4. The accounting procedure when there is a devaluation of the currency of the seller’s currency, which produces a currency gain is to:
a. Book the value of the purchase at the date and the value of seller’s invoice, in this case obtained dividing the dollar value, 74,800 by 1.7 US$ per pound, equal to 44,000, Typical Transaction 2. Exchange rate at this date 1.7 US$ per pound.
b. Pay the invoice, booked value, 44,000, at the new exchange rate of 2.0 US$ per pound = 74,800/2 = 37,400. Transaction 8.
c. Currency gain adjustment: 44,000 minus 37,400 = 6,600 pounds. Transaction 14. This amount will be debited to Fixed Assets credited to the Income Statement.