TT2 Book the Purchase of Fixed Assets

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:

Accounting Equation
Purchase Fixed Assets on Commercial Credit Terms Increase in Fixed Assets (+)
Increase in Creditors (+)
> Enter new exchange rate of 2.0 in field: “New value of Exchange Rate”
> 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 Y1
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:
Calculation of Current Ratio
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.