Question

A US company with the US dollar as its functional currency is preparing to report consolidated financial statements for Year One. At the end of that year, because of a foreign subsidiary, the company has a translation adjustment account with an $18,000 credit balance. In addition, the US company had a receivable for 100,000 lira from a customer in Italy. This receivable was worth $11,000 when it was established on November 9. However, the currency exchange rates changed, and it was worth $14,000 when paid by the customer on January 30 of Year Two. The 100,000 lira receivable was worth $13,000 on December 31, Year One. What gain appears in this company's consolidated income statement for Year One?

Answer 1

The gain reported in the company's income statement for Year One is $2,000, resulting from the increased value of an Italian lira receivable due to exchange rate fluctuations.

Step-by-step explanation:

The gain that appears in the company's consolidated income statement for Year One is $2,000, which is the difference between the value of the receivable at the end of Year One ($13,000) and its value when it was established ($11,000).

Since financial reporting requires that foreign currency transactions be recorded at their U.S. dollar equivalent at the time of the transaction, any changes in exchange rates that occur afterward will result in transaction gains or losses.

The receivable was worth more U.S. dollars at the end of Year One than when it was first measured, thus the company will report a foreign exchange gain of $2,000 in its income statement for Year One. The money received when the receivable was paid in Year Two does not affect Year One's financial statements.