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On May 20, 2019, when the spot rate is $1.28/€, a U.S. company buys merchandise from a supplier in Italy, at a cost of €100,000. The spot rate is $1.25/€ on June 30, the company’s year-end. Payment of €100,000 is made on July 30, 2019, when the spot rate is $1.32/€. What is the effect on fiscal 2019 and fiscal 2020 income?

Fiscal 2019 Fiscal 2020
(a) No effect $4,000 exchange loss
(b) $3,000 exchange loss $7,000 exchane gain
(c) No effect $4,000 exchange gain
(d) $3,000 exchange gain $7,000 exchange loss

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Answer:

The effect on fiscal 2019 is $3,000 exchange gain and $7,000 exchange loss on fiscal 2020

Explanation: At the company year end on june 30, as it is a debt in foreign currency, the company must account for the exchange difference, that is $100,000 * $1.25/€ (year end) - $100,000 * $1.28/€ (date of purchase)= $125,000-$128,000. So the american company owes less money ($3,000) at year end (it is an exchange gain).

But when the debt is cancelled the spot rate is $1.32/€, and the debt was accounted at $125,000 so for fiscal year 2020 the exchange loss is $7,000

$100,000 * $1.32/€= $132,000-$125,000=$7,000 loss.

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