BRANCH HOUSE ACCOUNTING (Continued)
Foreign Exchange
The foreign trading of American firms has grown of late years to such
proportions that a practical acquaintance with the exchange values
of foreign currencies is necessary for the accountant. The rate of
exchange is the equivalent of the currency of one country in that of
another. For instance, the standard value of the British sovereign in
the currency of the United States is $4.8665; that is, the value of
the quantity of pure gold in one sovereign in London is equal to that
represented by $4.8665 in New York. Other things being equal, this
should always be the par rate of exchange between the United States
and England. The question of the rate of exchange between countries
which have a gold standard is a comparatively simple matter. Where one
of the countries has a silver currency, the variations assume more
importance, for the reason that the intrinsic value of silver converted
into gold must be accounted for. Paper currency, especially in times of
war, causes a still greater complication, because in this case it is
uncertain when such paper will be made convertible into gold or silver.
In addition to differences in exchange arising from the conversion
of one currency into another, called the par rate, other things enter
into exchange transactions which have a marked effect upon the actual,
or market, rate of exchange. Such conditions as supply and demand for
remittances between countries to satisfy debit balances; the necessary
expenses, including cost of transmission (which can never be more than
the actual cost of transporting the specie itself): interest on the
money for the time the draft has to run to maturity or to the time of
payment in the foreign country—these and other factors must be taken
into account. The expense of cabling and the profits of the bankers
who transmit the money must be added. Some intangible factors are the
credit condition of the countries and the risks involved in making
transfers.
The Accounting Problem of the Foreign Branch
From the viewpoint of accounting, the only problem in connection with
foreign branches which differs from those of domestic branches concerns
the conversion of the foreign currency—in terms of which the records
of the foreign branch are kept—into the currency of the head office.
Periodically—usually at the close of the fiscal period—the results as
shown by the branch records must be incorporated with those of the head
office. The problem involved is for the most part due to the fact that,
while the activities of the various branches have been transacted and
recorded in terms of one or more currencies, the net results of those
activities are to be taken effect of, usually as a disbursement of
dividends, in the terms of the head office currency. That is, earnings
are made and expenses incurred in one currency, and the net result of
the branch’s trading must be disbursed in terms of another currency.
The fluctuations in exchange prevailing throughout the year at the time
of the various transactions of the branch and at the time when the net
results of the branch are disbursed as dividends from the head office,
sometimes give rise to a very complicated problem if accurate and
satisfactory results are to be secured.
It is impossible, from the standpoint of practice, to convert every
transaction of the branch into the currency of the head office at
the rate prevailing at the time of the transaction; and furthermore,
the funds out of which ultimately some portion of the dividends must
be paid are, at the close of the fiscal period, still held in the
possession of the branch and so are not available except through
the process of conversion. Accordingly, the question of the rate of
exchange prevailing at the close of the fiscal period has a very
important bearing on the correct showing of the branch’s activities on
the head office books.
It is not purposed here to go into the question of organization, or
method of keeping accounts for the foreign branch. As was stated above
in connection with domestic branches, any system of accounts depends
very largely upon the general organization of the head office and
its branches, and this in turn depends on the degree of control and
amount of information desired. The discussion will be limited to the
assumption that the branch has an almost independent organization and
is expected to make a full report periodically by means, at least, of a
trial balance of the branch.
Accounts Opened on Books
On the books of the branch a Head Office Control or Adjustment account
will be carried which represents the ownership of the head office in
the branch; and on the head office books a Branch Control or Adjustment
account which is the complement of the head office account on the
branch books. Frequently, in addition to these interrelated accounts,
a Remittance account is carried for the purpose of facilitating
reference. In this account are entered the remittances made by the
branch to the head office, instead of entering such transactions in the
Head Office Control account. The problem to be discussed here concerns
the method of converting the branch trial balance before incorporating
it, and the root of the problem lies in the determination of the basis
for the conversion of the various kinds of items listed therein. Fixed
and current asset and liability items, expense and income items, the
Head Office Control and Remittance accounts—all must be converted.
For an accurate and equitable showing of the branch activities on the
head office books under certain conditions, these different classes of
items should not be converted at the same rate. Under other conditions
no serious inequity results from the use of a uniform rate of exchange
for the conversion of all items, and in practice such a rate is handled
much more simply than different rates. Of course, the branch trial
balance is in balance previous to conversion but is almost invariably
out of balance after conversion. It becomes necessary, therefore, to
take up the difference by means of a debit or credit to an account
called “Exchange” or “Fluctuations in Exchange”—sometimes also called
“Reserve for Fluctuations in Exchange.”
Handling Fluctuations in Foreign Exchange
The proper handling and ultimate disposition of this Exchange or
Fluctuations in Exchange account requires some consideration. If there
is a loss in the conversion of the branch trial balance into the head
office currency, that may be treated as a current expense to be charged
ultimately to the current period’s profit and loss. Any profit accruing
from the same source may be similarly handled. Some concerns set aside
all profits accruing in this manner into a Reserve for Fluctuations
in Exchange account, against which are charged any losses incurred
through conversion. If the first period shows a loss on conversion, it
would, of course, be necessary to reserve out of that period’s profits
a sufficient amount to take care of the loss. Usually, however, the
items of profits and losses on conversion of exchange counterbalance
each other fairly well throughout succeeding periods. The item is for
the most part comparatively small and either method of handling it
is satisfactory and gives sufficiently correct results under normal
conditions but often too inaccurate under abnormal conditions.
Conversion of Branch Results
The basis on which the closing entries are converted from the foreign
to the local currency is a very important factor. If the ratio between
the two countries is more or less stable, an average rate may be
adopted without much variation in the established values. All profits
or losses on exchange resulting from differences between actual rates
on current transactions and this average rate will be entered in the
Fluctuations in Exchange account. However, in periods of rapidly
fluctuating rates of exchange, or in transactions with branches where
silver currency or depreciated paper or non-guaranteed currency are
in use, the conversion of all items at some arbitrary or average
rate will not give accurate or satisfactory results. In such cases
certain practices have been established as being the most equitable
in converting the various accounts of the branch balance sheet into
the local currency for the purpose of amalgamating them into the home
office balance sheet. These practices are summed up as follows:
First convert the foreign currency into dollars at the following rates:
1. Fixed assets at the same rate as before, that is, the
rate at the time of purchase, or average rate for
the purchases of a fiscal period. The reason for
this is that _fluctuations_ in the value of fixed
assets, whether expressed in one currency or another,
are not allowed to affect the period’s results.
2. Floating assets and liabilities at the rate current
as of the date of the balance sheet.
3. Revenue items at an average rate for the period.
4. Remittances at the actual rates paid.
5. Control or adjustment account at the same rate
as that which had been established on the head
office books at the last period.
To arrive at the average rate in the case of fixed assets it is
sufficient to take the rate prevailing at the end of each month
throughout the year and divide the total by twelve. This becomes
necessary where construction or purchases of fixed properties take
place throughout the year. The difference, if the rate is less than
par, is credited to the capital expenditure and debited to Profit and
Loss on the head office books. The branch is notified of the adjustment
and makes a similar entry crediting Exchange and debiting the head
office with the amount.
Current assets and liabilities are converted at the rates current
at the date of the balance sheet because the balance sheet should
represent these values at the exact cost of converting them into cash
at the present moment. If in practice they were actually liquidated,
this could not be realized but in principle it represents the present
condition. Revenue items are convertible at the average rate because
they represent items accumulating during the entire fiscal period; they
represent the result of the business activities for the past period,
at varying rates of exchange. Since the remittance account represents
the actual cash paid for cash transmitted, there is no occasion for
changing the rate which has been used at various times during the
period. The Control or Adjustment account likewise was converted at the
time the entries were made to it and represents the exact cost of the
various transactions recorded in it.
After all balance sheet items have been converted according to the
rates prescribed, it is a general custom to provide a reserve account
to cover any losses on exchange not provided in the conversion of
the accounts. This is done for the purpose of guarding against
overstating values and thus paying dividends out of the capital, since
the conversion into head office currency merely serves as a medium
of estimating what the foreign investment really represents to the
stockholders.
An illustrative problem is given below with its solution based on
the principles of conversion just stated. It is to be noted that in
practice, within the limitation stated on page 546, a uniform rate of
conversion is generally made use of for all items except remittances,
for which the actual rate is used.
Illustrative Bookkeeping Problem
_Problem._ At the close of the fiscal period a condensed trial balance
report of the London branch of a New York concern showed as follows:
TRIAL BALANCE—LONDON BRANCH
£ £
N. Y. Control (4.7475) 100,000
Remittance 50,000
Cash 5,000
Customers 75,000
Merchandise Inventory 25,000
Furniture and Fixtures 1,000
Creditors 31,000
Sales 150,000
Purchases 95,000
Expenses 30,000
-------- -------
281,000 281,000
======== =======
Final Inventory £30,000
The London Control account on the New York books showed a balance of
$474,750, and the Remittance account $237,987.50. Set up, in journal
form, the entries necessary to take on the New York books the results
of the period’s activity at London and show the London Control and
London Profit and Loss accounts after adjustment, using the additional
data:
1. The Remittance account comprised 5 drafts of
£10,000 each, at 4.75, 4.7575, 4.74875, 4.7625,
and 4.78 respectively.
2. The current rate of exchange is 4.7545.
3. The average rate is 4.7525.
4. The rate at time of purchase of fixed assets was 4.83.
5. No account is to be taken of probable loss from
uncollectible accounts nor of depreciation.
6. Carry the difference in exchange to a reserve.
_Solution_
CONVERSION OF LONDON TRIAL BALANCE
=================+=======+=======+=======================+============
| | | Rate of | |
| £ | £ |Conversion| $ | $
+-------+-------+-----------------------+------------
New York Control | |100,000| 4.7475 | | 474,750.00
Remittances[70] | 50,000| |(See note)| 237,987.50|
Cash | 5,000| | 4.7545 | 23,772.50|
Customers | 75,000| | 4.7545 | 356,587.50|
Merchandise | | | | |
Inventory | 25,000| | 4.7475 | 118,687.50|
Furniture and | | | | |
Fixtures | 1,000| | 4.83 | 4,830.00|
Creditors. | | 31,000| 4.7545 | | 147,389.50
Sales | |150,000| 4.7525 | | 712,875.00
Purchases | 95,000| | 4.7525 | 451,487.50|
Expenses | 30,000| | 4.7525 | 142,575.00|
Reserve for | | | | |
Fluctuations | | | | |
of Exchange | | | | | 913.00
+-------+-------+----------+------------+------------
|281,000|281,000| |1,335,927.50|1,335,927.50
+=======+=======+==========+============+============
Final Inventory £30,000 @ 4.7545 = $142,635
[70] This item comprised 5 drafts, of £10,000 each, at 4.75, 4.7575,
4.74875, 4.7625, and 4.78 respectively.
JOURNAL ENTRIES TO ADJUST NEW YORK BOOKS
(1) Remittances $237,987.50
London Control $237,987.50
To Credit London with its remittances:
£10,000 @ 4.75 = $47,500.00
10,000 @ 4.7575 = 47,575.00
10,000 @ 4.74875 = 47,487.50
10,000 @ 4.7625 = 47,625.00
10,000 @ 4.78 = 47,800.00
(2) London Control $712,875.00
London Profit and Loss $712,875.00
To charge London with its sales:
£150,000 @ 4.7525
(3) London Profit and Loss 118,687.50
London Control 118,687.50
To credit London with initial
inventory:
£25,000 @ 4.7475
(4) London Profit and Loss 451,487.50
London Control 451,487.50
To credit London with its purchases:
£95,000 @ 4.7525
(5) London Control 142,635.00
London Profit and Loss 142,635.00
To charge London with final
inventory:
£30,000 @ 4.7545
(6) London Profit and Loss 142,575.00
London Control 142,575.00
To credit London with its
expenses:
£30,000 @ 4.7525
(7) London Control 913.00
Reserve for Exchange Fluctuations 913.00
To charge London with the
profit arising from conversion.
(8) London Profit and Loss 142,760.00
Profit and Loss 142,760.00
To transfer profit at London
branch to general Profit and Loss.
Appended are the London Control account as it would appear after
posting the above entries on the New York books; and the London Profit
and Loss account on the New York books.
LONDON CONTROL
=====================+========+=========+=============
Items | Rate | £ | $
---------------------+--------+---------+-------------
Balance one year ago | | 100,000 | 474,750.00
London Profit & Loss | | |
(Sales) | 4.7525 | 150,000 | 712,875.00
London Profit & Loss | | |
(Final Inventory) | 4.7545 | 30,000 | 142,635.00
Reserve for Exchange | | |
Fluctuations | | | 913.00
| | |
| +---------+-------------
| | 280,000 | 1,331,173.00
|========+=========+=============
Balance | | 80,000 | 380,435.50
=====================+========+=========+=============
Items | Rate | £ | $
---------------------+--------+---------+-------------
Remittances See | J(1) | 50,000 | 237,987.50
London Profit & Loss | 4.7475 | |
(Initial Inventory) | 4.7525 | 25,000 | 118,687.50
London Profit & Loss | 4.7525 | |
(Purchases) | | 95,000 | 451,487.50
London Profit & Loss | | |
(Expenses) | | 30,000 | 142,575.00
Balance | | 80,000 | 380,435.50
| | |
| | 280,000 | 1,331,173.00
+========+=========+=============
LONDON PROFIT AND LOSS[71]
===============================+=============================
Initial Inventory $118,687.50 | Sales $712,875.00
Purchases 451,487.50 | Final Inventory 142,635.00
Expenses 142,575.00 |
Profit & Loss 142,760.00 |
----------- | -----------
$855,510.00 | $855,510.00
=========== | ===========
[71] This also may be kept in both currencies if desired and only
totals carried in the London Control account.
Local Supervision of the Foreign Branch
A question which enters into the accounting with foreign branches
arises in connection with the law of the land in which the branch is
opened. “Most foreign countries have some regulations as to what books
must be kept, and the manner of recording the transactions. In France,
for instance, the law requires that a summary of all transactions shall
be entered through the journal, which therefore becomes the posting
medium for every transaction. This book has, in the first instance,
to be produced to a public official, who examines it to see that it
is duly paged, none missing, etc., and then stamps it as correct, and
anything requiring legal proceedings in which accounts are concerned
must be proved from the journals with the official _visa_.”
“Since the work of organizing and installing systems of accounting in
branch houses abroad is of undoubted and growing importance, it is
necessary to have not only a practical acquaintance with the currencies
in which the foreign books are kept, and the laws of the land in regard
to the kind of books which must be kept, but in addition a thorough
knowledge of the manner in which transactions are to be transmitted
periodically to the home office, and of their assimilation with the
home accounts and the drafting of the final accounts, balance sheets
and profit and loss statements becomes indispensable.”
The Foreign Sales Agency
Where the foreign branch is merely a selling agency for the home
office, and invoices must be made out at the home office in foreign
currency, a convenient way to handle these accounts is to keep a
separate set of records for each foreign currency. A foreign sales
journal, customers ledger, and cash receipts journal, together with
foreign notes receivable and sales returns and allowances journals,
where necessary, will comprise all books of original entry needed to
secure sources for postings to the customers’ individual accounts in
terms of foreign money. In this way all charges for goods sent, and
credits for returns, allowances, cash and notes received and discounts
allowed, can be kept entirely in foreign currency.
Method of Conversion of Results
Periodically—say, once a month—the total transactions for the month
must be converted into home currency and brought into the general
ledger. In _normal_ times a fixed average rate of exchange based
on past experience gives sufficiently accurate results, saves many
tedious calculations and much unnecessary work. At certain times and in
certain businesses the prevailing rate of exchange on the actual day,
or the monthly average of daily rates, may need to be used to secure
satisfactory results. With the use of the fixed average rate, as above,
the totals of foreign sales and sales returns journals are converted
into home currency and carried respectively as debits and credits to
Accounts Receivable control, and credits and debits to Sales. The total
of the discount column of the cash receipts journal is converted,
at the average rate, and charged to Sales Discount and credited to
Accounts Receivable control.
The conversion of the cash received must be handled differently,
however. The actual rate at which the foreign draft or bill received
in payment of the customer’s account is converted by sale to the
banker—and so credited to the home office bank account—almost always
differs from the average rate at which the item was charged to the
customers’ controlling account. This, of course, makes no difference
with his individual account which is kept in foreign currency, but does
make necessary an adjustment of the general ledger Accounts Receivable
control in order to make it agree with the foreign customers ledger
when converted at the average rate.
Accordingly, in the general cash book two additional columns are
provided, viz.: Profit on Exchange and Loss on Exchange columns, which
are used somewhat as is the Sales Discount column. Every foreign
draft or bill when received is entered, in foreign currency, in the
foreign cash book and posted from there to the credit of the customer.
When that draft or bill is sold at the bank (it may be held for some
time after receipt for a favorable turn of the money market) and so
converted into home currency, it is entered in the Accounts Receivable
column at a figure representing conversion at the fixed average rate.
The difference between this figure and the actual amount received
at the bank is entered in either the Profit on Exchange or Loss on
Exchange column as the case may be, with extension of the actual amount
into the bank column as a charge to the bank account. Thus, the total
of the Accounts Receivable column when posted to the general ledger
Accounts Receivable control adjusts that account so that it controls
the foreign customers ledger converted at the average rate. The totals
of the Profit on Exchange and Loss on Exchange go as credits and debits
respectively to the Profit and Loss on Exchange account.
The foreign sales agency often collects the accounts and remits total
collections periodically by purchase of one bill or draft on its
local bank for the total. There must, of course, accompany each such
remittance a statement of the detailed receipts for proper credit to
individual accounts. The general cash book will show only the total
remittance, however. Regular agency accounts as explained in Chapter
XXX will secure the control of the home office over the agency’s
expenditures.
It is usually best to make the foreign customers ledger
self-balancing. The Adjustment account necessary to effect this may,
if desired, be kept in both foreign and home currency, thus showing
on its face, by the balance of the home money columns, the agreement
of the foreign ledger with its control account on the general ledger.
If, instead of one fixed average rate of conversion, varying rates are
used, the keeping of the Adjustment account in both currencies becomes
imperative.
Where, in the case of foreign sales, the sales invoice and charge to
the customer are made in home currency and payment of that amount in
home currency is demanded, the problem of conversion, as explained
above, is not encountered, foreign sales being recorded and handled in
exactly the same way as home sales.
The Foreign Purchasing Agency
If the purchase is made in terms of foreign currency and settlement
must be made in that currency, a procedure and system may be used
exactly similar to that just explained for handling sales.
In both the sales and purchase record books, returns may be entered in
the same record by using red ink, and deducting the red ink totals at
the end of each page. This obviates the necessity of keeping subsidiary
adjustment accounts in a separate book, and brings all information
regarding the branch transactions in one compact record.