The basic problem with reporting foreign currency balances is that exchange rates are constantly in flux. The price of one euro in terms of U.S. dollars changes many times each day. If these rates remained constant, a single conversion value could be determined at the time of the initial transaction and then used consistently for reporting purposes. However, exchange rates are rarely fixed; they often change moment by moment. For example, if a sale is made on account with the money to be received in a foreign currency in sixty days, the relative worth of that balance will probably move up and down many times before collection. When such values float, the reporting of foreign currency amounts poses a challenge for financial accounting with no easy resolution. Question: Exchange rates that vary over time create a reporting problem for companies working in international markets. To illustrate, assume a U.S. company makes a sale of a service to a Mexican company on December 9, Year One, for 100,000 Mexican pesos that will be paid at a later date. The exchange rate when the sale was made is assumed to be 1 peso equal to $0.08. However, by the end of Year One when financial statements are produced, the exchange rate has changed to 1 peso being equal to $0.09. What reporting does a U.S. company make of transactions that are denominated in a foreign currency if the exchange rate changes as time passes?
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By the end of the year, the exchange rate is 1 peso equal to $0.09. The Mexican peso is worth a penny more relative to the U.S. dollar. Thus, 100,000 pesos can now be changed into $9,000 (100,000 × $0.09). When adjusting entries are prepared in connection with the production of financial statements, one or both of the above account balances could remain at $8,000 or be updated to $9,000. The sale took place when the exchange rate was $0.08 but, now, before the money is collected, the peso has risen in value to $0.09. FASB had to set a standard rule as to whether the current rate or the historical rate was appropriate for reporting foreign currency balances. For over twenty-five years, U.S has required that monetary assets and liabilities denominated in a foreign currency be reported at the current exchange rate as of the balance sheet date. All other balances continue to be shown at the exchange rate in effect on the date of the original transaction. That is the approach that all organizations adhering to U.S. GAAP must follow. Both the individuals who produce financial statements as well as the outside decision makers who use them should understand that this rule is applied.
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