Question

On September 30, 2015, Ericson Company negotiated a 2-year, 1,000,000 dudek loan from a foreign bank at an interest rate of 2 percent per year. It makes interest payments annually on September 30 and will repay the principal on September 30, 2017. Ericson prepares U.S.-dollar financial statements and has a December 31 year-end.

a.Prepare all journal entries related to this foreign currency borrowing assuming the following exchange rates for 1 dudek:

September 30, 2015	$0.100
December 31, 2015	0.105
September 30, 2016	0.120
December 31, 2016	0.125
September 30, 2017	0.150

b.Determine the effective cost of borrowing in dollars in each of the three years 2015, 2016, and 2017.

Answer 1

30-Sep-15	Bank account Dr	$     100,000
	To Loan from Foreign Bank		$     100,000
	(To record loan taken from a Foreign bank for 2 years @2% p.a)
	Loan amount in USD = 1,000,000*0.1
31-Dec-15	Foreign Exhange Loss	5000
	To Loan from Foreign Bank		5000
	(To adjust the loan balance to exhange rate on reporting date)
	Loan amount in Foreign currency	1000000
	Exchange Rate	0.105
	Loan amount in USD	105000
	Initial recognition	100000
	Difference - Forex Loss	5000
31-Dec-15	Interest expense Dr	525
	To Interest Payable		525
	(To record Interest payable on 31 Dec, 2015 @2% p/a for 3 months)
	Loan amount received	105000
	Interest rate	2% p.a
	Interest expense ((1,000,000*2%*3/12)*.105)	525
	Effective rate = (525/100000*(12/3))	2.10%
	Effective Interest rate = (1+i)(1+ef)-1	5.29%
	í= Interest rate	0.01
	ef = % change in the foreign currency - (0.105-0.1)/0.105	0.05
30-Sep-16	Interest expense Dr	1875
	Interest Payable Dr	525
	To Bank account		2400
	Loan amount in Dudek	1000000
	Annual interest @2% p.a	20000
	USD required to pay (2000*.120)	2400
31-Dec-16	Foreign Exhange Loss	20000
	To Loan from Foreign Bank		20000
	(To adjust the loan balance to exhange rate on reporting date)
	Loan amount in Foreign currency	1000000
	Exchange Rate	0.125
	Loan amount in USD	125000
	Initial recognition	100000
	Forex loss on 31 Dec 2015	5000
	Forex loss for 2016	20000
31-Dec-16	Interest expense Dr	625
	To Interest Payable		625
	(To record Interest payable on 31 Dec, 2015 @2% p/a for 3 months)
	Loan amount in Foreign currency	1000000
	Interest rate	2% p.a
	Interest expense Accrued ((1,000,000*2%*3/12)*.125)	625
	Interest expense paid	1,875
	Total Interest	2,500
	Effective rate = 2500/100,000	2.50%
30-Sep-17	Interest expense Dr	2375
	Interest Payable Dr	625
	To Bank account		3000
	Loan amount in Dudek	1000000
	Annual interest @2% p.a	20000
	USD required to pay (2000*.150)	3000
30-Sep-17	Loan from Foreign Bank	125000
	Foreign exchange Loss	25000
	To Bank account		150000
	Loan amount in Dudek	1000000
	Loan amount in USD as of 30 Sep 2017	150000
	Balance in loan account including Forex aadjustments at year ends 2015 and 2016 (100,000+5,000+20,000)	125000
	Forex loss	25000
	Interest expense for 2017=	2375
	Loan received in USD	100000
	Effective rate for 9 months (2,375/100,000*12/9)	3.17%

Effective borrowing cost for 2015 - 2.1%, 2016 - 2.5% and 2017 - 3.17% (workings provided above in the answer)