XYZ Corp. has a calendar year end. On January 1, 2019, the company borrowed $5,000,000 U.S. dollars from an American Bank. The loan is to be repaid on December 31, 2022 and requires interest at 5% to be paid every December 31. The loan and applicable interest are both to be repaid in U.S. dollars. XYZ does not hedge to minimize its foreign exchange risk. The following exchange rates were in effect throughout the term of the loan:
$$1.1487\begin{array} { | l | c | } \hline \text { Jaruary } 1,2019 & \text { US } \$ 1 = \text { CDN } \$ 1.1500 \\\hline \text { Decerrber } 31,2019 & \text { US } \$ 1 = \text { CDN } \$ 1.1490 \\\hline \text { December } 31,2020 & \text { US } \$ 1 = \text { CDN } \$ 1.1485 \\\hline \text { December } 31,2021 & \text { US } \$ 1 = \text { CDN } \$ 1.1483 \\\hline \text { December } 31,2022 & \text { US } \$ 1 = \text { CDN } \$ 1.1487 \\\hline\end{array}$ The average rates in effect for 2019 and 2020 were as follows:
$$1.1487\begin{array} { | l | l | } \hline2019 : & \text { US } \$ 1 = \text { CDN } \$ 1.1493 \\\hline 2020 : & \text { US } \$ 1 = \text { CDN } \$ 1.1487 \\\hline\end{array}$ By what amount (in Canadian Dollars) would XYZ have to adjust its Loan Liability on December 31, 2019 as a result of the year's foreign exchange rate fluctuations?

A) A $5,000 decrease.
B) A $2,500 decrease
C) A $5,000 increase.
D) Nil.

Question

XYZ Corp. has a calendar year end. On January 1, 2019, the company borrowed $5,000,000 U.S. dollars from an American Bank. The loan is to be repaid on December 31, 2022 and requires interest at 5% to be paid every December 31. The loan and applicable interest are both to be repaid in U.S. dollars. XYZ does not hedge to minimize its foreign exchange risk. The following exchange rates were in effect throughout the term of the loan:

$1.1487\begin{array} { | l | c | } \hline \text { Jaruary } 1,2019 & \text { US } \$ 1 = \text { CDN } \$ 1.1500 \\\hline \text { Decerrber } 31,2019 & \text { US } \$ 1 = \text { CDN } \$ 1.1490 \\\hline \text { December } 31,2020 & \text { US } \$ 1 = \text { CDN } \$ 1.1485 \\\hline \text { December } 31,2021 & \text { US } \$ 1 = \text { CDN } \$ 1.1483 \\\hline \text { December } 31,2022 & \text { US } \$ 1 = \text { CDN } \$ 1.1487 \\\hline\end{array}

The average rates in effect for 2019 and 2020 were as follows:

$1.1487\begin{array} { | l | l | } \hline2019 : & \text { US } \$ 1 = \text { CDN } \$ 1.1493 \\\hline 2020 : & \text { US } \$ 1 = \text { CDN } \$ 1.1487 \\\hline\end{array}

By what amount (in Canadian Dollars) would XYZ have to adjust its Loan Liability on December 31, 2019 as a result of the year's foreign exchange rate fluctuations?

A) A $5,000 decrease.
B) A $2,500 decrease
C) A $5,000 increase.
D) Nil.

lavatharshan tharmalingam · Accepted Answer

Final Answer : A, Explanation :  Since XYZ does not hedge, the accounting treatment is to use the spot rate at each balance sheet date to translate the loan balance from U.S. dollars to Canadian dollars. Thus, on December 31, 2019, the loan balance of $5,000,000 U.S. dollars needs to be translated into Canadian dollars using the spot rate of 1.2960 (CAD/USD) to get the Canadian dollar equivalent of $6,480,000.However, the loan liability was initially recorded on January 1, 2019 at the spot rate of 1.3000 (CAD/USD). Therefore, the year's fluctuations in the exchange rate have resulted in a decrease in the Canadian dollar value of the loan liability of $5,000 (=$6,480,000 - $6,485,000), which is Option A.

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