Detailed Answer
(c) The requirement is to determine the amount that
Tyrola should accrue for royalties payable, 12/31/Y2. This situation
is a foreign currency transaction in which settlement is denominated
in other than a company’s functional currency. In this
case the functional currency is the US dollar because it is the
currency of the primary economic environment in which the
Colorado firm operates. Note that in this royalty agreement,
12/31/Y2 is the point at which the amount due to the author
(50,000 Canadian dollars × 10% = 5,000 Canadian dollars) is
determined. Royalty expense is measured and the related liability
is denominated at 12/31/Y2. The year-end accrual would be
.89 (10% × 50,000 Canadian dollars) = $4,450.
On January 10, year 2, Tyrola will have to purchase 5,000 Canadian
dollars for payment to the Canadian author. The amount of
US dollars required to accomplish this will depend on the spot
rate on January 10 ($.90 in this case). The number of US dollars
required to satisfy the obligation will be $50 greater [($.90 – .89)
× 5,000 Canadian dollars]. This will result in a $50 foreign exchange
transaction loss which would be included in year 2 net
income.