Question

Question 3: Accounting for Foreign Currencies & The PNG FX
Challenge (20 Marks)
A major economic challenge for PNG companies is the limited availability of foreign
currency (FX), particularly US Dollars (USD) and Australian Dollars (AUD), to pay for
imported goods and services. You are to analyze this challenge across different sectors.
Required:
a) The Mechanism: (4 Marks)
A PNG company imports goods from an Australian supplier for A$100,000 on credit.
The spot exchange rate at the transaction date is PGK 1.00 = A$0.40. At the year-end,
the rate is PGK 1.00 = A$0.38, and by the payment date, it is PGK 1.00 = A$0.39.
 Calculate the Kina value of the payable at the transaction date, year-end, and
payment date.
 Prepare the journal entry for each of these three dates.
b) Sectoral Analysis & Mitigation Strategies: (16 Marks)
Analyze the specific FX challenges and propose practical mitigation strategies for each
of the following sectors:
i) Retail Sector (e.g., City Pharmacy, Hardware Haus): (4 Marks)
 Challenge: Their shelves are stocked with imported goods (e.g., medicine, tools,
electronics). How does a shortage of FX and a volatile exchange rate directly impact their business model and profitability?
 Mitigation: What strategies can a retail CEO employ to reduce their company's
exposure to FX risk? (Think about sourcing, pricing, and financial tactics).
ii) Agriculture Sector (e.g., PNG Coffee Exports): (4 Marks)
 Challenge: A coffee exporter sells its beans in USD but pays its costs (labour,
transport, utilities) in PNG Kina. How does a strengthening of the Kina (e.g., from
USD 1 = PGK 3.50 to USD 1 = PGK 3.20) impact their operations?
 Mitigation: What is the most appropriate financial hedging instrument this exporter
should use to lock in a future exchange rate for their USD earnings? Explain how
it would work.
iii) Mining, Oil & Gas Sector (e.g., ExxonMobil PNG, Newcrest Lihir): (4 Marks)
 Challenge: These companies have massive USD-denominated debts (e.g.,
project finance loans) and pay dividends to overseas shareholders in USD.
However, a significant portion of their revenue may be in Kina from domestic
power sales or fuel levies. What is the specific nature of their FX mismatch?
 Mitigation: Beyond financial hedging, what large-scale operational strategies can
these companies use to generate the USD they need to service their foreign
debts? (Think about their sales structure and government negotiations).
iv) Your Professional Advice: (4 Marks)
As a future CPA, you are advising the Treasurer of a mid-sized PNG import-export
business. Write a brief memo (max. 150 words) outlining the two most critical
steps they must take to begin formally managing their foreign currency exposure.

Answer 1

### Question 3: Accounting for Foreign Currencies & The PNG FX Challenge

### a) The Mechanism: (4 Marks)

**Transaction Date:**
- Amount payable in AUD: A$100,000
- Spot exchange rate: PGK 1.00 = A$0.40
- Kina value of the payable:
\[
\text{Kina Equivalent} = \frac{100,000}{0.40} = PGK 250,000
\]

**Year-End:**
- Spot exchange rate: PGK 1.00 = A$0.38
- Kina value at year-end:
\[
\text{Kina Equivalent} = \frac{100,000}{0.38} = PGK 263,157.89 \, (approx.)
\]

**Payment Date:**
- Spot exchange rate: PGK 1.00 = A$0.39
- Kina value at payment date:
\[
\text{Kina Equivalent} = \frac{100,000}{0.39} = PGK 256,410.26 \, (approx.)
\]

**Journal Entries:**

1. **Transaction Date:**
- **Debit:** Inventory (or relevant expense account) PGK 250,000
- **Credit:** Accounts Payable PGK 250,000

2. **Year-End:**
- **Debit:** Foreign Exchange Loss PGK 13,157.89
- **Credit:** Accounts Payable PGK 13,157.89 (adjust accounts payable to year-end value)

3. **Payment Date:**
- **Debit:** Accounts Payable PGK 256,410.26
- **Credit:** Cash PGK 256,410.26
- **Credit/Debit:** Foreign Exchange Gain/Loss depending on prior adjustments.

### b) Sectoral Analysis & Mitigation Strategies: (16 Marks)

#### i) Retail Sector (e.g., City Pharmacy, Hardware Haus): (4 Marks)
**Challenge:** A shortage of FX means retail businesses struggle to pay for imported goods. A volatile exchange rate could lead to increased costs and reduced profitability as prices may rise unexpectedly due to currency fluctuations.

**Mitigation:**
- **Sourcing Locally:** Shift towards local products to reduce reliance on imports.
- **Dynamic Pricing:** Adjust prices in real-time to reflect cost changes due to FX fluctuations.
- **Negotiation with Suppliers:** Engage in negotiations for local currency pricing or flexible payment terms.

#### ii) Agriculture Sector (e.g., PNG Coffee Exports): (4 Marks)
**Challenge:** A stronger Kina reduces the value of USD sales when converted to Kina. Profits can diminish as costs are in PGK and income decreases when converted at unfavorable rates.

**Mitigation:**
- **Forward Contracts:** The exporter should use forward contracts to lock in the exchange rate for their USD earnings. For example, if the current forward rate is set to USD 1 = PGK 3.35, they could secure that rate, thus guaranteeing revenue when the USD is converted to PGK.

#### iii) Mining, Oil & Gas Sector (e.g., ExxonMobil PNG, Newcrest Lihir): (4 Marks)
**Challenge:** These companies often face an FX mismatch, as they earn revenue in Kina from domestic operations but have debts and dividend obligations in USD, amplifying financial risks with currency fluctuations.

**Mitigation:**
- **Increase USD Revenue Streams:** Negotiate and structure contracts to ensure certain sales (like exports or supplies to USD businesses) are priced in USD.
- **Currency Swaps:** Collaborate with the government for local tax-based revenues to be pegged in USD, stabilizing cash flows in the required currency for debt payments.

#### iv) Your Professional Advice: (4 Marks)
**Memo:**

To: Treasurer, [Import-Export Business]
Subject: Steps to Manage Foreign Currency Exposure

1. **Implement Currency Hedging:** Begin utilizing financial instruments, such as forward contracts or options, to hedge against adverse currency movements. This will help stabilize costs and protect profit margins.

2. **Establish a Currency Risk Management Policy:** Develop a comprehensive policy that governs currency exposure assessment, risk limits, and strategic responses in currency fluctuations. This should include regular reviews to adjust strategies based on changing market conditions.

Best regards,

[Your Name]
Future CPA