use the decimal system in their coinage. The par value of the franc or lira (Italian) is 19.3 cents, or 5.1813 francs or lire to the dollar.

If it is required to find the cost of a draft on Antwerp for 1,000 francs when exchange is quoted at 5.1934, it is evident that if 5.1934 fr. are worth $1, 1,000 fr. will be worth as many dollars as 5.19 is contained in 1,000. Therefore 1,000 5.1975 192.40, the required cost in dollars.

To find how many francs a given amount in dollars will purchase at a given rate of exchange, multiply the amount in dollars by the value in francs of one dollar. Thus, to find how large a draft in Paris can be bought for $192.40 when exchange is at 5.1934, multiply 192.40 by 5.1975.

The process of computing the cost of exchange between two places by means of one or more intermediate exchanges is called the arbitrage of exchange. The object of using an intermediate exchange is to take advantage of variations in rates between different places. It is adopted when the rate of direct exchange is unfavorable.

To illustrate, a New York concern wishes to transfer $10,000 to its agent in Paris. The New York rate for francs is 5.254. Sterling may be bought in New York for 4.842, and the rate between London and Paris is 25.73 francs to the pound sterling. Is it better to remit direct to Paris or to remit sterling to the agent in London with instructions for him to remit to the Paris agent?

If the $10,000 is used to buy a direct draft on Paris at 5.254, it will realize 52,525 francs. With sterling at 4.842, $10,000 will buy £2,063.98 (10,000 ÷ 4.845). It is not necessary to reduce the decimal to shillings and pence. Multiplying 2,063.98 by 25.73, the number of francs in a pound, gives 53,162.05, the number of francs obtained. The Paris agent will therefore receive 637.05 francs more if the money is sent through London than if it is sent direct.

Unless there is some way to guarantee the rate between London and Paris this comparison can be made only on cable transfers. When the margin is not very large a slight change in the London-Paris rate might change a profit into a loss, during the time it would take to send a draft to London by mail.

Banks or brokers dealing in foreign exchange keep their accounts in one of two ways. The first, which is the usual method in the United States, resembles a single merchandise account with a running inventory, to which purchases are debited and sales credited both in quantities and values. At the closing date the balance in foreign currency is inventoried at the current rate, giving consideration to the various portions of the balance which are subject to cable transfers, to cheques and to time drafts. The United States money column is then balanced by an offsetting debit or credit to exchange, according to whether a loss or profit has been made. An example will make this clearer. A dealer in sterling exchange had these entries during a certain month:

The drafts bought and sold are recorded in both currencies, the interest allowed is charged in sterling only, as it is only the sterling balance that is affected. If the English bank had charged any commissions, interest or other expenses, the account would have contained a credit for them in sterling only. When the sterling balance is struck it is inserted in both currencies at the current rate for the day. The sterling columns will now balance. The amount necessary to balance the dollars is entered in the dollar column only, the offsetting entry being a debit or credit to exchange. It is to be noted that part of the above profit is due to the interest allowed by the English bank. This might be credited to interest and charged in the dollar column at 4.864 (the current rate used for conversion of the balance of the account) or $12.16, reducing the credit to exchange at $10.37. Another complication arises when the drafts bought and sold are drawn at some time after sight, since interest to maturity will have to be taken into consideration in fixing the value of the balance.

The second method of carrying a foreign-exchange account reduces all values to the par of exchange, the difference between par and the actual price being treated as a debit or credit to exchange. This necessitates a debit and a credit column in the purchase register and in the sales register and also a par column in each. The purchase register would show:

The ledger account would contain the purchases and sales at par, and the balance would be brought down at par, the interest having been entered in the dollar column also at $12.16 and credited at that amount. This would indicate the following profit:

When inhabitants of a gold-standard country invest money in branches in a country whose coinage is on a silver or paper money basis, the variations in the rate of exchange are apt to be very wide from time to time. The owners of the property must keep their accounts in gold values, while the foreign managers are obliged to keep theirs in the currency of the

country in which operations are conducted. If the enterprise is in a silver country and the home office is in the United States, the manager at the property must make his periodical reports in his local silver currency. When these reach the home office they must be converted into gold values at the rate that will express as nearly as possible the true condition of affairs. In order to ascertain the correct procedure it is necessary to analyze the conditions.

When the enterprise is started, the first steps will be the purchase of land, the construction of buildings and the purchase and installation of machinery. The purchase of the land and the erection of buildings will probably be paid for in silver currency. The money sent from the United States will be charged to land and buildings by the home office at the gold value of the drafts sent. The local manager will credit the home office with the silver value he receives and will charge land and buildings on the silver basis when he pays out the money. Machinery may be sent from this country. The cost including the freight would be charged to machinery by the home office at the gold value of the money expended. If the local manager put it on his books he would charge machinery and credit home office at the current rate of exchange. The money sent for the labor and other expense of installation would be charged by the home office in gold and by the manager in silver at the rates actually paid. When construction is finished, the total cost of the fixed assets is recorded in one place in gold and in the other in silver. These relative values are never changed, except as new fixed assets are added at the rate of exchange then current. In consolidating the home office and branch balance-sheets, the fixed assets at the branch would be taken up at the dollar values shown on the home-office books. Hence it is not necessary that the branch continue to carry the fixed assets at their cost in the local silver currency, and the fixed-asset accounts may be closed by a charge to the home-office account. If it is desired to continue to carry the fixed assets on the branch books as well as on the home-office books, it would be desirable to divide the home-office account on the branch books by setting up a homeoffice account for fixed assets and a home-office current account.

When the enterprise reaches the operating stage, the home office will be obliged to send money with which to carry on the business. This should be charged to a current account with the foreign branch, and not to the previous construction or capital account. The home office should keep this current account in both currencies, in silver in an inside set of debit and credit columns and in gold in the regular account columns. The silver debits will be the amount of the draft remitted by the home office, if that draft is drawn direct on the silver country, or the proceeds of a gold draft when the latter is sold by the manager of the plant.

Periodically the manager of the plant should render a report in which he should credit the home office with the silver value of the money received from it and should charge the home office with all his expenditures in silver, properly classified for statistical purposes. The home office should credit the current account in the inside column at the silver value actually expended and at the gold value of the remittances made, beginning with the first remittance at the rate shown on the debit side and then taking

up in turn the subsequent remittances. In this way the actual amount paid both in silver and in gold will be reflected in the accounts.

If the home office buys for gold and ships to the plant any raw materials or supplies that are not immediately used, it should charge and the plant should credit the silver value at the rate of exchange at the time of shipment. As the articles are used, it would seem the proper procedure to charge them to operating costs at the same rate. However, Sir A. Lowes Dickinson says, "The most satisfactory method of dealing with this condition is to keep the accounts of materials, stores and supplies originating in the United States in United States currency until they are used, and then to charge them out to the accounts concerned-whether construction or operating at the rate of exchange current on the date of issue for consumption; in other words, these materials, etc., while in fact in China, are deemed to be in the United States until issued for consumption, and are only then passed through the current accounts between the two offices." This is open to the objection that the accounts at the plant will not reflect the true conditions, as the plant may be in possession of a large amount of materials, etc., which will not appear on its books until used, and to the further objection that, if the materials are issued very frequently, the rate at which they must be charged to operations by the branch manager will be subject to constant variation with regard to actual cost, and that no silver value can be expressed on the home-office books until the report of the dates and quantities of the different issues is received in the United States.

When any finished products are shipped from the plant to the home office, they should be charged at cost in silver. The home office should credit them at the same figure in the silver column and at the current rate of exchange in the gold column.

At the close of the fiscal period, when the books are closed, no change is made in the debit balances of the fixed-asset accounts because of the established principle that fixed assets should be valued at cost, regardless of market fluctuations. In regard to the floating assets and liabilities, the custom is to convert the values at the rate of exchange current on the day of closing. There is considerable variation in the procedure for the valuation of nominal account balances-sometimes they are converted at an average rate for the period, and sometimes at the current rate at the end of the period. While the average-rate method is usually advocated on the ground that the earnings and expenses accrued during the period, this method is subject to the objection that a simple average of the rates of all days during the period fails to take into consideration the fact that transactions varied in volume from day to day. As the operations resulted in an increase or decrease of the net current assets at the branch and since these current assets and current liabilities are converted at the rate current at the end of the period, it would seem consistent to convert the current-account balances at the same rate.

The following example will illustrate the procedure of closing branch and home-office books and consolidating the revenue statements and balance-sheets.

PROBLEM

The trial balance of the London branch of the Eastern and Western Manufacturing Co. at December 31, 1919, follows:

Inventory, December 31, 1919, £5,000.

The rate of exchange current at the date of purchasing the furniture

and fixtures was 4.83.

The current rate at January 1, 1919, was 4.64.

The average rate for the year was 4.65.

The current rate at December 31, 1919, was 4.665.

The trial balance at the same date drawn from the books of the home office was:

Capital stock

$ 75,000.00

18,000.00

Reserve for depreciation-factory building

2,000.00

London branch current account

249,750.00

500.00

232,500.00

780,000.00

279,000.00

2,515.00

15,500.00

$1,405,015.00 $1,405,015.00