CHAPTER 7

ACCOUNTING FOR FOREIGN CURRENCY TRANSACTIONS

Introduction
The continuing growth in world trade and the significance of foreign operations in Philippine
companies have resulted in increasing attention being paid to international accounting practices
and problems.These problems are generally subdivided into two broad areas:
1) Problems related to transactions which give rise to receivables and payables denominated
in foreign currencies must be measured and recorded in Philippine currency; and
2) Problems arising from the translation of foreign currency statements into Phillipine
currency.

Basis: International Accounting Standards (IAS) No.21-Accounting for the effects of changes
foreign exchange rate

IAS No. 39- Financial Instrument: Recognition and Measuremen

Specific Objectives
At the end of the lesson, the students should be able to:
Account for foreign currency transactions.
Translate the financial statements of a foreign operation.

Duration: 6 hours (Lecture/Discussion/Problem Solving)

LESSON PROPER

Definition of exchange rate:

An exchange rate is a measure of how much one currency may be exchanged for another
currency. The following terms are used to describe exchange rate:

1) A direct quote measures how much of the domestic currency must be exchanged to receive
one unit of a foreign currency (i.e. Peso : Foreign currency). An indirect quote measures
how many units of a foreign currency will be received for one unit of domestic currency
(i.e. Foreign currency : peso).
2) A currency may either strengthen (gain) or weaken (lose) relative to another currency. A
strengthening of a currency means that the directly quoted amount decreases and the
indirectly quoted amount increases. The opposite should be true for a weakening currency.
3) Buying and selling rates of exchange respectively represent what a currency broker is
willing to pay to acquire or sell a currency.
4) A spot rate indicates the number of units of a currency that would be exchanged for one
unit of another currency on a given date.
5) A forward rate establishes, at one point in time, the number of units of one currency to be
exchanged for one unit of another currency at a specified future date. On a given date,
different forward rates may exist for the same currency, depending on how far in the future
an exchange is to take place.
 a) The agreement to exchange currencies on a future date is called a forward contract.
b) A premium or discount refers to when the forward rate is greater than or less than
the spot rate, respectively.

Accounting for Foreign Currency Transactions – PAS no.21 Revised

A transaction that requires settlement or payment in a foreign currency is called a foreign

currency transaction.

Some of the more common foreign currency transactions are:

1) Importing and exporting goods on credit with the receivable or payable denominated
in foreign currency;
2) Borrowing or lending denominated in foreign currency;
3) Entering into a forward exchange contract to buy or sell foreign currency.

In each unsettled foreign currency transactions (i.e. a receivable or a payable exists),

there are three issues of concern. These issues and the appropriate exchange rate to be used in
translating accounts denominated in units of foreign currency (except for forward exchange
contracts), are as follows:

1) At the date the transaction is first recorded – each asset, liability, revenue, gain or
loss arising from the transaction is measured and recorded in Phil. Pesos by multiplying
the units of FC by the closing exchange rate, that is, the spot rate in effect on a given
date.

2) At each balance sheet date that occurs between the transaction date and
settlement date- Recorded balances that are denominated in foreign currency are
adjusted to reflect the closing exchange rate in effect at the date of the SFP. Foreign
exchange gain (or loss) is recognized for the difference in exchange rate between the
transaction date and the balance sheet date.

3) At the settlement date- in the case of a FC payable, a Philippine company must convert
Phil. Pesos into FC units to settle the account, while FC units received to settle a FC
receivable will be converted into pesos. Although translation is not required, a FC gain
(or loss) is recognized if the amount of pesos paid or received upon conversion does
not equal the carrying value of the related payable or receivable.

Translation of Financial Statements of Foreign Operations (IAS 21)

Only one translation method is described for foreign operations, the closing or current rate
method that was applied to foreign entities under the original IAS 21.

The following procedures are prescribed by IAS 21 to translate foreign entity’s statements
from its functional currency into the presentation currency:
 1) Translate all items of financial position, including the allocated goodwill, at the closing
rate, except for share capital and pre-acquisition surplus which should be translated at
their historical rate. Post acquisition profits are derived based on the balances in their
year-to-year translation. Exchange surplus are derived as the balancing figure.

2) Translate all items of income and expense at the average rate or as the accounting policy
requires. Translate items of other comprehensive income at the average rate

3) Retained earnings brought forward should be based on the prior year’s post acquisition
profits in the presentation currency (e.g. in local pesos) . Interim dividend paid is
translated at the actual rate ruling on the date of payment while dividend payable, if
any, is translated at the closing rate.

4) Prepare the consolidated financial statements using the normal consolidation

procedures,

5) Prove the total exchange difference as follows:

a) Net assets and goodwill at acquisition date translated at closing rate minus net
assets and goodwill at acquisition date translated at their historical rate.
b) Year-to-year increase in net assets (i.e. retained earnings for each year)
translated at closing rate minus their year-to-year reported amounts in Phil.
Peso, and
c) Any revaluation surplus arising during the year translated at the closing rate
minus the amount translated at the date of revaluation.

PROBLEM SOLVING:

On December 31, 2020, a branch in Singapore submitted the following financial statements stated in
Singapore Dollar:
Statement of Financial Position
Monetary Assets $ 20,000
Non Monetary Assets 15,000
Monetary Liabilities 18,000
Common Stock 12,000
Retained Earnings, Dec.31 5,000

Income Statement and Retained Earnings

Sales $ 27,000
Expenses (including depreciation of $1,000) 25,000
Net income 2,000
Retained Earnings, Jan.1 3,000
Retained Earnings, Dec. 31 5,000
 Current rate- 1 Singapore Dollar =
The exchange rates are: P37
Historical rate- 1 Singapore Dollar = P34
Average rate- 1 Singapore Dollar = P35

Assuming the Retained Earnings on Jan.1, 2020 of the Singapore Branch in Phil. Pesos is P128,100.

Translate the above statements into Phil. Peso. Your answer must start with the Statement of
Income and Retained Earnings, followed by the Statement of Financial Position.

Functional Currency is the Currency of a Hyperinflationary Economy

Determining whether an economy is hyperinflationary in accordance with IAS 29 requires

judgement. The standard does not establish an absolute rule at which hyperinflation is deemed to
arise. However, when cumulative inflation over three years approaches or exceeds 100%, it
must be conceded that the economy is suffering from hyperinflation.

Financial statements of entities whose functional currency is that of a hyperinflationary economy

first have to be restated and then translated under IAS 21 if the parent has a different
presentation currency, in order that they can be incorporated in the consolidated financial
statements of the parent company.

Restatement of Statement of Financial Position (sample problem)

Before Historical Year-end After
Restatement GP Index* GP Index Restatement***
(HC) (HC)
Cash 200 200
Inventory 500 500 600 600
Property, Plant & Eqt. 450 150 600 1,800
Total Assets 1,150 2,600

Accounts Payable 360 360

Long term debt 500 500
Equity** 290 1,740
Total Liabilities & Equity 1,150 2,600

*General price index at the date of purchase

**Equity is restated as follows:

(1)the components of the equity , except retained earnings and any revaluation
surplus, are restated by applying a general price index from the dates the
components were contributed or otherwise arose;

(2) any revaluation surplus that arose from previous periods is eliminated;
 (3) restated RE are derived from all the other amounts in the restated SFP.

*** Historical cost x General price index at the end of the reporting period
General price index at the date of acquisition

Activity:
Exercises/problems on foreign exchange transactions will be uploaded in LMS for
discussion.