Overview of Functional Currency, Local Currency and Presentation (Reporting) Currency,

A multinational corporation is a firm that has business operations located in at least one country besides
its home country. It may engage in transactions that are denominated in foreign currency or invest in
foreign subsidiaries that keep their financial records in a foreign currency. This exposes the firm to
foreign currency effects. There are three different forms of currencies, as demonstrated below:

Assume that we have a sizable US-based organization, XYZ, i.e., the parent company with three
subsidiaries in India, Kenya, and Mexico. At the financial year-end, the Indian company prepares its
financial statements in Indian Rupees (INR), the Kenyan company in Kenyan Shillings (KES), and the
Mexican company in Mexican Pesos (MXN).

The subsidiaries use their local currency to prepare their financial statements, whereas the parent
company uses USD to prepare its consolidated financial statements. USD, in this case, is called
the presentation currency. If the Kenyan subsidiary carries out all its transactions in KES, then we say
that KES is the functional currency. Assume that XYZ entirely controls the Mexican subsidiary. This
means that it makes all operation decisions for the subsidiary, and consequently, all transactions are in
USD. In this instance, USD is the functional currency for the Mexican subsidiary.

To summarize the above explanations, we have:

1. Presentation (Reporting) Currency

Presentation currency refers to the currency that the parent company uses to prepare its financial
statements. Mostly, a company’s reporting currency is the currency of the country where the company is
located.

2. Functional Currency
It is the currency of the primary economic environment in which an entity operates. A company’s
management determines its functional currency. It is the currency in which an entity generates and
expends cash. The functional currency can be the local currency or some other currency.

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 3. Local Currency
The national currency of the country in which a foreign firm operates is called the local currency.
Typically, the local currency is the entity’s functional currency. For accounting purposes, any currency
other than the entity’s functional currency is a foreign currency for that entity.

 Functional Currency is the primary currency in which a business operates and keeps its financial
records.
 Local Currency is the official currency of the country where a business entity is located.
 Reporting Currency is the currency in which a company's consolidated financial statements are
presented.

What Is Foreign Currency Translation?

If your business entity operates in other countries, you will be using different currencies in your business
operations. However, when it comes to accounting, your financial statements have to be recorded in a single
currency. This is why you need to perform foreign currency translation.

For example, if your company has its headquarters in the US but has operations in the UK, you must
translate the British pound into US dollar.

A part of their financial record keeping, foreign currency translation is the process of estimating the amount
of money in one currency in the denomination of another currency. The process of currency translation
makes it easier to read and analyze financial statements which would be impossible if they were to feature
more than one currency.

Foreign Currency Translation Process

The three steps in the foreign currency translation process are as follows:

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 1. Determine the functional currency of the foreign entity
Businesses must determine a functional currency for reporting. The functional currency is the one which the
company uses for the majority of its transactions. You can choose the currency of the country where your
main headquarters are located or where your major operations are.

This can be difficult to determine when you conduct an equal amount of business in multiple countries.
However, once you choose the functional currency, changes to it should be made only when there is a
significant change in circumstances and economic facts.

2. Remeasure the financial statements of the foreign entity into the functional currency
You need to ensure that all your financial statements use the reporting currency.

The translation of financial statements into domestic currency begins with translating the income statement.
It is vital that you keep a close eye on the dates in which any of the above transactions occurred. Although
most currency translation occurs at the financial year-end, the exchange rates are determined by the
transaction date in some instances. Bank statements and income records help you to determine the right
rates.

3. Record gains and losses on the translation of currencies.

The gains and losses arising from foreign currency transactions that are recorded and translated at one rate
and then result in transactions at a later date and different rate are recorded in the equity section of the
balance sheet.

Foreign Currency Translation Methods

Since exchange rates are constantly fluctuating, it can cause difficulty while accounting for foreign currency
translations. Instead of simply using the current exchange rate, businesses may look at different rates either
for a specific period or specific date.

A. Current rate Method

Using this method of translation, most items of the financial statements are translated at the current
exchange rate. The assets and liabilities of the business are translated at the current exchange rate.

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Since this can lead to volatility associated with changes in the exchange rate, gains and losses associated
with this translation are reported on a reserve account instead of the consolidated net income account.

B. Temporal Rate Method

The temporal rate method, also known as the historical method, is applied to adjust income-generating
assets on the balance sheet and related income statement items using historical exchange rates from
transaction dates or from the date that the company last assessed the fair market value of the account.

C. Monetary-Nonmonetary Translation Method

The monetary-nonmonetary translation method is used when the foreign operations are highly integrated
with the parent company. The method translates monetary items such as cash and accounts receivable using
the current exchange rate and translates nonmonetary assets and liabilities including inventories and
property using the historical exchange rate.

What Is Foreign Currency Translation Adjustment?

The foreign currency translation adjustment or the cumulative translation adjustment (CTA) compiles all
the fluctuations caused by varying exchange rate.

Businesses with international operations must translate their transactions like the acquisition of assets or the
purchase of services into their functional currency. With foreign exchange fluctuations, the value of these
assets and liabilities are also subject to variations.The gains and losses arising from this are compiled as an
entry in the comprehensive income statement of a translated balance sheet.

There are different rules for translating items in financial statements including assets and liabilities, income
statement items, cash flow statement items, etc. Considering its complexity, it may be best to consult an
accountant regarding the rules of accounting for foreign currency translation.

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Types Of Foreign Exchange Market

The foreign exchange market, also known as the forex market, is a global marketplace for trading in
currencies. It is a decentralised market that allows you to buy and sell foreign exchange. The market is
an over-the-counter market and the foreign exchange rates will be dictated by it. It involves the buying,
selling and exchanging of currencies at the market rate. With regard to trade rate, forex is the largest in
the world.
Types of foreign exchange markets.
1. The Spot Market
In the spot market, transactions involving currency pairs take place. It happens seamlessly and quickly.
The transactions require instant payment at the prevailing exchange rate which is also known as the spot
rate. The traders in the spot market are not exposed to the uncertainty of the market, which can lead to
an increase or decline in the price between the agreement and trade.

2. Futures Market
The transactions in the futures market require future payment and distribution at a previously agreed
upon exchange rate which is known as the future rate. The transaction or agreement is more formal in
nature which ensures that the terms of the transaction are set in stone and cannot be altered. Traders who
conduct the majority of the transactions enjoy a consistent return on the assets. Regular traders prefer a
future market transaction.

3. Forward Market

The third type of foreign exchange market is the forward market where deals are similar to future market
transactions. In this case, the parties will negotiate the terms of the transactions and the terms agreed-
upon can be negotiated and altered as per the needs of the concerned parties. The forward market has
higher flexibility as compared to the futures market.
4. Swap Market
When there is a simultaneous borrowing and lending of two types of currencies between two investors,
it is known as a swap transaction. Here, one investor borrows a currency and in turn, pays in the form of

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 a second currency to the second investor. The transaction is done to pay off their obligations without
having to deal with a foreign exchange risk.
5. Option Market
In the options market, the currency of exchange from one denomination to the other is agreed upon by
the investor at a specific rate and on a specific date. The investor has a right to convert the currency on a
future date but there is no obligation to do so.

These are the five types of foreign exchange markets that exist in the country. In short, the market
enables easy and quick conversion of currency from one denomination to another. If you want to start
forex trading, simply open a demat trading account and start investing. The transactions can be done in
all conversions of currencies. Globalisation has led to a surge in the number of foreign
exchange transactions that are carried out in the year.
Foreign exchange transactions also include the conversion of currencies done at the airport kiosks or the
payments made by government and financial institutions.

What is an exchange rate?

An exchange rate is the amount that one currency is worth compared to another. Both the domestic
currency and foreign currency values affect the exchange rate, which changes constantly. Exchange
rates are determined by a number of factors, including:

 Economic activity and data

 Gross domestic product

 Market interest rates

 Unemployment rates

 Periods of political unrest or uncertainty

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 Countries use a fixed or floating (also known as pegged) exchange rate. A floating exchange rate is
influenced by market forces, while a fixed exchange rate isn’t, and is regulated by the country’s
government.

The exchange rate affects financial institutions, which trade currencies constantly. It also affects
businesses because it changes supply and demand from other countries.

The exchange rate for a specific currency is often referred to using an acronym. Some you might have
seen include:

 GBP: Pound sterling

 USD: US dollar

 EUR: Euro

Let’s use the pair of GBP/EUR as an example. If you wanted 200 GBP worth of EUR and the exchange
rate was 1.19, £200 would buy €238.

Most traded currencies

The forex market is by far the largest financial market in the world – with more than $7.5 trillion worth
of trades executed every day according to the Bank for International Settlements. There are 180
currencies in circulation today, but just ten of them make up over 90% of all trades.

List of most traded currency daily

1. US dollar (USD)2. Euro (EUR)3. Japanese yen (JPY)

4. British pound sterling (GBP)

5. Chinese yuan

6. Australian dollar (AUD)

7. Canadian dollar (CAD)

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 8. Swiss franc (CHF)

9. Hong Kong dollar (HKD)

10. New Zealand dollar (NZD)

UNIT THREE: CONDUCT THE TRANSACTION

Conducting a foreign currency transaction refers to the process of buying or selling one
currency in exchange for another. This transaction typically involves converting the value
of one currency into the equivalent value in another currency, based on the prevailing
exchange rate.

Here are the basic steps involved in conducting a foreign currency transaction:

1. Determine the Exchange Rate: Know the current exchange rate between the two currencies involved
in the transaction. Exchange rates fluctuate based on various factors like economic conditions,
geopolitical events, and market demand.
2. Specify the Amount and Currencies: Decide on the amount of money you want to exchange and
identify the source and target currencies.
3. Choose a Service Provider: You can conduct foreign currency transactions through various channels,
such as banks, currency exchange offices, online currency exchange platforms, or financial institutions.
Choose a reliable and reputable service provider.
4. Provide Necessary Information: Depending on the service provider and the nature of the transaction,
you may need to provide identification, account details, and other relevant information.
5. Execute the Transaction: Once you have provided the required information and confirmed the details,
the transaction is executed. If you are buying a foreign currency, you'll pay in your domestic currency,
and if you are selling a foreign currency, you'll receive the equivalent amount in your domestic currency.

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6. Transaction Confirmation: After the transaction is complete, you should receive a confirmation of the
exchange, detailing the amount exchanged, the exchange rate, and any fees or charges associated with
the transaction.

It's important to be aware of potential fees, commissions, or other costs associated with foreign currency
transactions. Additionally, keep in mind that exchange rates may vary between service providers, so it
can be beneficial to shop around for the best rates.

3.1 Calculating conversion of foreign currency amounts

Calculating the conversion of foreign currency amounts involves using exchange rates to convert the
value from one currency to another. The basic formula for currency conversion is:

Amount in Target Currency=Amount in Source Currency × Exchange Rate

Here:

 Amount in Target Currency: This is the amount you want to find in the currency you are converting to.
 Amount in Source Currency: This is the original amount in the currency you are converting from.
 Exchange Rate: This is the rate at which one currency can be exchanged for another. It tells you how
much of the target currency you can get for one unit of the source currency.

Here are the steps to calculate the converted amount:

1. Find the Exchange Rate: Look up the exchange rate between the two currencies. Exchange rates can
be quoted in different ways (e.g., 1 USD to EUR or EUR to USD). Make sure you use the correct rate
for your calculation.
2. Plug the Values into the Formula: Insert the values into the formula mentioned above.
3. Perform the Calculation: Multiply the amount in the source currency by the exchange rate.
4. Round if Necessary: Depending on the context, you may need to round the result to a certain number of
decimal places.

Here's an example:

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 Suppose you want to convert 100 US dollars to euros, and the exchange rate is 1 USD to 0.85 EUR.

Amount in EUR=100 USD×0.85 EUR/USD=85 EUR

So, 100 US dollars is equivalent to 85 euros at this exchange rate.

Keep in mind that exchange rates fluctuate, so it's essential to use the most recent and accurate rate for
your calculation. Additionally, consider transaction fees or commissions that may apply, especially if
you're converting currency through a financial institution.

3.2 Providing the customer with a copy of the rates

When conducting foreign currency transactions, especially in a business or financial institution setting, it
is common and good practice to provide customers with a copy of the exchange rates used for the
transaction. This transparency helps build trust and ensures that customers are informed about the terms
of the exchange.

Here's how you can provide customers with a copy of the rates:

1. Include Rates on Receipts or Transaction Documents:

 If you are providing a physical receipt or transaction document, make sure to include the exchange
rates used for the transaction.
 Clearly state the source and target currencies, the amount exchanged, and the applicable exchange
rate.
2. Display Rates at the Transaction Location:
 If you have a physical location (such as a currency exchange office or a bank), consider displaying
the current exchange rates prominently.
 This can be done on a board, electronic display, or through printed materials.
3. Send Rates Electronically:
 If the transaction is conducted electronically or online, ensure that customers can easily access and
review the exchange rates.
 Provide a summary of the rates in confirmation emails or electronic receipts.

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4. Offer Rate Information in Advance:
 For larger transactions or if requested by the customer, you may provide rate information in
advance of the transaction.
 This can help customers plan and make more informed decisions.
5. Explain Additional Fees or Charges:
 Alongside the exchange rates, clearly communicate any additional fees, commissions, or charges
associated with the transaction.
 This transparency is crucial for ensuring that customers understand the total cost of the exchange.
6. Update Rates Regularly:
 Exchange rates can fluctuate, so make sure to update and display the rates regularly to reflect the
current market conditions.

Providing customers with a copy of the rates not only fosters transparency but also helps in addressing
any potential misunderstandings or disputes. It's an essential part of good customer service in the realm
of currency exchange.

3.3 What Is a Traveler’s Check?

Traveler's checks, also spelled travellers cheques, are a form of pre-paid paper or plastic checks that are
used as a safer alternative to carrying cash when traveling. The product is typically used by people on
vacation in foreign countries. It offers a safe way to travel overseas without the risks associated with
losing cash. They are typically issued by banks and are available in various currencies. Traveler's checks
can be purchased or sold through banks, currency exchange offices, and certain financial institutions.

Brief overview of the process for purchasing or selling traveler's checks:

Purchasing Traveler's Checks:

1. Visit a Bank or Financial Institution:

 Traveler's checks are commonly available at banks, credit unions, and some financial
institutions. Visit a branch that offers this service.
2. Choose the Currency and Denominations:

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  Specify the currency in which you want the traveler's checks. They are often available in major
currencies such as US dollars, euros, or British pounds.
 Decide on the denominations of the checks you wish to purchase.
3. Provide Identification:
 To purchase traveler's checks, you will typically need to provide identification, such as a
passport or driver's license.
4. Pay for the Checks:
 Pay the equivalent amount in your local currency to purchase the traveler's checks. Some
institutions may charge a fee or commission for this service.
5. Receive Documentation:
 After the transaction is complete, you should receive the traveler's checks along with
documentation that includes the check numbers. Keep this documentation in a safe place,
separate from the checks.

Selling or Cashing Traveler's Checks:

1. Visit a Bank or Exchange Office:

 To sell or cash traveler's checks, visit a bank, currency exchange office, or another authorized
institution.
2. Provide Identification:
 Similar to purchasing, you'll need to provide identification to sell or cash traveler's checks.
3. Endorse the Checks:
 Before handing over the checks, you may need to endorse them by signing the designated area
on the back.
4. Receive Local Currency:
 In exchange for the endorsed traveler's checks, you'll receive the equivalent amount in your local
currency.
5. Pay Attention to Fees:
 Some institutions may charge a fee for cashing or selling traveler's checks. Be aware of any fees
involved in the transaction.

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 Remember that traveler's checks have become less popular in recent years due to the widespread
acceptance of credit and debit cards, as well as the availability of ATMs in many locations. Before
relying solely on traveler's checks, it's a good idea to check with the institutions at your destination to
ensure they are accepted.

3.4 Entering details of the transaction into the database

When entering details of a foreign currency transaction into a database, it's important to accurately
capture and store relevant information. The specifics of the database structure may vary depending on
the nature of the business, the type of transaction, and any regulatory requirements. However, here are
common fields you might consider including in your database for recording foreign currency
transactions:

1. Transaction ID:
A unique identifier for each transaction. This helps in tracking and referencing the transaction later.
2. Date and Time:
 Record the date and time when the transaction took place. This information is crucial for auditing
and tracking purposes.
3. Customer Information:
 Include details about the customer involved in the transaction, such as name, contact
information, and any customer ID or account number.
4. Transaction Type:
 Specify whether it's a purchase or sale of foreign currency, and the currencies involved.
5. Amount in Source Currency:
 Record the amount in the original or source currency before the conversion.
6. Exchange Rate:
 Document the exchange rate used for the conversion.
7. Amount in Target Currency:
 Calculate and store the equivalent amount in the target or foreign currency.
8. Fees and Charges:
 Include any fees, commissions, or charges associated with the transaction.

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9. Payment Method:
 Indicate how the transaction was paid for, such as cash, credit card, or bank transfer.
10. Transaction Status:
 Track the status of the transaction, whether it's completed, pending, or canceled.
11. Location:
 Specify the location where the transaction occurred, especially if there are multiple branches or
offices.
12. Staff ID:
 If applicable, record the ID or name of the staff member who handled the transaction.
13. Notes or Comments:
 Provide a space for any additional notes or comments that might be relevant to the transaction.
14. Confirmation Number:
 Include a field for a confirmation or reference number associated with the transaction.
15. Currency Codes:
 Use standardized currency codes (such as USD for US dollars, EUR for euros) to avoid
confusion.

After entering these details into the database, it's crucial to regularly back up the data to prevent loss and
to ensure compliance with data protection regulations. Additionally, proper security measures should be
in place to protect sensitive customer information. The structure and requirements of the database should
align with the specific needs and regulations of the business or financial institution.

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