CHAPTER FIVE
ACCOUNTING FOR FOREIGN EXCHANGE TRANSACTION
IAS 21
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Foreign currency transactions
• Foreign currency transactions are economic activities denominated in a currency
other than the entity’s recording currency.
• These include:
1. Purchases or sales of goods or services (imports or exports), the prices of
which are stated in a foreign currency
2. Loans payable or receivable in a foreign currency
3. Purchase or sale of foreign currency forward exchange contracts
4. Purchase or sale of foreign currency units
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Cont…
• Foreign currency transactions of an Ethiopian company
denominated in other currencies must be restated to their Br
equivalents before they can be recorded in the Ethiopian
company’s books and included in its financial statements.
– Translation: The process of restating foreign currency transactions
to their Br equivalent values.
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Foreign Currency Exchange Rates
• Exchange Rate is the ratio of exchange of two currencies.
• Exchange Difference is resulting from translating a given number of units of one
currency in to another currency.
Two Methods of Reporting Exchange Rates
1. Direct Exchange Rate (DER): is the number of local currency units (LCUs) needed to acquire one
foreign currency unit (FCU).
– From the viewpoint of a Ethiopian entity:
Br – equivalent value
DER =
1 FCU
Example: On January 1, 2020, an Ethiopian based company can purchase one Dollar for Br 30.
Br 30
DER = = Br 30/$
1$
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Cont…
2. Indirect Exchange Rate (IER): is the reciprocal of the direct exchange rate. It is the number of
Foreign currency units (FCUs) needed to acquire one Local currency unit (LCU).
– From the viewpoint of a Ethiopian entity:
1 FCU
IER = Br – equivalent value
Example: On January 1, 2020, an Ethiopian based company can purchase one Dollar for Br 30.
$1
IER = Br 30
= $ 0.034/ Br
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ANALYSIS OF EXCHANGE RATE
DER Increase/IER Decreases
Weakening of Local currency
Taking More Local currency to acquire one Foreign Currency.
One LCU acquiring Fewer FCUs.
Export Increase and Import Decrease.
DER Decreases/IER Increase
Strengthening of Local currency
Taking Less Local currency to acquire one Foreign Currency.
One LCU acquiring Higher FCUs.
Export Decrease and Import Increase
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REASON OF EXCHANGE RATE FLUCTUATION
• Determination of exchange rates
– Exchange rates change because of a number of economic
factors affecting the supply and demand for a nation’s currency.
– Factors causing fluctuations are a nation’s
• Level of inflation
• Balance of payments
• Changes in a country’s interest rate
• Investment levels
• Stability and process of governance
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TYPES OF EXCHANGE RATES
1. Spot rate: is the exchange rate for immediate delivery of currencies
2. Current (Closing) Rate: is Spot rate on the entity’s balance sheet date.
3. Forward Rate: Expectations about the relative value of currencies are built into
the forward rate.
• Spread: The difference between the forward rate and the spot rate
on a given date.
• The spread gives information about the perceived strengths or
weaknesses of currencies.
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TYPES OF CURRENCIES FOR REPORTING PURPOSE
1. Functional currency: is the currency of the primary economic environment
in which the entity operates.
2. Presentation Currency: is the currency in which the financial statements
are presented.
3. Foreign Currency: is a currency other than the functional currency of the
entity.
4. Local Currency: is the currency of the country in which the entity operates.
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DETERMINATION OF FUNCTIONAL CURRENCY
Factors to be consider during determining Functional Currency:-
1. Sales prices for goods and services are denominated and settled.
2. The currency of competitive forces and regulations.
3. the currency that mainly influences labor, material and other costs.
Factors that provide evidence of an entity’s functional currency:
1. the currency in which funds from financing activities (i.e. issuing debt and
equity instruments) are generated.
2. currency in which receipts from operating activities are usually retained.
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Cont…
Note:
When the above indicators are mixed and the functional currency is not obvious,
management uses its judgment to determine the functional currency that most
faithfully represents the economic effects of the underlying transactions, events
and conditions
once determined, the functional currency is not changed unless there is a change in
those underlying transactions, events and conditions.
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FOREIGN CURRENCY IMPORT AND EXPORT TRANSACTIONS
1. Transaction date: Record the purchase or sale transaction at the Local
Currency Units using the spot direct exchange rate on this date.
2. Balance sheet date: Adjust the payable or receivable to its Local
Currency Units, end-of-period value using the current direct exchange rate.
• Recognize any exchange gain or loss for the change in rates between the
transaction and balance sheet dates.
3. Settlement date: Adjust the foreign currency payable or receivable for
any changes in the exchange rate between the balance sheet date (or
transaction date) and the settlement date, recording any exchange gain or
loss as required.
• Record the settlement of the foreign currency payable or receivable
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EXAMPLE 1
On October 1, 2010, ABC Company, an Ethiopian Company, acquired goods from
Martin, an American company, for $2,000,000.00. ABC prepared Financial
Statement at year end on December 31, 2010. Settlement of the payables was
made on April 1, 2011.
Spot rates
October ….........…..1$ = Br 30
December 31......…1$ = Br 34
April 1…………………..1$ = Br 32
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Solution
ABC
October 1 Purchase/Inventory……..Br 60,000,000.00
Account Payable………Br 60,000,000.00
($2,000,000 * Br 30/$ = Br 60,000,000)
December 31 Loss on Foreign Exchange Transaction …….Br 8,000,000.00
Account Payable………………………………….Br 8,000,000
($2,000,000 * Br 34/$ = Br 68,000,000)
April 1 Account Payable……….Br 4,000,000.00
Gain on Foreign Exchange Transaction…..Br 4,000,000.00
Account Payable………..Br 64,000,000.00
Cash……………………………………………Br 64,000,000.00
($2,000,000 * Br 32/$ = Br 64,000,000.00)
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EXAMPLE 2
Suppose ethio telecom buys a large consignment of goods from a
supplier in Egypt. The order is placed on 1 April and the agreed price is
124,250 Egypt Dollar. At the time of delivery the rate of foreign
exchange was Birr 1.00 to 3.50 Egypt Dollar.
Required
Show the initial recognition
What will the entries be if the exchange rate is 3.55 when payment is
made on may 1?.
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Solution
Initial recognition- ethio telecom will recognize the purchase using its functional currency (Birr) by
applying the spot exchange rate when the purchase was made (Birr 1.00 to 3.50 Egypt Dollar)
Inventory account (124,250 ÷ 3.5)....................Br 35,500
Payables account.........................................Br 35,500
When ethio telecom comes to pay the supplier, it needs to obtain some foreign currency. By this time,
however, if the rate of exchange has altered to 3.55 to 1, the cost of raising €124,250 would be (÷ 3.55)
35,000. The company would need to spend only 35,000 to settle a debt for inventories 'costing' 35,500.
Since it would be administratively difficult to alter the value of the inventories in the company's books of
account, it is more appropriate to record a profit on conversion of 500.
Account Payable..................................Br 500
Gain on Foreign Exchange Transaction...................Br 500
Account Payable.............................Br 35,000
Cash...........................Br 35,000
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Example 3
Ethio telecom, whose year end is Dec. 31, buys some goods
from Sudanese company on Sep. 30. The invoice is 40,000
Sudanese Dollar (SD) and is due for settlement in equal
installment on Nov. 30 and Jan. 31. The spot exchange rate is:
Sudanese Dollar (SD) Ethiopian Birr
September 30 1.6 1
November 30 1.8 1
December 31 1.9 1
January 31 1.85 1
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Solution
September 30: 40,000 SD * 1 Br
Br 25,000
1.6 SD
Purchase/Merchandise Inventory……..25,000
Account Payables………………………….25,000
November 30: 20,000 SD * 1 Br Br 11,111.11
1.8 SD
Account Payable………………….12,500
Cash………………………………………11,111.11
Gain on Forex Transaction….1,388.89 18
Solution
December 31: 20,000 SD * 1 Br
1.9 SD Br 10,526.316
12,500 – 10,526.316 = 1,973.684
Account Payables ………….……1,973.684
Gain on Forex Transaction……………….1,973.684
January 31: 20,000 SD * 1 Br
1.85 SD
Br 10,810.81
10,810.81 – 10,526.316 = 284.494
Loss on Forex Transaction…………………284.494
Account Payable…………………. 284.494
Account Payable ………………………………………10,810.81
Cash…………………………………………………...10,810.81
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