Foreign exchange transactions IAS21

1. Foreign exchange transactions IAS21

2. Terms • Functional Currency – Currency of the primary economic environment in which entity operates • An entity does not have free choice of functional currency. • Currency that influence sales prices for goods and services. • Currency that influences labour, material, and other costs.

3. Terms • Presentation currency – currency in which financials are presented. • Foreign currency transactions – transactions in currency other than functional currency

4. Exchange rate is a ratio of exchange for two currencies i.e. describes how many units of one currency you can buy (or are equivalent to) per unit of another currency. Always quoted relative to another currency. Direct – amount of domestic currency per one foreign currency unit i.e. DC/FC e.g. N$6/$, or Indirect – amount of foreign currency per one domestic currency unit i.e. FC/DC e.g. $0,1667/N$ Exchange rates

5. Understand how currencies are traded: Foreign exchange market permits transfer of purchasing power denominated in one currency for that of another currency Through an electronically-linked network of banks, brokers and dealers, bringing together buyers and sellers of foreign currency Foreign exchange market

6. Spot market Currencies trade for immediate delivery. The spot rate is the exchange rate at which currencies will trade on that day. Forward market Contracts are entered into to buy or sell currencies for future delivery. Forward rate is an exchange rate at which one can contract to transact in the future. Forward rates are an integral component of Forward Exchange Contracts (FECs). Foreign exchange market

7. Profit of bank rather than commission Bank sells foreign exchange at price > price willing to buy Difference is called a spread. Quoted exchange rate (direct or indirect) has two numbers associated with it, namely the ‘buy’ (‘bid’) and the ‘sell’ (‘offer’/ask) rate. Quoted from bank’s perspective. Currency bought and sold from and to the bank. Bid-ask spread

8. Foreign currency transactions are recorded in the functional currency by applying to the foreign currency amount the spot exchange rate at the date of transaction (i.e. date on which transaction can be recognized in terms of IFRS) Initial recognition

9. Will depend on shipping terms, based on the transfer of risks and rewards. The accounting treatment is the same for “Free On Board” (FOB) and “Cost Insurance Freight” (CIF) , for both - risks passes when goods are delivered by the seller at the port. Initial recognition

10. Subsequent measurement • Differentiate between monetary and non-monetary items • Monetary items- Cash or assets and liabilities held to be received or paid in a fixed or determinable number of units of currency. • Right to receive or obligation to give a fixed or determinable number of units of currency

11. Subsequent measurement Monetary items- • If settled – Spot rate at settlement date • If outstanding at year end, translated at spot rate at reporting date (closing rate) • Examples: • Cash, loans, payables and receivables • Pensions etc payable in cash • Provisions settled in cash(accruals) • Dividends in cash (not shares)

12. Subsequent measurement • Non-monetary items – Absence of a right to receive currency • Examples - items such as Property, plant and equipment, inventory, rental e.g. prepayment, Goodwill, intangibles etc. • Translated at acquisition date rates. • Fair value adjustment and revaluations are accounted for by using the spot rate at year end.

13. Subsequent measurement • Non-monetary items – absence of a right to receive currency • Examples - items such as Property, plant and equipment, inventory, rental e.g. prepayment, Goodwill, intangibles etc. • Translated at acquisition date rates. • Fair value adjustment and revaluations are accounted for by using the spot rate at year end.

14. Subsequent measurement • Non-monetary items • Non-monetary items measured at historical cost - translated at acquisition date/transaction rates. • Non-monetary items measured at fair value - measured using exchange rates that existed when fair values were determined.

15. Exchange differences arise for monetary items. Forex gains or losses are recognised in P/L. Certain gains and losses are recognised in equity for example when cash flow hedge accounting is applied or FCTR in foreign operations. Example 14.2 Subsequent measurement

16. Differences in exchange rates between initial recognition and subsequent measurement Monetary items Differences arising from settlement/translating monetary items at rates different from those which applied on initial recognition recognised in P&L when they arise: Dr/Cr Monetary item Dr/Cr Forex gain/loss (P&L) Foreign exchange differences

17. Non-monetary items Do not give rise to exchange differences If gain/loss (increase of asset) on a non-monetary item is recognised in other comprehensive income, exchange component included in gain/loss recognised in other comprehensive income – e.g revaluations Foreign exchange differences (cont.)

18. Foreign exchange differences (cont.) • If gain/loss(increase in asset) on a non-monetary item is recognised in P&L, exchange component included in gain/loss recognised in P&L – e.g. fair value adjustment • Example 14.4 • Example 14.5

19. Contract to buy or receive a certain amount of foreign currency at a specific rate at a future date. To protect itself from currency fluctuations. FEC is a derivative i.e. value changes in response to spot exchange rates. Specific rate = forward rate Contract = FEC Forward exchange contracts (FECs)

20. Forward exchange contracts (FECs) • Although the entity will enter into an FEC in response to a foreign currency transaction there are two different transaction. • Buy or sell transaction with the supplier or customer. • FEC transaction between entity and the bank.

21. FEC accounted for separately from transaction it covers (underlying transaction) Date of entering into the contract, no accounting entry takes place – commitment, but no transaction at inception Subsequent reporting date, the contract is ‘marked to market’, that is, translating the contract at the rate available on that date (reporting date) for a contract with the same maturity Contract reaches maturity date (‘close-out date’), and will be settled. Enterprise either buys or sells foreign currency at the rate specified in the contract (‘forward rate’) Accounting treatment

22. Accounting treatment • If still outstanding at reporting date, it needs to be recognised at fair value. • Marked to market – Liability or asset to be recognised.

23. On 1 May 2001 Pyne Ltd purchased goods from Eik Ltd . The invoice was for £10 000 payable on 31 July 2001. • Year end is 30 June • Exchange rates were as follows: • Date 1 May 2001 • Spot rate 4,40 • FEC to 31 July 2001 4,46 • FEC to 1 June 2001 4.42 • Date 1 June 2001 • Spot rate 4.45 • FEC to 31 July 2001 4,50 • Date 30 June 2001 • Spot rate 4,41 • FEC to 31 July 2001 4,48

24. 31 July spot rate is 4,52 • Required • Prepare the journal entries • If no FEC was taken out • If FEC was taken out for the period 1 May 2001 until 31 July 2001.