Impact of Accounting for Exchange Rates by Companies
2016
Good Day Finance Colleagues,
It is worthy of note that recent development and information from questions and enquiries made by
accounting and finance practitioners in the most recent times revealed the following contemporary and
contentious issues with respect to the relevant “1Exchange Rate(s)” applicable for Conversion and
Booking of Transactions consummated in 2Foreign Currencies and Translation of Balances held in
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Monetary Items (i.e. Monetary Assets and Liabilities) within the entities accounting records and books.
The following are selected and identified issues to be addressed:
1.
2.
3.
4.
5.
6.
When is the Spot Rate used?
When is the Average Rate (i.e. Standard/Corporate Rate{s}) applicable?
What is the frequency of updating and/or revising Average Rate?
From which source is the Rates (Spot and/or Average Rate Rates) obtained?
What exchange rate(s) is/(are) applicable for Subsequent Measurement?
What is the treatment of Exchange Differences?
Many companies in today’s world engage in international transactions (imports and exports) carried out in
a variety of foreign currencies. In course of international business and multinational operations,
companies are exposed to effect of foreign exchanges rates. We need to understand the impacts that
fluctuations in foreign exchange rates have on the financial statements of a multinational company and
recognize which foreign exchange gains/losses are realized and unrealized.
The prices at which foreign currencies can be purchased or sold are called foreign exchange rates. The
value of foreign currency payables and receivables fluctuate as foreign exchange fluctuates. The major
accounting challenge is how to reflect the value of changes in foreign currency payables and receivables
in the financial statements.
We need to understand the impact that fluctuations in foreign exchange rates have on the financial
statements of a multinational company and how foreign currency gains and losses, whether realized or
unrealized, are reflected in the company’s financial statements.
However, an entity can decide to present its financial statements in a currency different from its
functional currency, but there are many factors that dictate the choice of “4Presentation Currency” and
“5Functional Currency”.
How to determine functional currency?
Where an entity operates in several different national environments, it may not always be a straight
forward matter to determine its functional currency. Entities need to consider the following issues in
determine their functional currency.
Which currency principally influences selling prices for goods and services?
Which country’s competitive forces and regulations principally determine the selling prices of the
entity’s good and services?
In which currency are funds for financing activities (debt and enquiry instruments) generated?
1Exchange rate: is the ratio of exchange for two currencies.
2 Foreign currency: is a currency other than the functional currency of the entity.
3 Monetary items: are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.
4 Presentation currency: is the currency in which the financial statements are presented.
5 Functional Currency: Is the currency of the primary economic environment on which the entity operates.
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Impact of Accounting for Exchange Rates by Companies
2016
In which currency are receipts from operations generally kept?
Which currency influences labour, material and other costs of providing goods or services?
Technical Note:
Where consideration of the different factors does not result in a clear identification of the
functional currency, the issue becomes a matter of judgment for management.
How to determine presentation currency?
The functional currency of an entity is a matter of fact, although identifying it may not be straight
forward. By contrast, the entity’s presentational currency is a matter of choice. IAS 21 permits an entity to
present its financial statements in any currency it chooses; this may differ from the entity’s functional
currency.
Why would an entity choose a presentation currency that is different from its functional currency? One of
the following reasons may apply:
The entity’s functional currency is relatively obscure. The entity may then choose to report in a
currency such as US dollars or Euros in order to make its financial statements more transparent
The entity’s principal investors tend to function in another currency from the entity’s own
functional currency.
The entity may be seeking investment from potential investors whose functional currencies is not
the same as the entity’s functional currency.
When is the 6Spot Rate used?
Spot rate is the exchange rate for immediate delivery. It represents the exchange rate between the
functional and foreign currency at the point of transaction (i.e. transaction date).
Initially, all foreign currency transactions shall be translated to functional currency by applying the spot
exchange rate between the functional currency and the foreign currency at the date of the transaction.
The date of transaction is the date when the conditions for the initial recognition of an asset or liability are
met in line with IFRS.
Examples of transactions that could necessitate the use of spot rate(s) include:
Acquisition or disposal of assets denominated in a foreign currency
The spot rate applicable is the exchange rate existing as at the “Trade Date”. The Trade date of the
transaction represents the date in which all the significant risk and rewards of the transaction(s) has/(have)
passed from the seller/initiator of the transaction(s) to the buyer/other party in the transaction(s).
The implication of the aforementioned in practical sense is the trade date is synonymous to the value date
of the transaction (i.e. upon delivery of goods or otherwise; and upon rendering of services) and not
necessarily the invoice date (as in most cases for our entities, the invoice date is usually a later date).
Technical note:
As average rate for a period may be used if exchange rates do not fluctuate significantly.
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Spot rate: the exchange rate for immediate delivery.
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Impact of Accounting for Exchange Rates by Companies
2016
When is the Average Rate (i.e. Standard/Corporate Rate{s}) applicable?
Average exchange rate can be obtained based on simple averages and/or weighted averages over the
range of period which includes: weekly, bi-weekly, monthly, bi-monthly, quarterly (rarely in use), yearly
(rarely in use). The frequency of determine the averages is determined by the volatility of the currencies
(i.e. trending and cyclical movement of the currencies).
The date of a transaction is the date on which the transaction first qualifies for recognition in accordance
with IFRSs. For practical reasons, a rate that approximates the actual rate at the date of the transaction is
often used, for example, an average rate for a week or a month might be used for all transactions in each
foreign currency occurring during that period.
Average rate is applicable in the following situations:
1. Where the average rate reasonable approximates the spot rate.
2. Where exchange rates do not fluctuate significantly.
3. Where an entity operates a volatile sales volumes on a continuous basis.
Technical Note:
However, if exchange rates fluctuate significantly, the use of the average rate for a period is
inappropriate.
What is the frequency of updating and/or revising Average Rate?
Average exchange rate can be obtained based on simple averages and/or weighted averages over the
range of period which includes: weekly, bi-weekly, monthly, bi-monthly, quarterly (rarely in use), yearly
(rarely in use).
The frequency of determine the averages is determined by the volatility of the currencies (i.e. trending
and cyclical movement of the currencies).
The change in use of average rate will be more frequent in periods on immense volatility.
From which source is the Rates (Spot and/or Average Rate Rates) obtained?
Exchange rate should equally reflect its 7fair value in accordance with the requirement of IFRS 13.
Hence, the primary market in which an entity source for funds and/or convert its foreign exchange
earnings should be the same source of its exchange rates (be it spot rate, average rate and closing rate). In
our situation, the applicable exchange rate is the official CBN rate for transactions, which is equally the
same as the inter-bank official rate.
Furthermore, it is the Ask Price and not the Bid Price that is applicable because it is the representation of
the “Exit Price” with reference to Fair Value principles of IFRS (refer to IFRS 13).
7 Fair value: is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date.
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Impact of Accounting for Exchange Rates by Companies
2016
Consequently, the Mid-Rate (or Mid-Price or Central Rate) is a surrogate and/or a reasonable
approximation only for the purpose of obtaining “Average Rate” and not the Spot Rate, neither can the
Ask Price be used in determining the Spot Rate of transaction; and the Actual Rate of exchange used from
the applied source(s) as debited/charged to the Bank Account(s), Line of Credits and Letter of Credits
(LCs).
What exchange rate(s) is/(are) applicable for Subsequent Measurement?
Subsequently, at the end of each reporting period, you should translate:
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All monetary items in foreign currency using the 8closing rate;
All non-monetary items measured in terms of historical cost using the exchange rate at the date
of transaction (historical rate);
All non-monetary items measured at fair value using the exchange rate at the date when the
fair value was measured.
What is the treatment of Exchange Differences?
Exchange differences occur when there is a change in the exchange rate between the transaction date
and the date of settlement of monetary items arising from a foreign currency transaction.
Exchange differences arising on the settlement of monetary items (receivables, payables, loans, and cash
in a foreign currency) or on translating an entity’s monetary items at rates different from those at which
they were translated initially, or reported in previous financial statements, should be recognized in profit
or loss in the period in which they arise.
There are two situations to consider.
a) The transaction is settled in the same period as that in which it occurred: all the exchange
difference is recognized in that period.
b) The transaction is settled in a subsequent accounting period: the exchange difference
recognized in each intervening period up to the period of settlement is determined by the change
in exchange rates during that period.
In other words, where a monetary item has not been settled at the end of a period, it should be restated
using the closing exchange rate and any gain or loss taken to the income statement.
Please, for further enquiry do not hesitate to contact Adebayo Olumuyiwa (08026937304,
08149572684) of FinPolNomics - Green Finance
8 Closing rate: is the spot exchange rate at the end of the reporting period.
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