Module - Foreign currency transactions PDF

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The Effects of Changes in Foreign Exchange RatesINTRODUCTIONPAS 21 prescribes the accounting for foreign activities and the translation of financial statements into apresentation currency.TWO WAYS OF CONDUCTING FOREIGN ACTIVITIES(1) FOREIGN CURRENCY TRANSACTIONSü e., import or export transactions th...

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The Effects of Changes in Foreign Exchange Rates INTRODUCTION PAS 21 prescribes the accounting for foreign activities and the translation of financial statements into a presentation currency. TWO WAYS OF CONDUCTING FOREIGN ACTIVITIES (1) FOREIGN CURRENCY TRANSACTIONS ü e.g., import or export transactions that are to be settled in a foreign currency. These transactions need to be translated to Philippine pesos before they can be recorded in the books of accounts. (2) FOREIGN OPERATIONS ü e.g., a branch in another country. The overseas branch will normally maintain its accounting records and prepare its financial statements in a foreign currency. Those financial statements need to be translated to Philippine pesos before they can be combined with the home office’s financial statements. TWO MAIN ACCOUNTING ISSUES Exchange rates are constantly changing. Therefore, the principal issues in the accounting for foreign activities are determining: (1) which exchange rate(s) to use; and (2) how to report the effects of changes in exchange rates in the financial statements. (A) FUNCTIONAL CURRENCY ü PAS 21 requires an entity to determine and disclose its functional currency, which is “the currency of the primary economic environment in which the entity operates.” ü This functional currency is the currency in which the entity’s cash inflows and outflows are normally denominated into and NOT necessarily the currency of the country where the entity is based. ü An entity considers the following factors (in descending order) when determining its functional currency: (a) The currency that mainly influences the entity’s sale prices and costs of goods sold or services (primary factors); (b) The currency in which cash flows from financing activities and operating activities are usually generated and retained (secondary factors) ü Any change in functional currency is accounted for by translating the financial statements into the new functional currency prospectively from the date of change. ü ALL CURRENCIES OTHER THAN THE ENTITY’S FUNCTIONAL CURRENCY ARE CONSIDERED FOREIGN CURRENCIES.

ILLUSTRATION: PRIMARY AND SECONDARY FACTORS ABC CO. is a mining company registered in Canada whose shares are traded in the Toronto Stock Exchange. ABC’s operating activities take place in the gold and silver mines in the Philippines. Question: What is the functional currency of ABC Co.? Answer: ABC’s functional currency is likely to be the Philippine Pesos, even though the company is based in Canada. This is because its operating activities take place in the Philippines and so the company will be economically dependent on the pesos if most of its sales and operating expenses are in pesos. Question: What is the presentation currency of ABC Co.? Presentation currency is the currency in which the entity’s financial statements are presented. Answer: ABC’s presentation currency is Canadian dollars. This is a requirement of the Canadian financial market regulators for listed companies in Canada. PAS 21 requires ABC Co. to prepare its financial statements in pesos (functional currency). However, when ABC files its financial statements with the Toronto Stock Exchange, it shall translate its financial statements to the Canadian dollars (presentation currency). Question: ABC acquired specialized mining equipment from Japan, invoiced in Japanese yen. What type of currency is the Japanese yen under PAS 21? Answer: The Japanese yen is deemed a foreign currency for the purpose of preparing ABC’s accounts. A foreign currency is a currency other than the entity’s functional currency. ILLUSTRATION: CHANGE IN FUNCTIONAL CURRENCY ABC Co. started its operations in China, where the currency is the yuan. After several years, ABC Co. expanded and exported its product to the Philippines, and conducted business through a branch. The functional currency of the group was deemed to be the yuan but by the end of 2021, 80% of the business was conducted in the Philippines. At the beginning of 2021, 30% of the business was conducted in Philippine pesos. Question: On December 31, 2021, should the group’s functional currency remain as yuan or changed to the Philippine peso? Answer: The functional currency should be changed to Philippine pesos at the end of 2021 if it is considered that the underlying transactions, events, and conditions of business have changed.

FOREIGN CURRENCY TRANSACTIONS A foreign currency transaction is a transaction that is denominated or requires settlement in a foreign currency. Examples: purchase or sale of goods, services or other assets at a price that is denominated in a foreign currency, and borrowing, lending or settling receivables or payables at amounts that are denominated in a foreign currency. INITIAL RECOGNITION A foreign currency transaction is initially recognized by translating the foreign currency amount into the functional currency using the spot exchange rate at the date of the transaction. ü Spot exchange rate is the exchange rate for immediate delivery or simply, the current exchange rate on a given date. ü Date of a transaction is the date on which the transaction first qualifies for recognition in accordance with PFRSs. SUBSEQUENT MEASUREMENT ü At each reporting date, the following items are translated as follows: ITEMS Translated using a. Monetary items *Closing rate b. Nonmonetary items measured at historical cost Exchange rate at the date of transaction c. Nonmonetary items measured at fair value Exchange rate at the date when the fair value was determined ü *Closing rate – the spot exchange rate at the reporting date. MONETARY ITEM VS. NON-MONETARY ITEMS ü Monetary items are currencies held and assets and liabilities to be received or paid in a fixed or determinable amount of money. ü Non-monetary items are those which do NOT give rise to the receipt or payment of a fixed or determinable amount of money. Monetary items (examples) Non-monetary items (examples) a. Inventories Monetary assets a. Cash and cash equivalents b. Prepaid assets c. Property, plant and equipment b. Accounts/Notes/Loans receivable and their related d. Investment property allowances and other financial assets measured at amortized cost e. Intangible assets f. Share capital and share premium c. Cash surrender value Monetary liabilities a. Accounts/Notes/Loans/Bonds payable and other financial liabilities measured at amortized cost b. Employee benefits to be paid in cash c. Provisions and accrued payables to be settled in cash d. Cash dividends payable

Spot exchange rate vs. Closing exchange rate ü The current exchange rates on September 1, 2021 and December 31, 2021 are the spot exchange rates on those dates. If the entity uses a calendar year period, the closing rate is the exchange rate on December 31, 2021. Direct vs. Indirect quotation ü Exchange rates may be either stated in: a. Direct quotation – the exchange rate is stated in how much of a local currency must be exchanged to receive one unit of a foreign currency, e.g., “P45: $1.” b. Indirect quotation – the exchange rate is stated in how much of a foreign currency must be exchanged to receive one unit or a local currency, e.g., “P1: $0.022.” SEVERAL EXCHANGE RATES ü When several rates are available, the rate used is that at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date. If exchangeability between two currencies is temporarily lacking, the rate used is the first subsequent rate at which exchanges could be made. ü Exchange rates may also be classified as either buying or selling rates. Buying and selling rates refer to the rate a currency broker (e.g., a bank) is willing to pay or sell a currency. ü The terms “buy” and “sell” are interpreted from the point of view of the currency broker (e.g., bank).

** As a guide, consider the following: Are you the: (a) IMPORTER? – you will pay your supplier in foreign currency, but your money is in PESOS. Go to the bank and exchange your peso to foreign currency. The BANK SELLS foreign currency. (SELLING SPOT RATE). (b) EXPORTER? – you will collect from your customer in foreign currency, but you need money in PESOS. Go to the bank and exchange your foreign currency to peso. The BANK BUYS your foreign currency. (BUYING SPOT RATE).

EXERCISES and SOLUTIONS I-Exchange Rates Suppose the direct foreign exchange rates in Philippine peso are: 1 US dollar = P40.00 1 Singapore dollar = P32.00 Required: 1. What are the direct exchange rates for the Philippine peso to US dollar and the Singapore Dollar? 2. What are the indirect exchange rates for the US dollar and the Singapore Dollar? 3. How many US dollars must a U. S. company pay to purchase goods costing P8,000 from a Philippine company? 4. How many Philippine peso must be paid for a purchase costing 4,000 Singapore dollars?

SOLUTION: 1.

Indirect Exchange Rates Philippine Viewpoint: 1 $ = P40; 1 Peso = $0.025 ($1/P40) 1 Singapore dollar = P32.00; 1 Peso = 0.03125 Singapore (1 Singapore Dollar/P32)

2.

FCU

=

Peso Direct Exchange Rate

=

P8,000 P40.00

=

$200; or

= P8,000 x $1/P40 = $200 3.

4,000 Singapore dollars x P32 = P128,000 II - Importing Transaction (Exposed Liability)

Assume that on November 1, 20x4 ordered 1,200 units of inventory from a U. S. firm for $24,000. The inventory was shipped and invoiced to the Philippine firm on December 1, 20x4, to be paid on March 1, 20x5. The firm’s fiscal year-end is December 31. Assume further that the Philippine firm did not engage in any form of hedging activity. The spot rates for U. S. dollars at various times are as follow: Buying Spot Rates

Selling Spot Rates

November 1, 20x4 . . . . . . . . . . . . . . . .

P39.80

P 40.25

December 1, 20x4 . . . . . . . . . . . . . . . .

40.00

40.55

December 31, 20x4 . . . . . . . . . . . . . .

40.70

40.80

March 1, 20x5 . . . . . . . . . . . . . . . . . . .

40.60

40.65

Required: 1. Prepare all entries on Petra Corporation’s books to record the above transactions. 2. Determine the following: a. Foreign exchange gain or loss on: a.1. December 1, 20x4 a.2. December 31, 20x4 a.3. March 1, 20x5 b. On December 31, 20x4: b.1. Accounts payable b.2. Inventory

SOLUTION: 1. December 1, 20x4 (Transaction date): Purchases…………………….. Accounts payable ($24,000 x P40.55)………………………………

973,200 973,200

December 31, 20x4 (Balance sheet date): Foreign currency transaction loss….………………….. Accounts payable [$24,000 x (P40.80 – P40.55)]……… Accounts payable valued at 12/31 Balance Sheet ($24,000 x P40.80)……… Accounts payable valued at 12/1 Date of Transaction ($24,000 x P40.55)……… Adjustment to accounts payable needed………..

6,000 6,000

P979,200

P

973,200 6,000

March 1, 20x5 (Settlement date): Accounts payable………………… Foreign currency transaction gain [$24,000 x (P40.80 – P40.65)] Cash ($24,000 x P40.65)…………….

979,200 3,600 975,600

2. a. a.1. None – transaction date (December 1, 20x4) a.2. P6,000 loss a.3. P3,600 gain (March 1, 20x5) b. b.1. P979,200 – spot rate on the balance sheet date or current rate on the balance sheet b.2. P973,200 – spot rate on the transaction date or historical rate on the balance sheet date.

III - Exporting Transaction (Exposed Asset) On November 1, 20x4, a Philippine firm received an order for 120 units of inventory for $60,000 to a U. S. firm. The Philippine firm shipped the inventory and billed the U. S. firm on December 1, 20x4. The Philippine firm received the customer’s remittance in full on March 1, 20x5. The firm’s fiscal year-end is December 31. Assume further that the Philippine firm did not engage in any form of hedging activity. The spot rates for U. S. dollars at various times are as follow: Buying Spot Rates

Selling Spot Rates

November 1, 20x4 . . . . . . . . . . . . . . . .

P39.80

P 40.25

December 1, 20x4 . . . . . . . . . . . . . . . .

40.00

40.55

December 31, 20x4 . . . . . . . . . . . . . .

40.70

40.80

March 1, 20x5 . . . . . . . . . . . . . . . . . . . .

40.60

40.65

Required: 1. Prepare all entries on Petra Corporation’s books to record the above transactions. 2. Determine the following: a. Foreign exchange gain or loss on: a.1. December 1, 20x4 a.2. December 31, 20x4 a.3. March 1, 20x5 b. On December 31, 20x4: b.1. Accounts receivable b.2. Sales

SOLUTION: 1. December 1, 20x4 (Transaction date): Accounts receivable ($60,000 x P40.00)……………………………… Sales

2,400,000 2,400,000

December 31, 20x4 (Balance sheet date): Accounts receivable……….. Foreign currency transaction gain [$60,000 x (P40.70 – P40.00)] Accounts receivable valued at 12/31 Balance Sheet ($60,000 x P40.70)……… Accounts receivable valued at 12/1 Date of Transaction ($60,000 x P40.00)……… Adjustment to accounts receivable needed………..

42,000 42,000

P2,442,000 2,400,000 P 42,000

March 1, 20x5 (Settlement date): Cash ($60,000 x P40,60)……………….. Foreign currency transaction loss……… Accounts receivable ($60,000 x P40.70)……….

2,436,000 6,000 2,442,000

2. a. a.1. None – transaction date a.2. P42,000 gain a.3. P6,000 loss (March 1, 20x5) b. b.1. P2,442,000 – spot rate on the balance sheet date or current rate on the balance sheet b.2. P973,200 – spot rate on the transaction date or historical rate on the balance sheet date.

IV - Foreign C urrency T ransactions (Financial Asset – Equity Investment and Exposed Liability - Importation) John Corporation, whose functional currency is the domestic currency (DC) – peso, entered into the following transactions during 20x4 and 20x5. 1. On November 1, 20x4, Jen purchased 1,200 shares of Orange Computers, Inc. (a listed company in the U. S.) at a price of $80 per share. Jen classified the investment as equity investment – fair value through profit or loss (FVTPL)/financial asset. The peso/US$ exchange rates on November 1, 20x4 and December 31, 20x4 were P40 and P40.50 respectively. The price of Orange Computers, Inc shares on December 31, 20x4 was $100. 2. On December 10, 20x4, John purchased equipment from an Italian company invoiced at 12,000 euros t o be settled on February 28, 20x5.The peso/euro exchange rates on December 10, 20x4, December 31, 20x4 and February 28, 20x5 were P53.00, P53.20 and P53.80, respectively. Required: Prepare entries to record the above transactions. John Corporation's financial year ends on December 31 The entries to record these transactions and the effects of changes in exchange rates are as follows:

SOLUTION: November 1, 20x4 (Transaction date): Equity investment (FVTPL)/Financial Asset …………… Cash

3,840,000 3,840,000

To record the purchase of shares in Orange Computers at a cost of $96,000 at the exchange rate of P40.

December 10, 20x4 (Transaction date): Equipment ………………………… Cash

636,000 636,000

To record the purchase of equipment costing 12,000 euros at the exchange rate of P53.

December 31, 20x4 (Balance sheet date): Equity investment (FVTPL)/Financial Asset …………… Unrealized gain in fair value of equity investment (financial asset) To record gain in fair value of Orange Computer’s share. 12/31/x4: Revalued Investment and translated at the rate on the date of revaluation (closing/current rate): (1,200 units x $100 x P40.50)……………. 11/1/x4: Investment, cost (1,200 units x $80 x P40.00) Unrealized gain on equity investment Less: Foreign currency transaction gain – equity investment 11/1/20x4: Date of transaction (1,200 units x $80 x P40).. Less: 12/31/20x4: B/S Date (1,200 units x $80 x P40.50)…. Other unrealized gain in the fair value of equity investment... Foreign currency transaction loss….………………….. Accounts payable [$96,000 x (P53.20 – P53)]……… To record exchange loss on accounts payable in euros.

1,020,000 1,020,000

P4,860,000 3,840,000 P1,020,000 P3,840,000 3,888,000

48,000 P 972,000

19,200 19,200

Accounts payable valued at 12/31 Balance Sheet (1,200 x $80 x P53.20)……… Accounts payable valued at 12/1 Date of Transaction (1,200 x $80 x P53.00)……… Adjustment to accounts payable needed………..

5,107,200 5,088,000 P 19,200

February 3, 20x5 (Settlement date): Accounts payable………………… Foreign currency transaction loss [$96,000 x (P53.80 – P53.20)] Cash ($96,000 x P53.80)…………….

5,107,200 57,600 5,164,800

To record exchange loss on accounts payable in euros and settlement of accounts payable in euros at the spot rate of P53.80.

Note the following: • The investment in Orange Computers, Inc shares is a non-monetary item that is carried at fair value as it is classified as equity investment through profit or loss (or a financial asset – FVTPL refer PFRS 9). The investment is revalued and translated at the rate on the date of revaluation, that is, December 31, 20x4. • The equipment is translated at the spot rate at the date of purchase and, being a non-monetary item, is carried at cost. It is not adjusted for the change in the exchange rate at balance sheet date. The accounts payable in euros is a monetary item and is remeasured using the current /closing rate at balance sheet date. The exchange loss is expensed off to the income statement

***ACKNOWLEDGMENTS*** The contents of this file are lifted from the brilliant works of Mr. Zeus Vernon B. Millan and Mr. Antonio J. Dayag. Accordingly, dear students, please refrain from sharing this file to others who may take undue advantage of the works of the aforementioned accounting luminaries....