ACCOUNTING FOR FOREIGN
CURRENCY TRANSACTIONS AND
TRANSLATION OF FOREIGN
CURRENCY FINANCIAL STATEMENTS
(IAS 21)
PREPARED BY: MELESE Z.(MSc)
CHAPTER OBJECTIVES AND CONTENT
Definition of terms
Exchange Rates and Meaning of Translation
Types of currency-related exposures
Determination of functional currency
Accounting for foreign currency transactions
Recognition and reporting of exchange
differences
Translation of foreign operations
• Rationale/Objectives of translation
• Translation methods & criteria for
applications
Definition of terms
Foreign currency transactions -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
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.
CONT……
Foreign Currency Exchange Rates-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:
DER Br – equivalent value
=
1 FCU
Example: On January 1, 2020, an Ethiopian based company can purchase
one Dollar forDER
Br 30. = Br
Br30/$
30
=
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
IER of a Ethiopian entity:
= 1 FCU
Br – equivalent value
Example: On January 1, 2020, an Ethiopian based company
can purchase one Dollar for Br 30.
$1
= $ 0.034/
IER = Br 30 Br
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.
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
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.
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.
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.
3. High volume of intercompany transactions
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.
Monetary and Non-Monetary Items
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.
Eg. Accounts receivable, investments in bonds , accounts
payable, bond liabilities, pensions and other employee
benefits to be paid in cash, provisions that are to be settled
in cash, and cash dividends that are recognized as a liability.
Cont…..
Conversely, the essential feature of a non-monetary item
is the absence of a right to receive (or an obligation to
deliver) a fixed or determinable number of units of
currency.
Eg. are amounts prepaid for goods and services (e.g.,
prepaid rent); goodwill; intangible assets; inventories;
property, plant, and equipment; deferred income taxes; and
provisions that are to be settled by the delivery of a non-
monetary asset.
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
Note- Individual transactions must be translated into the functional
currency at the historical rate.
CONT…..D
According to IAS 21, a foreign currency transaction must be
recorded, on initial recognition, in the functional currency
by applying to the foreign currency amount the spot
exchange rate between the functional currency and the
foreign currency at the date of the transaction.
CONT…D
At the end of each reporting period,
(a) Foreign currency monetary items must be translated
using the closing rate,
(b) Non-monetary items that are measured in terms of
historical cost in a foreign currency must be translated
using the historical rate, and
(c) Non-monetary items that are measured at fair value in a
foreign currency must be translated using the spot
exchange rates at the date when the fair value was
CONT…D
Any exchange adjustments arising on the settlement of
monetary items or on the translation of them at rates
different from those at which they were translated on
initial recognition or in previous financial statements
must be recognized in profit or loss in the period in
which they arise, with one exception.
When a gain or loss on a non-monetary item is recognized
in other comprehensive income, any exchange adjustment
pertaining to that item must also be recognized in other
comprehensive income. For example, IAS 16 requires
some gains and losses arising on a revaluation of property,
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
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?.
AN IMPORT EXAMPLE
On June 1, Year 1, Glory Importers Inc. purchased
merchandise from a supplier in Australia at a cost of
10,000 Australian dollars (A$), with payment in full to be
made in 60 days. The exchange rate on the date of
purchase was A$1 = Br.52and A$1 = Br52.5 on June 30,
Year 1, the company’s year-end. Maritime paid its supplier
on July 30, Year 1, when the exchange rate was A$1 =
Br.52.9. The following journal entries, recorded in
Ethiopian Birr, illustrate the company’s purchase of
merchandise, year-end adjustments, and subsequent
payment.
AN EXPORT EXAMPLE
We will now consider an example of the export of goods by
Ethiopian Company. On November 15, Year 1, LMD Malt
Producers Ltd. shipped a carload of malt to a brewery in the
United States, with full payment to be received on January
31, Year 2. The selling price of the malt was US$26,000.
LMD Malt has a December 31 year-end. The following
exchange rates existed on the dates significant for accounting
purposes:
Transaction date Nov. 15, Year 1
Exchange rate US$1 = Br.54
Year-end Dec. 31, Year 1
Exchange rate US$1 = Br.54.62
Settlement date Jan. 31, Year 2
Translation of foreign Currency Financial
Statements
Foreign-currency-denominated financial statements must be
translated to the presentation currency of the reporting entity.
There are two methods used under IAS 21 to translate the
financial statements of a foreign operation.
The two methods as the functional currency translation (FCT)
method and the presentation currency translation (PCT)
method.
Cont……
The FCT method was used to translate and account for
foreign transactions. The same method will be used to
translate the financial statements of a foreign operation
from its recording currency to its functional currency.
Foreign operation as an entity that is a subsidiary, associate, joint
arrangement or branch of a reporting entity, the activities of which are
based or conducted in a country or currency other than those of the
reporting entity.
The PCT method will be used to translate the financial
statements of a foreign operation from its functional
currency to a different presentation currency.
Procedures to translate functional currency to
presentation currency (PCT) in
(a) Assets and liabilities shall be translated using the
closing rate
(b) Income and expenses shall be translated using
exchange rates at the dates of the transactions; and
(c) All resulting exchange differences shall be
recognized in other comprehensive income in the
name of Foreign currency translation adjustments
For depreciation and Cost of goods sold, historical rate for
FCT method is the rate when the asset was acquired,
whereas All revenues and expenses are translated using
the exchange rate in effect on the dates on which such
items are recognized in income during the period for
PCT.
Dividends are translated at the historical rate on the date
of declaration.
Under the PCT method, the net assets position of the
foreign entity is at risk from currency fluctuations, while
ADVANCED FINANCIAL ACCOUNTING
II(ACFN 402)
COURSE INSTRACTOR –MELESE Z.(MSc.)
MAY, 2023
ADDIS ABABA, ETHIOPIA
