Chapter-5
Foreign Currency Transactions &
Translation of Foreign Currency
Financial Statements
Foreign Currency Transactions
• Foreign Currency Transactions is a transaction that
is denominated and requires settlement in a foreign
currency.
• These transactions include :
import dealings with foreign suppliers
export dealings with foreign customers
borrowing and lending in foreign currencies
Measurement of Foreign Currency Transaction Gains (Losses)
Presentation of Foreign Currency
Transaction Gains (Losses)
Example: Import Transaction
• On December 16, 2009, Kenema Pharmacy
purchased Pharmaceuticals(drugs) from a U.S.
supplier at a cost of 10,000 dollars. The U.S. supplier
made the sale on net 30 days open account.
Spot rates:
• December 16 : ETB 12.50; December 31 : ETB
12.40; January 15: ETB 12.20
• Required:
• Record the necessary journal entries on the book of
Kenema Pharmacy
Example2: Sale (Export) Transaction
• On June 17, 2009, ECX , which uses the
perpetual inventory system, sold
Coffee(merchandise) with cost of ETB 122,000
to a US customer for USD15,000, with
payment due July 16, 2009.
• Spot rates:
• Transaction date, June17: ETB12.10; Balance
sheet date, June30: ETB12.07; Settlement
date, July 16 : ETB12.075
Example cont…
• Record entries on transaction, b/sheet and
settlement dates on the book of ECX
Excersice
• On June10, 2010, Giniad Sold merchandise with cost of 100,000Br
to a US customer at $ 10,000 which due on September 1, 2010.
• On December 1, 2010, it has also made additional sales of
merchandise costing 195,000Br to US customer for 90-days, 8%
promissory note of $20, 000. Due date March 1,2011
Example3: FC Loan Payable
• On Apr. 30, ETBC Purchased from a US supplier Inventory
for $10,000 translated at selling spot rate of USD1 =
ETB12.50.
• On Apr. 30, ETBC Borrowed USD 10,000 from CBE for 30-
days, 6% Loan to be repaid in dollars, and paid the liability
of US supplier.
Selling spot rate
• USD1 = ETB12.50 on april30
• USD1 = ETB12.60 on May30,
• Record the necessary entries on april30 and May30
Example4: Loan Receivable Denominated in a Foreign Currency
• On May30, Sold a merchandise to US customer for 60-day, 9%
promissory note of $10, 000 .
• Spot rates
• May30 USD1= ETB 12.60
• June30 USD1= ETB12.70.
• July29 USD1= ETB 12.65
• Record the necessary entries
Foreign Exchange Matrix
LC process- Exercise
• Assume EPSA , a pharmaceuticals importer has opened
an L/C at CBE for $100, 000 to import drugs from USA.
The LC was opened at bank on Tir 1, 2001 and the L/C is
settled on Ginbot 28, 2001. The exchange rate is ETB
22(Tir 1) and ETB 22.5 (Ginbot 28).
– Discuss the how companies get Forex from bank?
– What is the Foreign Exchange Gain/loss and the necessary
transactions?
16
Translation of Foreign Currency Financial
Statements
• Meaning of Translation
– Translation is the conversion of financial
statements from one currency to another. Such
that:
Account measured in X Appropriate Account measured in Reporting
Foreign Currency Units Exchange Rate = Currency Equivalent Value
• Two major accounting issues while translation of
subsidiary’s financial statements reported in a foreign
currency to reporting currency are to:
– Determine the appropriate exchange rates for each balance,
and
– Disclosure of resulting exchange gains & loses in the reporting
currency statements
Appropriate Exchange Rate could be:
– Historical rate
– Current /closing rate
– Average rate
Translation Methods & Criteria for Application
• Functional Currency of the subsidiary determines
which translation method is to be used
• The translation method used should reflect the
parent’s exposure to exchange rate changes of
the subsidiary
Functional Currency
– An entity’s functional currency is the currency of
the primary economic environment in which the
entity operates;
– is the currency of the environment in which an
entity primarily generates and expends cash (i.e. it
can be the local currency of the subsidiary or the
currency of the reporting enterprise(Parent)
Economic Indicators Functional currency probably is:
Local Currency Parent’s Currency
Sales prices of the Determined more by local Determined more by
foreign Sub. operation competition and local world-wide competition
government regulation and international prices
Sales market of the Primarily within the Primarily outside the
foreign Sub operation country of the Subsidiary country of Subsidiary
costs of RM Obtained primarily from Obtained primarily from
the country of Subsidiary the parent country
Financing of day-to-day Primarily from Subsidiary Primarily from Parent
activities of the foreign country country bank
Sub
Functional Currency
• If presentation(parent) currency is Functional
currency
Use temporal method
Translation adjustment is reported as gain/loss in income
statement
• If Local currency of subsidiary is Functional currency
Use current method
translation adjustment is reported as translation
adjustment in equity(b/sheet)
Exercise: Presentation Currency is Functional
currency
A US company(Maxmill company ) had acquired a subsidiary(SW Company) from
Switzerland on January1,2008 . After operating for one year the subsidiary has
presented the following income statement, retained earning and balance sheet
statements. The subsidiary’s books of account is kept in swiss frank . On next
slide are given balance sheet and I/statement for December 31, 2008 in swiss
franks. Direct exchange rates for Swiss franc are:
Dollars per Franc
January 1, 2008 $.5987*
December 31, 2008 .5321
Average for 2008 .5654
Dividend declaration and payment date .5810
*Representative of historical rate
Income Statement & statement of R.E
Revenue Fr.75,000
Operating Expenses(3000 Deprecation) 30,000
Net Income 45,000
Retained Earnings 1/1 /08 10,000
55,000
Dividends (15,000)
Retained Earnings 31/12/08 40,000
Balance Sheet
Cash and receivables Fr. 55,000
Net Plant, Property and Equipment 37,000
Total Asset 92,000
Accounts Payable 32,000
Common stocks 20,000
Retained Earnings 40,000
Total Liability and Equity 92,000
Required:
Translate the year-end balance sheet and
income statement from the Swiss frank to USD
under the following cases
Case 1: Swiss Frank is Functional currency
Current Method
Cumulative translation adjustment (OCI)
•Is the amount by which balance sheet/trial doesn't
balance
•is reported in the balance sheet as cumulative translation
adjustment under current method
Current Method
Swiss Translation
Income Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses(30,000) 0.5654 (16,962)
Net income 45,000 25,443
Retained earnings 1/1
10,000 0.5987 5,987
55,000 31,430
Dividends (15,000) 0.5810 (8,715)
Retained earnings 12/31
40,000 22,715
Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment
37,000 0.5321 19,688
Total assets 92,000 48,954
Accounts payable 32,000 0.5321 17,027
Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,715
92,000 51,716
Cumulative translation adjustment (2,762)
Total liab. &92,000
equity 48,954
Case 2: USD is Functional currency
Temporal Method
Temporal Method
Translation gain/loss
• Is the amount by which balance sheet won’t
balance , but it is reported in the income
statement under temporal method
• Therefore,
– we translate Income statement, R/E and Balance sheet
using temporal rates as it is.
– Compute the amount by which the b/sheet will not
balance ( translation gain or loss)
– Re-start the translation starting from Income statement
by including translation gain / loss computed before.
Case 2: Temporal Method –gain/loss…
Swiss Tran.
Income Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses: depreciation (3,000) 0.5987 (1,796)
Operating expenses: other (27,000) 0.5654 (15,266)
Net income 45,000 25,343
Retained earnings 1/1 10,000 0.5987 5,987
55,000 31,330
Dividends (15,000) 0.5810 (8,715)
Retained earnings 12/31 40,000 22,615
Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment 37,000 0.5987 22,152
Total assets 92,000 51,418
Accounts payable 32,000 0.5321 17,027
Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,615
Total liab. & equity 92,000 51,616
Balancing amount/gain/loss (198)
Case 1: USD is Functional currency : Temporal Method …
Swiss Translation
Income Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses: depreciation (3,000) 0.5987 (1,796)
Operating expenses: other (27,000) 0.5654 (15,266)
Translation loss (198)
Net income 45,000 25,145
Retained earnings 1/1 10,000 0.5987 5,987
55,000 31,132
Dividends (15,000) 0.5810 (8,715)
Retained earnings 12/31 40,000 22,417
Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment 37,000 0.5987 22,152
Total assets 92,000 51,418
Accounts payable 32,000 0.5321 17,027
Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,417
Total liab. & equity 92,000 51,418
Disclosures
•The standard(IAS-21) requires an entity to disclose some important
disclosures for the purpose of fair and faithful presentation:
Amount of exchange difference be recognized in profit or loss;
Net exchange differences recognized under other comprehensive
income
whether presentation currency is different from functional
currency and the reason for this difference; any
Whether there is any change in functional currency and reason for
the change
END
