Accounting And Foreign Exchange – What To Look Out For

Zampa Debattista
Posted on 10th September 2020

In the simplest of worlds, there would be one global currency.

In the simplest of companies you work on, most probably the file is organised, the company has no foreign currency exposure, and the client speaks your language.

Today’s article focuses on the main aspects to be on the lookout for when entities are exposed to foreign currencies.

The first distinction to make is that between three terms that tend to be confusing, that is – functional currency, presentation currency and foreign currency:

Functional Currency is the currency of the primary economic environment in which the entity operates.

Any currency in the world which is not the functional currency of an entity is a Foreign Currency

Presentation Currency is the currency in which the financial statements are presented.

Functional Currency

The determination of the functional currency is one of the crucial matters to determine before starting to work on any file. IAS 21 ‘The Effects Of Changes in Foreign Exchange Rates’ guides preparers in relation to how to determine the functional currency.

The primary indicators of the functional currency are the currencies that affect the sales price and costs of an organisation. Since the assessment of the primary indicators may not enable preparers to arrive at a conclusion in relation to which is the functional currency of an entity, the standards provides secondary factors. Such secondary factors include the currency of the entity’s financing activities and the currency in which receipts from operating activities are usually accumulated.

When determining the functional currency of a foreign operation, there are additional factors which are also listed in IAS 21, such as whether the foreign operation is autonomous from the reporting entity, or not.

In any case, the determined functional currency should be the currency in which the books of account are kept. Any other currencies in which the entity deals with are foreign currencies.

Presentation Currency

The presentation currency is the currency in which the financial statements of an entity are presented. This is an accounting policy choice under IAS 21. The entity is free to choose the currency in which to present to its shareholders. In general, the simplest solution would be to present financial statements in the same currency as the functional currency.

However, it’s imperative to stress that the Maltese Companies Act requires that the accounts are presented in the same currency as the share capital. As a result, there isn’t a choice for preparers.

Changes In Functional And Presentation Currency

In the rare eventuality of a change in functional currency, the change is made prospectively, and all figures are converted at the date of the change, including share capital.

Since the choice of the presentation currency is technically an accounting policy choice, it follows that a change in presentation currency is a change in accounting policy. As a result, the change needs to be reflected retrospectively, just like other changes in accounting policy.

Exchange Rate Selection

There are two main sets of rules when selecting exchange rates:

  • Rules for booking transactions in foreign currency.
  • Rules for other situations.

Transactions In Foreign Currency

Even though the entity has selected its functional currency, the entity may still enter into foreign currency transactions. For instance, a EUR company might purchase goods in USD. Such transactions are foreign currency transactions.

The exchange rate to use for transactions entered into is the rate at the date of the transaction. An average rate for the period is permitted insofar as this doesn’t distort the figures. The complication arises at the reporting date. The entity needs to distinguish between monetary and non-monetary items. Monetary items are those that will result in a settlement in a fixed or determinable number of units of currency (such as cash balances, debtors and creditors) whilst non-monetary items are all other items (such as property, inventory and shares). At the reporting date, all monetary items are translated at the exchange rate of that day, whilst non-monetary items are not retranslated from the historical exchange rate (that is, from the rate at the date of initial recognition).

Differences on transactions are recognised in profit or loss – retranslations result in unrealised exchange movements whilst gains or losses upon settlement result in realised exchange movements.

Other Situations

There are other situations requiring different treatment, whereby assets and liabilities are converted at the closing rates, irrespective of whether they’re monetary or not. Income statement items are converted at actual (or average) rates, just like with transactions in foreign currency. In this case, differences are recognised in the exchange fluctuation reserve.

Such situations include:

  • The process of converting from the functional currency of an entity to its presentation currency.
  • The process of converting a foreign operation into the presentation currency of the reporting entity.

Should you wish to discuss further our IFRS team would be happy to assist you.

Contact us on [email protected]

Disclaimer – Please note that this article is intended for information purposes only and whilst utmost care has been taken to ensure a correct application and interpretation of IFRS rules, Zampa Debattista shall bear no responsibility legal or otherwise, for misuse.

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