PAS 21 – EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

OVERVIEW
This standard prescribes how the entity should:
1. Account for foreign currency transactions
Includes:
o Importations
o Exportations
o Lending
o Borrowing
2. Translate financial statements of a foreign operation into entity’s functional currency
(Remeasurement and Translation into Functional Currency)
o Investment in associate (outside the Philippines)
o Investment in subsidiary (outside the Philippines)
o Branches (outside the Philippines)
o Investment in joint venture (outside the Philippines)
Note: Exchange differences would be part of Profit/Loss for both 1 and 2
3. Translate the entity’s financial statements into a presentation currency (OCI)

ACCOUNTING FOR FOREIGN CURRENCY TRANSACTIONS

Why is there a need for PAS 21 (Foreign Currency transactions)?
o Many countries here in the Philippines engage in international transactions such as:
✓ Importing and exporting goods
✓ Establishing branches to another countries;
✓ Holding investments in foreign companies
o Accounting issues are encountered when transactions are measured in a currency other than our local currency.
What is Foreign Currency?
o A transaction to be settled in a currency other than the local currency.
o A foreign transaction must be expressed in terms of our local currency before they can be recorded in the books.
What is an exchange rate?
o It is the price of one currency in terms of another currency.
o Presentation of exchange rates:
✓ Direct quotation
How much is 1 foreign currency unit (FCU) in terms of local currency unit (LCU)?
Example: $1 = ₱52
✓ Indirect quotation
How much is the LCU in terms of FCU?
Example:
₱1 = $0.02
What are the principal accounting issues?
1. What kind of exchange rate to use?
2. How to report the effects of changes in exchange rates in the financial statements?
Types of Exchange rates
o Spot rate
The exchange rate for immediate delivery.
o Forward (or future) rate
The exchange rate at which the currency can be exchange at a future date.
Initial recognition
o A foreign currency is initially recognized by translating the foreign currency amount into the local currency using
the spot exchange rate at the date of transaction.
Foreign Exchange risk
o Foreign currency transactions are exposed to foreign exchange risk.
Types of exposure risk:
Exposed liability position
✓ Type of exposure risk arising from an importing transaction which arise from purchase transaction
Exposed asset position
✓ Type of exposure risk arising from an exporting transaction which arise from sale transaction
o As a result of exposure risk, exchange differences arise when foreign exchange rates change between two dates.
Treatment of Exchange Differences
o Exchange differences (or exchange gains and losses) are recognized in profit or loss.

EXAMPLES:
Problem No. 1: (Importing transaction)
On November 2, 2020, Palitan Company, a Philippine Company, ordered goods from a US supplier for $40,000. The
inventory was shipped and invoiced in December 1, 2020, to be paid in US Dollars on February 28, 2021. The spot rates
for US Dollars are as follow:

Selling spot rates Buying spot rates

2-Nov-20 80.50 79.60
1-Dec-20 81.10 80.00
31-Dec-20 81.60 81.40
28-Feb-20 81.30 81.20

Prepare the journal entries to record the above transaction in the books of Palitan Company.
Note:

o There are two spot rates in the problem, the selling spot rate and the buying spot rate (used by foreign exchange dealers). The selling spot rate – selling price
of the foreign currency unit. The buying spot rate is the purchase price of the foreign currency unit.
o In importing transactions always use the selling spot rate.
Problem No. 2: (Exporting transaction)
On November 2, 2020, Palitan Company, a Philippine Company, received an order from a foreign firm for $40,000. Palitan
Company shipped the inventory and billed the foreign firm on December 1, 2020. The foreign firm settled its account on
February 28, 2021 by remitting the payment in US Dollars. The spot rates for US Dollars are as follow:

Selling spot rates Buying spot rates

2-Nov-20 80.50 79.60
1-Dec-20 81.10 80.00
31-Dec-20 81.60 81.40
28-Feb-20 81.30 81.20

Prepare the journal entries to record the above transaction in the books of Palitan Company.
Note:

o In exporting transactions always use the buying spot rate.

Other considerations: (Shipping terms are also considered)

o FOB Shipping point – transaction date is the date of shipment
o FOB Destination – transaction date is when the good are received

Illustrative Problem:
On November 29, 2019, Alien Co. placed a non-cancellable purchase order with a company based in USA to import
machinery. The machine was shipped on December 1, 2019 and was received by Alien on December 15, 2019. The purchase
price was settled in US$ on January 3, 2020.
1. What is the transaction date if the shipping term is FOB Shipping point?

2. What is the transaction date if the shipping term is FOB destination?

TRANSLATION OF FINANCIAL STATEMENTS

There are two types of currencies
o Functional currency
The currency of the primary economic environment in which the entity operates. It is the currency in which the
entity’s cash inflows and outflows are normally denominated into and is not necessarily the currency of the country
where the entity is based.
o Presentation currency
The currency in which the entity’s financial statements are presented.
Problem 1
Halfhalf Co. is a company registered in Canada whose shares are traded in the Toronto Stock Exchange. Halfhalf
operating activities take place in the Philippines.
1. What is Halfhalf Co.’s functional currency?
2. What is Halfhalf Co.’s presentation currency?
Manila Company is a parent company based in the Philippines. It has a subsidiary based in Turkey. Determine the
functional currency and presentation currency of Manila Company and its subsidiary.
 Functional Currency Presentation Currency
Manila Company
Subsidiary

Translation Method

Functional currency is not

the currency of a Closing rate
hyperinflationary economy method
Translation method

Functional currency is the

currency of a Restate and
hyperinflationary economy Translate method

The Closing Rate Method

Account Exchange rate to use

Assets Closing rate (Reporting period)
Liabilities Closing rate (Reporting period)
Exchange rate as of transaction dates
Income and expenses For practical reasons, average rate is used
Contributed capital accounts Historical rate (date of acquisition)
Retained earnings
First year of translation - year of acquisition -
Beginning balance historical rate

Subsequent year - translated balance last period

Exchange rate as of transaction dates
P/L For practical reasons, average rate is used
Exchange rate as of transaction date - date of
Dividends declaration

Treatment of exchange differences

o Other terms would be:
✓ Translation adjustments
✓ Translation reserves
✓ Translation gains and losses
o Taken into other comprehensive income
Taken into profit or loss when the foreign operation is disposed of
Problem 1
On January 1, 2019, Marilyn Company acquired for 1,000,000 a 100% interest in the ordinary shares of Monroe Co., a firm
in USA where the currency is the US Dollars. On that date, Monroes’s stockholder’s equity accounts were as follows:
Ordinary shares, $10 par $50,000
Retained Earnings $20,000
On December 31, 2019, Monroe’s trial balance contains the following account balances:

Debit ($) Credit ($)

Cash 22,500.00
Accounts receivable 14,000.00
Inventory 33,500.00
Property, plant and equipment 12,000.00
Accumulated depreciation 1,200.00
Accounts payable 3,800.00
Ordinary shares 50,000.00
Retained earnings 20,000.00
Sales 45,000.00
Cost of goods sold 22,500.00
Operating expenses 12,500.00
Dividends 3,000.00
120,000.00 120,000.00

Purchase of goods are made evenly during the year. Items in the ending inventory were purchased on November 1, 2019.
Revenues and expenses were incurred evenly during 2019. Monroe declared and paid dividends of $3,000 on December 1,
2019. Relevant rates are as follows:

Date Rates in peso

1-Jan-19 50.00
1-Nov-19 51.50
1-Dec-19 52.00
31-Dec-19 53.00
Average rate during 2019 51.00

Required:
1. How much is the total assets of Monroe Company on December 31, 2019 translated in Philippine peso?
2. How much is the total liabilities of Monroe Company on December 31, 2019 translated in Philippine Peso?
3. How much is the net income of Monroe Company for 2019 translated in Philippine peso?
4. How much is the total shareholders equity of Monroe Company on December 31, 2019 translated in Philippine
Peso?
5. How much is the ordinary shares of Monroe Company on December 31, 2019 translated in Philippine Peso?
6. How much is the retained earnings of Monroe Company on December 31, 2019 translated in Philippine Peso?
7. As a result of translation process, what amount is recognized on the December 31, 2019 consolidated financial
statements as translation adjustment?
Problem 2
Wright Company, a Philippine Company, has 100% owned subsidiary in Japan that began operation on January 1, 2019.
The subsidiary conducts operation in the company owned building. The subsidiary also maintains its books and records in
Japanese Yen.
Presented below are the subsidiary’s statement of financial position at December 31, 2019 and December 31, 2020 and its
combined statement of comprehensive income and retained earnings for the year ended 2019 and 2020.

Statement of Financial Position

2019 (Janpanese Yen) 2020(Japanese Yen)
Total Assets 66,000.00 73,000.00
Total Liabilities 44,000.00 50,000.00
Shareholders' equity
Ordinary shares 4,000.00 4,000.00
APIC 16,000.00 16,000.00
Retained Earnings 2,000.00 3,000.00
Total Liabilities and SHE 66,000.00 73,000.00 \

Combined SCI and RE

2019 (Janpanese Yen) 2020(Japanese Yen)
Revenues 20,000.00 22,000.00
Expenses (17,000.00) (17,000.00)
Net income 3,000.00 5,000.00
Retained earnings 1/1 - 2,000.00
Dividends declared and paid (1,000.00) (4,000.00)
Retained earnings 12/31 2,000.00 3,000.00

Assumed exchange rates for 2019 and 2020 are as follows:

2019 (Philippine peso) 2020 (Philippine peso)

Beginning of the year 0.90 1.20
Average rate 1.05 1.16
Date the dividends were declared and paid 1.10 1.10
Closing rate 1.20 1.08

As of December 31, 2019, determine the following:

1. Total assets translated in Philippine peso
2. Total liabilities translated in Philippine peso
3. Net income translated in Philippine peso
4. Total shareholders’ equity translated in Philippine peso
5. Contributed capital translated in Philippine peso
6. Total retained earnings translated in Philippine peso
7. Translation adjustment to be presented in the Consolidated Statement of Financial Position.
As of December 31, 2020, determine the following:
1. Total assets translated in Philippine peso
2. Total liabilities translated in Philippine peso
3. Net income translated in Philippine peso
4. Retained earnings translated in Philippine peso
5. Total shareholders’ equity translated in Philippine peso
6. Translation adjustment to be presented in the Consolidated Statement of Financial Position.
7. Translation adjustment presented in Consolidated Statement of Comprehensive Income.

Hyperinflationary economy
o If the functional currency is the currency of a hyperinflationary economy, the entity’s financial statements are
restated first in accordance with PAS 29 Financial Reporting in Hyperinflationary Economies before they are
translated under PAS 21 The Effects of Changes in Foreign Exchange Rates
✓ After restatement in accordance with PAS 29, all amount shall be translated at the closing rate at the year-
end date of the most recent period.