Accounting for effects of foreign exchange rates (IAS 21)

3 types of currencies:
1. Foreign currency – currency other than functional currency
2. Functional currency – currency of the primary economic environment wherein the entity operates
(main currency of the operations of the business); usually, this is the currency in which the revenue is
normally denominated in; additional consideration: currency of inputs such as labor and materials,
currency of borrowings and financing (debt and equity); currency of the journal entries, ledgers
and accounting records
3. Presentation currency – currency of the financial statements (usually same as functional currency); an
entity may have more than one presentation currency

Translation from foreign currency to functional currency

Initial recognition – at spot rate (exchange rate today for immediate delivery) on date of transaction
Subsequent measurement:
1. Monetary item such as cash, receivables and payables – retranslated to the closing spot rate
2. Nonmonetary items such as prepayments, inventories, PPEs
a. Measured at fair value or its equivalent (such as NRV, FVCTS) – measured using spot rate
on the date of fair value measurement
b. Measured at cost or its equivalent (such as cost model) – measured using spot rate at date
of transaction (no retranslation)

Example:
On November 21, 2022, ABC Company, a Philippine firm (functional currency is the Philippine peso),
ordered (purchase or importation) merchandise from XYZ Company, a British entity (functional currency is
the British pound), for 41,500 pounds. The freight term was FOB shipping point (shipping date). The
merchandise was received on December 20, 2022. The invoice was dated December 4, 2022, which is also the
shipping date. ABC Company settled the invoice on January 30, 2023.

The spot rates for a pound on the respective dates were as follows:
November 21, 2022 P56.90
December 4, 2022 56.15
December 20, 2022 55.75
December 31, 2022 52.35
January 30, 2023 53.15

ABC Co. (in PHP) XYZ Co. (in pounds)

November 21, 2022 No entry No entry

December 4, 2022 Inventory/Purchases 2,330,225 Accounts Receivable – pounds 41,500

Accounts Payable – Pounds (2,330,225) Sales (41,500)
(41,500 pounds x 56.15)

December 20, 2022 No entry No entry

December 31, 2022 Accounts Payable – Pounds 157,700 No entry

Forex Gain – profit or loss (157,700)
[41,500 x (52.35 – 56.15)]

January 30, 2023 Forex Loss – profit or loss 33,200 No entry

 Accounts Payable – Pounds (33,200)
[41,500 x (53.15 – 52.35)]

Accounts Payable – Pounds 2,205,725 Cash 41,500

Cash (2,205,725) Accounts Receivable – Pounds (41,500)

AP 12/4/2022 = 41,500 x 56.15 = 2,330,225

AP 12/31/2022 = 41,500 x 52.35 = 2,172,525
AP 1/30/2022 = 41,500 x 53.15 = 2,205,725

Change in AP = (41,500 x 53.15) – (41,500 x 52.35) = 41,500 x (53.15 – 52.35)

Direct (multiply) exchange rate – PXX: $1 (foreign currency is expressed in peso)

$1,000 = ? peso
$1 = P50

$1,000 x P50 divided by $1 = P50,000

Indirect (divide) exchange rate – P1 – 3 yen (peso is expressed in foreign currency)

3,000 yen = ? peso
P1 = 3 yen

3,000 yen x P1 divided by 3 yen = P1,000

Effects of translation from foreign currency to functional currency is generally recognized in profit or loss
(except for forex effect of investments at FVOCI – other comprehensive income)

Problem 2:
On October 21, 2022, ABC Company received an order (ABC is the seller of the goods, ABC will use the
buying rate) of goods for 65,500 pounds. The date of invoice (if silent, is assumed to be the shipping date) is
November 21, 2022 and payment is due on January 26, 2023. Relevant exchange rates are as follows:
Offer Rate Bid Rate
October 21, 2022 P57.50 P55.20
November 21, 2022 58.70 56.80
December 31, 2022 54.15 53.40
January 26, 2023 52.35 50.50

1. How much is the foreign exchange gain (loss) in 2022?

2. How much is the net foreign exchange gain (loss) related to the exportation?

BB ASO
Buy and Bid
Ask, Sell and Offer

Analysis: ABC sold inventories and will receive pounds. ABC does not use pounds in its operations;
therefore, ABC will convert the pounds into its functional currency of pesos. ABC will sell the pounds to the
bank in exchange for pesos. So, the bank will buy the pounds. Since the bank determines the rate, we will use
the bank’s buying rate
October 12, 2022 No entry

November 21, 2022 Accounts Receivable – pounds 3,720,400

Sales 3,720,400
(65,500 pounds x P56.80 divided by 1 pound)

December 31, 2022 Forex Loss 222,700

Accounts Receivable – pounds 222,700
[65,500 pounds x (53.40 – 56.80)]

January 26, 2023 Forex Loss 189,950

Accounts Receivable – pounds 189,950
[65,500 pounds x (50.50 – 53.40)]

Cash 3,307,750
Accounts Receivable – pounds 3,307,750
(65,500 x 50.50)

#1: (222,700)
#2: (222,700) + (189,950) = total loss on the exportation = (412,650)

Translation from functional currency to presentation currency

ASR CHA
Assets and liabilities @ Closing rate
Stockholders’ equity @ Historical rate
Revenues, expenses, gains, losses @ Average rate

Note: Income statement accounts (revenues, expenses, gains, losses) should be translated using historical
rates. Use of average rates is allowed if there are no significant fluctuations in the foreign exchange rate.

Assets @ closing = Liabilities @ closing + Equity @ historical +/- Translation adjustment (OCI)
Assets @ closing – Liabilities @ closing = Equity @ closing = Equity @ historical +/- Translation
adjustment (OCI)

Problem 3:
ABC Company is a subsidiary of XYZ Company. The functional currency of ABC Company is the Philippine
peso (P) while the presentation currency of XYZ Company and Subsidiaries is the Japanese yen. During the
year, ABC Company entered into foreign currency denominated transactions as follows:
• Sale of inventories for $10,000
• Purchase of prepaid asset of $1,000

The applicable historical rates are as follows:

Accounts Receivable $1 = P48 P0.50 = 1 yen
Prepaid Asset $1 = P45 P0.25 = 1 yen
The applicable exchange rates as of December 31, 2022:
Dollar exchange rate $1 = P52
Yen exchange rate P1 = 3 yen

1. How much should the accounts receivable be presented in the consolidated statement of financial
position as of December 31, 2022? 1,560,000 yen
2. How much should the prepaid assets be presented in the consolidated statement of financial position
as of December 31, 2022? 135,000 yen

Sale of inventories
Date of sale Accounts Receivable – USD 480,000
Sales 480,000
($10,000 x P48 divided by $1)

Year-end Accounts Receivable – USD 40,000

Forex Gain 40,000
[$10,000 x (P52 – P48)]

AR – historical = 480,000
AR – year-end = $10,000 x P52 divided by $1 = 520,000

In the GL/TB, AR is carried at P520,000.

In the consolidated FS, the AR at pesos will be translated to Japanese yen.

Translation from functional currency of ABC (Php) to presentation currency of consolidated FS (yen)
P520,000 x 3 yen divided by P1 = 1,560,000 yen

Prepayment
Date of prepayment Prepaid Asset 45,000
Cash 45,000
($1,000 x P45 divided by $1)

Year-end No entry

In the GL/TB, Prepayment is carried at P45,000

In the consolidated FS, the prepayment at pesos will be translated to Japanese yen

Translation from functional currency of ABC (Php) to presentation currency of consolidated FS (yen)
P45,000 x 3 yen divided by P1 = 135,000 yen

Problem 4:
Entity ABC owns majority of the outstanding ordinary shares of XYZ Company which is operating in the
United States of America and whose functional currency is the US Dollar ($). However, the presentation
currency of the Entity ABC and Subsidiaries is the Philippine peso (P). For the year ended December 31,
2022, XYZ presented the following statement of financial position in US Dollars:
Current assets $100,000 Current liabilities $100,000
Noncurrent assets 400,000 Noncurrent liabilities 200,000
Ordinary share capital 50,000
 Preference share capital 80,000
Retained earnings 70,000
Total $500,000 Total $500,000

The following additional information are provided:

• The ordinary shares were issued on January 1, 2021 at par while the preference shares were issued on
July 1, 2021.
• XYZ reported $10,000 net income during 2022 and distributed $2,000 dividends on December 1,
2022.
• The translated retained earnings as of January 1, 2022 (also December 31, 2021) is P300,000.

Relevant exchange rates are as follows:

January 1, 2021 P40
July 1, 2021 P42
December 31, 2021 P43
December 1, 2022 P41
December 31, 2022 P45
2022 weighted average P44

1. How much is the translation adjustment – other comprehensive income as of December 31, 2022
(presented in the Consolidated Statement of Financial Position/ending balance of the translation
adjustment) to be presented in the consolidated financial statements? 2,982,000 credit
2. How much is the translation adjustment – other comprehensive income for 2022 (presented in the
Consolidated Statement of Comprehensive Income/change in the balance of the translation
adjustment during the year) to be presented in the consolidated financial statements? 386,000 credit

USD Applicable Rate Translated

Beginning retained earnings ? – 62,000 N/A P300,000
2022 net income 10,000 44 440,000
2022 dividends, December 1 (2,000) 41 (82,000)
Ending retained earnings 70,000 658,000

Ordinary share capital issued on January 1, 2021 ($50,000 x P40 per $1) 2,000,000
Preference share capital issued on July 1, 2021 ($80,000 x P42 per $1) 3,360,000
Retained earnings translated 658,000
Total shareholders’ equity at historical rate 6,018,000

Assets at closing ($500,000 x P45 per $1) 22,500,000 Liabilities at closing ($300,000 x P45 per $1) 13,500,000
Shareholders’ equity at historical 6,018,000
Subtotal 22,500,000 Subtotal 19,518,000
Ending translation adjustment – OCI 2,982,000
Total 22,500,000 Total 22,500,000

Ordinary share capital, in USD $50,000

Preference share capital, in USD 80,000
Retained earnings, in USD as of 12/31/2021 62,000
Total shareholders’ equity as of 12/31/2021 in USD $192,000
 Ordinary share capital as of 12/31/2021, translated ($50,000 x P40 per $1) 2,000,000
Preference share capital as of 12/31/2021, translated ($80,000 x P42 per $1) 3,360,0000
Retained earnings as of 12/31/2021, translated 300,000
Translated shareholders’ equity as of 12/31/2021 at historical 5,660,000
Translation adjustment as of 12/31/2021 (SQUEEZE) 2,596,000
Equity at closing rate, 12/31/2021/Equity, including translation adjustment ($192,000 x P43 per $1) 8,256,000

12/31/2021 translation adjustment 2,596,000

Change in translation adjustment during 2022 (SQUEEZE) 386,000
12/31/2022 translation adjustment 2,982,000

Alternative solution:
Computation of ending translation adjustment
Ordinary share capital as of 12/31/2021, translated ($50,000 x P40 per $1) 2,000,000
Preference share capital as of 12/31/2021, translated ($80,000 x P42 per $1) 3,360,0000
Retained earnings as of 12/31/2021, translated 300,000
Translated shareholders’ equity as of 12/31/2021 at historical 5,660,000

USD Applicable Rate Translated

Beginning equity ? – 192,000 N/A 5,660,000
2022 net income 10,000 44 440,000
2022 dividends (2,000) 41 (82,000)
Ending equity 200,000 6,018,000

Equity at historical rate 6,018,000

Ending translation adjustment 2,982,000
Equity at closing rate (including translation adjustment) [200,000 x P45] 9,000,000

Computation of change in translation adjustment

USD Applicable Rate Translated with
Beg. Trans. Adj.
Beginning equity 192,000 43 8,256,000
2022 net income 10,000 44 440,000
2022 dividends (2,000) 41 (82,000)
Ending equity 200,000 8,614,000

Equity at translated with beg. translation adjustment 8,614,000

Change in translation adjustment 386,000
Equity at closing (with ending translation adjustment) 9,000,000