Accounting for foreign currency transactions

Chapter 33

Accounting for foreign currency transactions

33.1 It is necessary to translate because if the transactions were not denominated in a single presentation currency, such as Australian dollars, then the financial statements could be made-up of accounts that were denominated in numerous currencies. Such financial statements would be very difficult to understand.

33.3 When a transaction occurs that is denominated in a foreign currency, that transaction should initially be translated to the functional currency at the exchange rate in place at the date of the transaction (also referred to as the ‘spot rate’).

33.9 A foreign currency swap arises where the obligation related to a loan denominated in one currency is swapped for a loan denominated in another currency.

For example, if a particular organisation has a number of receivables that are denominated in a foreign currency, then changes in spot rates may potentially create sizeable foreign currency gains, or sizeable foreign currency losses. If that same organisation is able to convert some of its domestic loans into foreign currency loans, of the same denomination as its receivables, then it will be able to effectively insulate or hedge itself from the effects of changes in spot rates. Such an organisation may seek to find another entity that is prepared to swap its foreign currency loans for the organisation’s domestic loans. That is, if we have receivables and payables that are both denominated in another particular foreign currency, then changes in the spot rates will create gains on one, but losses on the other. To the extent that the receivables and payables are for the same amount and denominated in the same currency, the losses on one monetary item (perhaps the foreign currency payable which would be considered to be the hedged item) will be offset by gains on the other monetary item (perhaps the foreign currency swap, which would be considered to be the hedging instrument).

33.11 On 1 July 2014 Double Island Ltd enters into an agreement to borrow £2 million from Point plc (UK). Point plc sends the loan money to Double Island Ltd’s Australian bank account. The loan for four years and requires the payment of interest at the rate of 8% on 30 June each year. Double Island Ltd’s reporting date is 30 June. The relevant exchange rates are:

1 July 2014 A$1.00 = UK£0.48

30 June 2015 A$1.00 = UK£0.50

REQUIRED

Provide the necessary journal entries that would be made in the books of Double Island Ltd to account for the above transaction for the year ending 30 June 2015.

Recognition of the foreign currency loan at the 1 July 2014 spot rate.

4 166 667 = 2 000 000 ¸ 0.48

30 June 2015

Recognition of year end interest payment.

320 000 = (2 000 000 × 8%) ÷ 0.50

Recognition of the effect of retranslation of the loan at 30 June 2015 spot rates. The decrease in the amount of the loan payable is to be treated as revenue in the period in which the exchange rate moves.

33.18 You are the finance director of ME Ltd. The company specialises in importing classic foreign vehicles from oversea countries and then selling these vehicles cheaply on the open market. The company enters into the following transactions during the year.

(a) The company purchases inventories from Hong Kong for HK$300,000. The order is placed on 22 April 2014, with delivery due by 30 April 2014. Under the conditions of the contract, title to the goods passes to company on delivery. Payment in respect of these inventories is due in equal instalments on 31 May 2014, 30 June 2014 and a final payment on 31 July 2014. The following exchange rates are applicable:

22 April 2014 HK$8.00 = A$1

30 April 2014 HK$8.50 = A$1

31 May 2014 HK$8.56 = A$1

30 June 2014 HK$8.59 = A$1

31 July 2014 HK$8.94 = A$1

(i) 30 April 2014

Being the recording of inventory delivered and the associated liability to the supplier. The inventory was delivered on 30 April 2014 and therefore the inventory and accounts payable will be translated at the exchange rate on that date.

HK$300 000 ÷ 8.50 = A$35 294

(ii) 31 May 2014

Being the payment of a third of the outstanding creditors balance on 30 May 2014 of HK$100 000

35 294 ¸ 3 = 11 765

(iii) 30 June 2014

Being the payment of a third of the initial creditors balance on 30 June 2014 of HK$100 000

As at the end of the reporting period we would have an outstanding liability of HK$100 000. This will need to be stated at the spot rate at 30 June 2014 and the exchange difference taken to profit or loss.

(iv) 31 July 2014

Being the payment of cash on 31 July 2014: HK$100 000 ¸ 8.94 = A$11 186

The remaining balance on accounts payable (A$11 641 – 11 186 = A$456) will be taken to the profit and loss as an exchange gain.

(b) The company enters into a long-term construction contract with a Japanese company. Under the terms of the contract the Japanese firm will manufacture an engine diagnosis machine, which can be used on all classic cars. The contract is enters into on 30 April 2013 for a fixed price of ¥5 million. The equipment is delivered on 31 May 2014, subject to a two-month credit period after the date of delivery to ensure that the company is satisfied with the equipment. Payment falls due on 31 July 2014. The following exchange rates are applicable:

30 April 2013 ¥160 = A$1.00

30 June 2013 ¥160 = A$1.00

31 May 2014 ¥240 = A$1.00

30 June 2014 ¥245 = A$1.00

30 July 2014 ¥260 = A$1.00

30 April 2014 ¥160 = A$1.00

The engine diagnosis machine will be a qualifying asset under the definitions within AASB 123, being an asset under construction or otherwise being made ready for future productive use by the company in its own operations.

The asset will be qualifying until construction is complete and the asset has been received by the company. Whilst being constructed the exchange differences must be included in the cost of construction.

30 April 2013

¥5 000 000 ¸ 160 = A$31 250

In practice, an adjustment would also be required to take account of the change in exchange rates to 30 June 2013. We will assume that exchange rates had not changed.

31 May 2014

Being exchange difference on asset up to date of ceasing to be a qualifying asset

At 30 June 2014 we will need to take the exchange difference to profit or loss, as the asset has ceased to be a qualifying asset from 30 May 2014.

30 June 2014

¥5 000 000 ¸ 245 = A$20 408.
Thus the exchange difference is A$(20 833 – 20 408) = A$425

The cash was paid on 31 July 2014.

31 July 2014

¥5 000 000 ¸ 260 = A$19 231

The remaining exchange difference will then need to be taken to profit or loss.

31 July 2014

20 408 – 19 231 = 1177