FOREIGN CURRENCY TRANSACTIONS

As the company grows or expands its operations, it engages in international activities like
exporting or importing goods and establishing a foreign branch or holding an equity
investment in a foreign company.

The ways of conducting international activities can classified as follows:

1. Foreign currency transaction or a transaction to be settled in a foreign currency

(e.g., exporting or importing goods)
2. Foreign operation or establishing a foreign branch or holding an equity investment
in a foreign company

International activities would more likely involve foreign currency or a currency other than
functional currency of the entity. The effects of exchange difference or difference resulting
from translating one currency into another currency will have to be considered to faithfully
present the company’s financial statements. Exchange rates are constantly changing,
therefore, determining the appropriate exchange rate is a principal concern in
accounting for international or foreign activities.

Accordingly, accounting concerns on currency measurement must be settled relating to

the following:

1. Recording transactions with a foreign company

2. Reporting the financial statements of a foreign branch or investee

Accounting exposure to changes in exchange rates includes (1) transaction exposure in

entering contractual rights (receivables) or obligations (payables) denominated in foreign
currencies and (2) translation exposure of integrating foreign currency financial statements
of foreign operation to the local currency financial statements.

A transaction with a foreign company that is to be settled in the local currency is not a foreign
currency transaction. To be classified as FOREIGN CURRENCY TRANSACTION, said
transaction will be settled in a foreign currency, and the firm is exposed to the risk of
unfavorable changes in the exchange rate that may occur between the date the
transaction is entered into and the date the account is settled. Foreign currency
transactions include sales and purchases of goods or services (exports or imports) or
acquiring or disposing of assets whose prices are denominated in foreign currency and loans
(payables or receivables) in a foreign currency.
Effects of Changes in Foreign Exchange Rates

Generally, there are three stages of concern translating accounts denominated in foreign
currency as follows:
• Date of transaction
• Balance sheet date
• Settlement date

How do we record foreign currency transactions?

At date of transaction or in its initial recognition, a foreign currency transaction is to be

recorded and measured by applying to the foreign currency the spot exchange rate. Spot
rate is the rate for the immediate delivery of currencies exchanged. It is the rate in which
currencies can be exchanged today. Often referred to as actual rate or historical rate

How do we report effects of foreign currency transactions at subsequent balance

sheet date?

Distinctions are made in subsequent reporting between monetary and non-monetary items
that arise from a foreign currency transaction.

• Monetary Item is the unit of currency held and assets and liabilities to be
received or paid in fixed or determinable number of units of currency or items
whose balances are fixed in terms of pesos regardless of changes in the general
price level. This includes the following:
• Cash
• Prepaid interest
• Accounts, notes and loans receivable
• Accounts, notes and loans payable
• Bonds and mortgage payable
• Tax payable

• Non-monetary Items are accounts whose peso amounts presented in the

financial statements differ from what they are actually realized or represents.
This includes the following:
• Inventories
• Prepaid expenses except prepaid interest
• Investments in equity instruments
• PPE
• Intangible assets
• Unearned revenue and refundable deposits
• Capital stock
• Deferred tax assets and liabilities
At each balance sheet date, effects of foreign currency transactions are reported as follows:

• The foreign currency monetary items are adjusted or re-measured for exchange
rate changes using the current rate/closing rate on balance sheet date.

Exchange gains and losses or transaction/exchange differences on monetary items

are recognized in profit or loss of the entity as they arise.

• The foreign currency non-monetary items that are measured in terms of historical
cost are translated using exchange rate on the date of transaction (meaning
historical or actual rate) on balance sheet date. No adjustment is necessary.

• The foreign currency non-monetary items that are measured at fair value are
translated using exchange rates on the date when the fair value was determine.
Usually, this date is the balance sheet date, hence the current/closing rate is used
to translate these items.

Investment in equity instruments are generally non-monetary items as the amount to

be received from these instruments is not fixed but is dependent on market
conditions or fair value.

Any gain or loss on a non-monetary item that is measured at fair value is recognized
directly in other comprehensive income.

TO ILLUSTRATE assume on November 1, 20x4 a Philippine firm ordered 1,000 units of

inventory from a US firm for $20,000. The inventory was shipped and invoiced to the Phil.
firm on December 1, 20x4, to be paid on March 1, 20x5. The firm’s fiscal year-end is
December 31. The spot rates for US dollars at various dates are as follows:

Buying rates Selling rates

Nov. 1, 20x4 P39.80 P40.25
Dec. 1, 20x4 40.00 40.55
Dec. 31, 20x4 40.70 40.80
March 1, 20x5 40.60 40.65

December 1, 20x4

Purchases ………………………. P811,000

Accounts payable ………. P811,000
($20,000 x P40.55)
#

December 31, 20x4

Fxcy transaction loss …………………. P 5,000

Accounts payable …………….. P 5,000
($20,000 x (P40.80-P40.55))
#
March 1, 20x5

Accounts payable ………………………. P816,000

Cash
($20,000 x P40.65) ………….….. P813,000
Fxcy transaction gain
($20,000 x (P40.80-P40.65)) …… 3,000
#

TO ILLUSTRATE FURTHER, assume on November 1, 20x4 a Philippine firm received an

ordered for 1,000 units of inventory for $50,000 to a US firm. The Phil. firm shipped the
inventory and billed the US firm on December 1, 20x4. The Phil. firm received the
customer’s remittance in full on March 1, 20x5. The firm’s fiscal year-end is December 31.
The spot rates for US dollars at various dates are as follows:

Buying rates Selling rates

Nov. 1, 20x4 P39.80 P40.25
Dec. 1, 20x4 40.00 40.55
Dec. 31, 20x4 40.70 40.80
March 1, 20x5 40.60 40.65

December 1, 20x4

Accounts receivable
($50,000 x P40.00)……………. P2,000,000
Sales ………. P2,000,000
#

December 31, 20x4

Accounts receivable……………………. P 35,000

Fxcy transaction gain…………. P 35,000
($50,000 x (P40.70-P40.00))
#

March 1, 20x5

Cash …………………………………… P2,030,000

($50,000 x P40.60)
Fxcy transaction loss …………………. 5,000
Accounts receivable …………….. P2,035,000
#
Illustration

Jen Corporation, whose functional currency is peso, entered the following transactions
during 20x4 and 20x5.

1. On Nov. 1, 20x4, Jen purchased 1,000 shares of Pineapple Computers, Inc. (a listed
company in the US) at a price of $80 per share. Jen classified the investment as
equity investment-fair value through profit or loss/financial asset. The peso/US$
exchange rates on November 1, 20x4 and December 31, 20x4 were P40 and P40.50
respectively. The price of Pineapple computers, Inc. shares on Dec. 31, 20x4 was
$100
2. On Dec. 10, 20x4, Jen purchased equipment from a German Co. invoiced at 10,000
euros to be settled on Feb 28, 20x5. The peso/euro exchange rates on Dec. 10,
20x4, Dec. 31, 20x4 and Feb 28, 20x5, were P53.00, P53.20 and 53.80 respectively.

Required: Journal entries relating to the above transactions

November 1, 20x4 – To record the purchase of shares of Pineapple Computers, Inc.

Equity investment ………………………. P3,200,000

Cash……………….. ………… P3,200,000
($80,000 x P40.00)
#

December 10, 20x4 – To record the purchase of equipment from a German Co.

Equipment
(10,000 euros x P53) …………………… P 530,000
Accounts payable….…….. P 530,000
#

December 31, 20x4 – To record gain in fair value of Pineapple Computer’s shares

Equity investment ………………………. P 850,000

OCI-FxCy Transaction gain …… P 40,000
Unrealized gain in FV of
equity investment ………… 810,000
#

12/31 Revalued investment (1T X $100 x P40.50)…… P4,050,000

11/1 Investment cost …………………………………. 3,200,000
Unrealized gain on equity investment P850,000
Less: FxCy Transaction gain:
P3,200,000 – (1T x $80 x P40.50) 40,000
Unrealized gain in FV of the equity investment P810,000
December 31, 20x4 – To record exchange loss on accounts payable

FxCy transaction loss ……………………….P 2,000

Accounts payable ………… P 2,000
(10T euros x (P53.20-P53)
#

February 3, 20x5 – To record settlement of accounts payable

Accounts payable………………………… P532,000

FxCy transaction loss
(10T euros x (P53.80-P53.20) .…………. 6,000
Cash
(10T x P53.80) …………..…….. P538,000
#

PRACTICE PROBLEM (Foreign Currency Transaction)

1. On November 1, 20x4 a Philippine firm ordered 1,200 units of inventory from a US firm
for $24,000. The inventory was shipped and invoiced to the Phil. firm on December 1,
20x4, to be paid on March 1, 20x5. The firm’s fiscal year-end is December 31. Assume
further that the Phil. firm did not engage in any form of hedging activity. The spot rates
for US dollars at various dates are as follows:
Buying rates Selling rates
Nov. 1, 20x4 P39.80 P40.25
Dec. 1, 20x4 40.00 40.55
Dec. 31, 20x4 40.70 40.80
March 1, 20x5 40.60 40.65

Required: Determine the following:

a. Foreign exchange gain or loss on:
i. December 1, 20x4
ii. December 31, 20x4
iii. March 1, 20x5
b. On December 31, 20x4:
i. Accounts payable
ii. Inventory
2. CDL imports and exports chocolate delicacies. Some transactions are denominated in
pesos and others in foreign currencies (FC1 and FC2). A summary of accounts
receivable and accounts payable on December 31, 20x6, before adjustments for the
effects of changes in exchange rates during 20x6 are as follows:

Accounts receivable
In pesos P164,000
In 475,000 FC1 P 73,600
Accounts payable
In pesos P 86,000
In 21,000,000 FC2 P175,300

The spot rates on December 31, 20x6 are as follows:

FC1 = P.176
FC2 = P.0081

The average exchange rates during the collection and payment period in 20x7 are as
follows:
FC1 = P.18
FC2 = P.0078

Required:
1. What was the foreign currency gain or loss on the accounts receivable transaction
denominated in FC1 for the year ended December 31, 20x6? For the year ended
December 31, 20x7? Over-all for this transaction?
2. What was the foreign currency gain or loss on the accounts payable transaction
denominated in FC2 for the year ended December 31, 20x6? For the year ended
December 31, 20x7? Over-all for this transaction?
3. What was the combined over-all foreign currency gain or loss for the year ended
December 31, 20x6? For the year ended December 31, 20x7? Both transaction?

FOREIGN CURRENCY TRANSLATION

Foreign currency translation is the accounting method in which a business entity converts
its foreign operation results expressed in foreign currency into its domestic currency. The
main purpose of foreign currency translation is to prepare consolidated financial statements
which are used by stakeholders to compare results across countries and enable them to
make sound decisions.

What is a foreign operation?

A foreign operation is an entity that is a subsidiary, associate, joint venturer or branch

of a reporting entity, the activities of which are based or conducted in a country or
currency other than those of the reporting entity.
The results and financial position of a foreign operation are translated into a presentation or
reporting currency so that the foreign operation can be included in the financial statements
of the reporting entity by consolidation.

The following are the rules in the translation of the financial position and results of operation
of a foreign operation into a different presentation currency:

1. The financial position and results of operation of an entity whose functional currency
is not that of a hyperinflationary economy shall be translated into a different
presentation currency using the following procedures:

• Assets and liabilities (both monetary and non-monetary) for each statement of
financial position presented shall be translated at closing rate at the date of
that statement of financial position.
• Income and expenses for each statement of results of operation shall be
translated at the exchange rates at the date of the transactions. For practical
reasons, a rate that approximates the exchange rates at the date of
transactions, such as average rate for the period, is often used.
• All exchange differences shall be recognized in other comprehensive
income.

Exchange differences are not recognized in profit or loss because the changes
in exchange rates have little or no direct or immediate effect on the cash flows.
Investment in foreign operation is presumed to be long-term.

2. The financial position and results of operation of an entity whose functional currency
is that of a hyperinflationary economy shall be translated into a different presentation
currency using the following procedures:

• All amounts (assets, liabilities, equity items, income and expenses) shall be
translated at the closing rate at the date of the most recent statement of
financial position, except that
• When amounts are translated into the currency of a non-hyperinflationary
economy, comparative amounts shall be those that were presented as current
year amounts in the relevant prior year financial statements

3. When the financial statements of a foreign operation are as of a date different from
that of the reporting entity, the assets and liabilities of the foreign operation are
translated at the exchange rate at the end of the reporting of the foreign operation.

4. Any goodwill arising on the acquisition of a foreign operation and any fair value
adjustments to the carrying amounts of the assets and liabilities arising on the
acquisition of that foreign operation shall be treated as assets and liabilities of the
foreign operation and shall be translated using the closing rate.

5. When the foreign operation is disposed, the cumulative amount of the exchange
differences relating to that foreign operation, recognized in other comprehensive
income, shall be reclassified from equity to profit or loss when the gain or loss on
disposal is recognized.
Illustration

Assume that on January 2, 20x4, P Company, a Philippine based company, acquired for
US$2,000,000 an 80% interest in S Company. S Company maintains its books and prepares
financial statements in U.S. dollars. Exchange rates for the U.S. dollars for 20x4 are as
follows:
Dates Spot rates
January 2, 20x4 (date of acquisition) P40.00
September 1, 20x4 40.10
December 31, 20x4 40.25
Average for the 4th quarter 40.22
Average for the year 40.20

In translating the statement of results of operations accounts, it is assumed that the

revenues were generated and expenses were incurred evenly during the year. It is also
assumed the company uses FIFO cost flow assumption, and that the ending inventory was
acquired during the last quarter.

The translation working paper would be as follows:

Combined Statement of Income Exchange Adjusted

Balances
and Retained Earnings Rate Amount
Sales 3,020,000 40.20 121,404,000
Cost of goods sold 1,850,000 40.20 74,370,000
Depreciation expense 100,000 40.20 4,020,000
Other expenses 655,000 40.20 26,331,000
Income tax expense 82,000 40.20 3,296,400
Net income to retained earnings 333,000 13,386,600
Retained earnings (beg) 480,000 40.00 19,200,000
Total 813,000 32,586,600
Dividends declared, 9/1/20x4 300,000 40.10 12,030,000
Retained earnings (end) 513,000 20,556,600
Statement of Financial Position
Cash 930,000 40.25 37,432,500
Accounts receivable (net) 608,000 40.25 24,472,000
Inventory (FIFO) 830,000 40.25 33,407,500
Land 500,000 40.25 20,125,000
Building (net) 650,000 40.25 26,162,500
Equipment (net) 430,000 40.25 17,307,500
Total 3,948,000 158,907,000
Accounts payable 640,000 40.25 25,760,000
Short-term notes payable 635,000 40.25 25,558,750
Bonds payable 900,000 40.25 36,225,000
Capital stock, P10 par 960,000 40.00 38,400,000
Share premium 300,000 40.00 12,000,000
Retained earnings (end) 513,000 20,556,600
Total 3,948,000 158,500,350
FxCy translation reserve gain (OCI) 406,650**
Total 3,948,000 158,907,000

** Balancing amount
Note: As a component of equity, dividends are translated using the exchange rate in effect
when the dividend was declared.

The translation adjustment maybe computed as follows:

Exchange Adjusted
Balances
Rate Amount
Net asset position (beg) 1,740,000 40.00 69,600,000
Adjustment for changes in net asset position
during the year
Net income for the year 333,000 13,386,600
Dividends declared (300,000) 40.10 (12,030,000)
Net assets before adjustment 1,773,000 70,956,600
Adjusted net asset 1,773,000 40.25 71,363,250
Translation adjustment 406,650
Cumulative adjustment (beg) 0
Cumulative adjustment (end) 406,650