Topic list Syllabus reference

5.3.1 Conversion gains and losses
Conversion is the process of exchanging amounts of one foreign currency for another. For example, suppose MerryCan Co, a US company, buys a consignment of goods from a supplier in Germany. The order is placed on 1 May and the agreed price is €124,250. At the time of delivery the rate of foreign exchange was €2 to $1. MerryCan Co would record the amount owed in its books as follows.
DEBIT Purchases (124,250 - 2) $62,125
CREDIT Trade Payables $62,125
When MerryCan Co comes to pay the supplier, it needs to obtain some foreign currency. By this time, however, if the rate of exchange has altered to €2.05 to $1, the cost of raising €124,250 would be (-? 2.05) $60,610. MerryCan Co would need to spend only $60,610 to settle a debt for inventories 'costing' $62,125. MerryCan Co will record a profit on conversion (or exchange gain) of $1,515.
DEBIT
CREDIT
CREDIT


Trade Payables
Cash
Profit on conversion


$62,125


$60,610 $1,515
Profits (or losses) on conversion would be included in profit or loss for the year in which conversion (whether payment or receipt) takes place.
Suppose that another YankiFed Co sells goods to a Mexican company and it is agreed that payment should be made in Mexican pesos at a price of MXN116,000. We will further assume that the exchange rate at the time of sale is MXN17.2 to $1, but when the debt is eventually paid, the rate has altered to MXN 18.1 to $1. YankiFed Co would record the sale as follows.


DEBIT
CREDIT


Trade Receivables (116,000 ■? 17.2) Revenue


$6,744


$6,744



When the MXN116,000 are paid, YankiFed Co will convert them into $, to obtain (-? 18.1) $6,409. In this example, there has been a loss on conversion of $335 which will be written off to profit of loss for the year:
DEBIT Cash $6,409
DEBIT Loss on conversion $335
CREDIT Trade Receivables $6,744

2. 
   Translation
   

Foreign currency translation, as distinct from conversion, does not involve the act of exchanging one currency for another. Translation is required at the end of an accounting period when a company still holds assets or liabilities in its statement of financial position which were obtained or incurred in a foreign currency.
These assets or liabilities might consist of:

1. 
   An individual home company holding individual assets or liabilities originating in a foreign currency 'deal'.
   
2. 
   An individual home company with a separate branch of the business operating abroad which keeps its own books of account in the local currency.
   

There has been great uncertainty about the method which should be used to translate the value of assets and liabilities from a foreign currency into $ for the year end statement of financial position.
Suppose, for example, that a Belgian subsidiary purchases a piece of property for €2,100,000 on
31 December 20X7. The rate of exchange at this time was €70 to $1. During 20X8, the subsidiary charged depreciation on the building of €16,800, so that at 31 December 20X8, the subsidiary recorded the asset as follows.
€ Property at cost 2,100,000
Less accumulated depreciation 16,800
Carrying amount 2,083,200
At this date, the rate of exchange has changed to €60 to $1.
The local holding company must translate the asset's value into $, but there is a choice of exchange rates.

1. 
   Should the rate of exchange for translation be the rate which existed at the date of purchase, which would give a carrying amount of 2,083,200 70 = $29,760?
   
2. 
   Should the rate of exchange for translation be the rate existing at the end of 20X8 (the closing rate of €60 to $1)? This would give a carrying amount of $34,720.
   

Similarly, should depreciation be charged to group profit or loss at the rate of €70 to $1 (the historical rate), €60 to $1 (the closing rate), or at an average rate for the year (say, €64 to $1)?

4. 
   Foreign currency transactions: initial recognition
   

IAS 21 states that a foreign currency transaction should be recorded, on initial recognition in the functional currency, by applying the exchange rate between the reporting currency and the foreign currency at the date of the transaction to the foreign currency amount. (IFRS 21: para. 21)
An average rate for a period may be used if exchange rates do not fluctuate significantly.
(IFRS 21: para. 22)

4. 
   Reporting at subsequent year ends
   

It is important to distinguish between monetary and non-monetary items. Monetary items involve the right to receive or the obligation to deliver a fixed or determinable amount of currency. This would include receivables, payables, loans etc. Non-monetary items would be items such as non-current assets and inventories.
The following rules apply at each subsequent year end.

1. 
   Report foreign currency monetary items using the closing rate
   
2. 
   Report non-monetary items (eg non-current assets, inventories) which are carried at historical cost in a foreign currency using the exchange rate at the date of the transaction (historical rate)
   
3. 
   Report non-monetary items which are carried at fair value in a foreign currency using the
   

exchange rates that existed when the values were measured. (IFRS 21: para. 23)

4. 
   Recognition of exchange differences
   

Exchange differences occur when there is a change in the exchange rate between the transaction date and the date of settlement of monetary items arising from a foreign currency transaction.
Exchange differences arising on the settlement of monetary items (receivables, payables, loans, cash in a foreign currency) or on translating an entity's monetary items at rates different from those at which they were translated initially, or reported in previous financial statements, should be recognised in profit or loss in the period in which they arise. (IFRS 21: para. 28)
There are two situations to consider:

1. 
   The transaction is settled in the same period as that in which it occurred: all the exchange difference is recognised in that period.
   
2. 
   The transaction is settled in a subsequent accounting period: the exchange difference recognised in each intervening period up to the period of settlement is determined by the change in exchange rates during that period.
   

In other words, where a monetary item has not been settled at the end of a period, it should be restated using the closing exchange rate and any gain or loss taken to profit or loss. (IFRS 21: para. 29)
Question
Seattle Co, whose year-end is 31 December, buys some goods from Telomere SA of France on 30 September. The invoice value is €60,000 and is due for settlement in equal instalments on 30 November and 31 January. The exchange rate moved as follows.
€ = $1

Presentation of published financial statements 1
11AS1 Presentation of Financial Statements 2
11AS 8 Accounting Policies, Changes in Accounting Estimates and Errors 302
11AS 33 Earnings per Share 322