Singapore Polytechnic

SP Business School
Diploma in Accountancy
Advanced Financial Accounting I (2015/16)
Accounting for the Effects of Changes in Foreign Exchange
Rates
Lecture Outline
1. Introduction
2. Exchange Rate Quotations
3. Types of Exchange Rate Exposures
4. Accounting for Foreign Currency Transactions
5. Translation of Foreign Currency Financial Statements

References
1

A Practical Guide to Financial Reporting Standards

(Singapore) (5th Ed)

FRS 21 The Effects of Changes in Foreign Exchange

Rates

Ng Eng Juan
ASC

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1. Introduction
In the past, most currencies are pegged to the US dollar, which was pegged to the
price of gold (fixed exchange rate system). In 1974, there was a worldwide shift to the
floating rate system, in which currencies fluctuate in response to changing supply and
demand for currency. Countries like US and Canada adopt free float but other
countries adopt a managed float approach, where the central bank will buy and sell
currency to maintain it at a certain rate.

2.

Exchange Rate Quotations

Exchange rate is the price of a currency expressed in another currency.

(a) Direct quote: expresses the price of one unit of foreign currency in terms of
domestic currency
SGD1.30/USD 1
SGD0.41/MYR 1
SGD1.31/AUD 1
(b) Indirect quote expresses one unit of domestic currency in terms of units of foreign
currency.
SGD1/USD 0.769
SGD1/MYR2.44
SGD1/AUD0.771

3.

2 Types of Exchange Rate Exposures introduced

Foreign exchange rate exposure can be broadly categorised into 2 types, operating and
accounting exposure.
Operating Exposure
Operating exposure affects the competitive position of a firm and the value of the
firm. Changes in foreign exchange rates can affect the demand and supply functions
for a firms goods and services, thereby, affecting its operating cash flows or items on
its financial statement.
Example: If a Singaporean company imports Japanese goods, it has exposure to
Japanese Yen. If the Yen appreciates, imported Japanese goods will be more costly.
Accounting Exposure
Accounting exposure impacts the statement of Comprehensive Income and Retained
Profits or financial position of a firm. Accounting exposure can be divided into:
(i) Transaction exposure: arises directly as a consequence of firms foreign currency
transactions. For instance,

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(a)

buys or sells goods or services whose price is denominated in a foreign

currency;

(b)

borrows or lends funds when the amounts payable or receivable are

denominated in a foreign currency; or

(c)

otherwise acquires or disposes of assets, or incurs or settles liabilities,

denominated in a foreign currency.

Since a foreign currency transaction is denominated in a foreign currency, it

may be exposed to risks arising from fluctuations in foreign exchange rates.
Typically, these transactions occur at one date and are settled on another later date.
Foreign exchange movements between the 2 dates will result in a transaction gain
or loss.
If a foreign transaction may be receivable or payable in domestic currency
(Singapore dollar), in which case, it would be a domestic currency transaction
with no exposure to exchange fluctuations, even though it is a foreign transaction.
(ii) Translation exposure: arises from translation of foreign currency financial
statements from local currency to the groups reporting currency for purposes of
consolidation. For example, a Singapore company with Malaysian subsidiary
needs to translate the subsidiary accounts, denominated in MYR to SGD before
consolidation.
(This will be covered later in the lecture)

4.

Accounting for Foreign Currency Transactions

Transactions denominated in Foreign Currency

The following time line represents a typical foreign exchange transaction.
____________________________________________________________________
Foreign currency
transaction recorded at
actual (historical)
exchange rate (eg
Accounts receivable)

Financial year end.

Outstanding amount

Settlement date

(a) Initial Recognition - FRS 21, Para 21 & 22

Foreign currency transaction should be recorded using the actual exchange rate
at the date of transaction.
Monetary vs Non-monetary item:

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Monetary items are units of currency held and assets and liabilities to be
received or paid in a fixed or determinable number of units of currency.
Example: cash, accounts receivable, accounts payable
Non-monetary items do not have the right to be received or paid in a fixed or
determinable number of units of currency. Examples include, prepayments,
intangibles and fixed assets

(b) Reporting at subsequent Balance Sheet dates - FRS 21, Para 23

At each balance sheet date:
(a)

Foreign currency monetary items shall be translated using the closing rate
This is because monetary items are carried at contractual amounts that are
eventually settled or received in a specific currency.
For example, a loan of US$100,000 is equivalent to S$130,000 as at 15
December 2011. Assuming that on 31 December 2011, the exchange rate is
US$1 to S$1.2, the loan in domestic currency should be remeasured to
S$120,000.

(b)

Foreign currency non-monetary items that are measured in terms of historical

cost in a foreign currency shall be translated using the exchange rate at the date
of the transaction
For example, the Singapore company bought fixed asset of US$10,000 on 1
December 2011 when exchange rate was US$1 to S$1.2. As at 31 December
2011, even if exchange rates have changed, the fixed asset is still carried at
historical cost.

(c)

Foreign currency non-monetary items that are measured at fair value in a

foreign currency shall be translated using the exchange rates at the date when
the fair value was determined
For example if Singapore company bought tradable securities denominated in
US$ on 1 December 2011 of US$10,000 when exchange rate was US$1 to
S$1.2, and the fair value as at 31 December 2011 was US$10,500 and exchange
rate was US$1 to S$1.25, the amount reflected on the balance sheet is S$13,125
(10,500*1.25)
Recognition of exchange differences - exchange gains or losses
Exchange differences can be recognised using 2 different methods, one
transaction perspective and two transaction perspective.
One transaction perspective

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The trading transaction and the settlement transaction are viewed as a single
transaction and the exchange difference will be adjusted to the trading
transaction.
Two transactions perspective
The trading transaction and the settlement transaction are viewed as a two
separate transaction and the exchange difference will be adjusted separately as
an exchange gain or loss.
FRS 21 requires the adoption of the two transactions perspective.
The Exchange differences arising on the settlement of monetary items or on
translating monetary items at rates different from those at which they were
translated on initial recognition during the period or in previous financial
statements shall be recognised in profit or loss in the period in which they arise,
FRS 21, para 28
Example:
1:
Exchange rates
2:
Reporting at subsequent Balance Sheet dates
Unrealised exchange differences on monetary items
3:
Realised exchange differences on monetary items
Example 1
A Ltd (a company incorporated in Singapore, year end 31 December) sold
goods invoiced at RM100,000 to B Bhd (a company incorporated in Malaysia)
on 10 November 20x1 when the exchange rate RM1 = S$0.80. What is the
journal entry to record on the transaction date?
In the books of A Ltd (Singapore Co.)
10/11/x1
Dr
Accounts Receivable
Cr
Sales
(To record sales on 10/11/20x1)

80,000
80,000

Example 2
Assume that at 31 December 20x1, B Bhd still has not paid A Ltd and the
exchange rate prevailing at 31 December 20x1 is RM1 = S0.75. What is the
journal entry to record at the financial year end?
31/12/x1
Dr
Unrealised exchange loss (P/L)
Cr
Accounts Receivable
(To record unrealised exchange differences)

5,000
5,000

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Example 3
Assume that the B Bhd paid A Ltd on 20 Jan 20x2 when RM1 = S$0.70
20/1/x2
Dr
Cash
Dr
Realised exchange loss (P/L)
Cr
Accounts Receivable
(To record cash received from B Bhd)

70,000
5,000
75,000

With reference to Example 3 above, the sales and the eventual receipt are
viewed as two separate transactions and exchange differences are recorded
separately according to the two transactions perspective as exchange gains and
losses.
If one transaction perspective was applied, the sale and eventual receipt will
be viewed as a single transaction and exchange differences will be adjusted to
sales. (For your reference)

5. Translation of Foreign Currency Financial Statements

5.1 What is Foreign Currency Translation?
Translation process involves converting the measuring unit of the final accounts
of the foreign operations (for examples, subsidiary company, associated
companies, joint ventures and branches) from foreign currencies to the reporting
currency of the holding company or head office.
There are 2 issues involved, as to:
(a)
(b)

Which exchange rate to be used to translate the various items in the final
accounts of the foreign operations;
Treatment of the exchange differences (translation gain or loss) arises from
the translation.

Presentation Currency:
The currency in which the financial statements are presented is called the presentation
currency.
Functional Currency:
Functional currency is the currency of the primary economic environment in which the
entity operates. This is the economic environment is the environment in operates that
primarily generates and expends cash.
The following primary factors are to be considered to determine the functional currency:
-The currency that sales prices are denominated and settled
-The currency of the country whose competitive forces and regulations mainly determine
the sales price of goods and services and

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-The currency in which labour and costs are denominated and settled.
Secondary factors to consider include:
-The currency in which funds from financing activities are generated
-The currency in which receipts from operating activities are usually retained.
Generally company needs to exercise judgement in determining the functional currency.
Firms need to designate a currency as its functional currency. It should be the currency
that firm receives most of its cash receipts and expends most of its cash outlays.
For example for Neptune Orient Lines, the national shipping company of Singapore,
most of its revenue is billed in US$ and most of its costs are fuel prices, also paid in
US$. Therefore, even though it is a Singapore-domiciled company, its functional
currency is US$.

5.2 Translation to the presentation currency (FRS 21 Para 39 & 42)

Non- hyperinflationary economy
The results and financial position of an entity whose functional currency is not
the currency of a non-hyperinflationary economy shall be translated into a
different presentation currency using the following procedures:
(a)

assets and liabilities for each balance sheet presented (i.e. including
comparatives) shall be translated at the closing rate at the date of that
financial position;

(b)

income and expenses for each income statement (i.e. including

comparatives) shall be translated at exchange rates at the dates of the
transactions (usually average rate is used); and

(c)

all resulting exchange differences shall be recognised as a separate

component of equity. (called the foreign currency translation reserve)

Hyperinflationary economy
The results and financial position of an entity whose functional currency is the
currency of a hyperinflationary economy shall be translated into a different
presentation currency using the following procedures:
(a)

all amounts (ie assets, liabilities, equity items, income and expenses,
including comparatives) shall be translated at the closing rate at the date of
the most recent statement of financial position, except that

(b)

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 (ie not
adjusted for subsequent changes in the price level or subsequent changes
in exchange rates). (exception includes dividends.) (Share capital and preacq reserves to be translated at acquisition date rates.)
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5.3 Closing rate method (Tested)

The method whereby the financial statements are translated from the functional
currency into the presentation currency is known as the Closing Rate Method.

5.4 Temporal method (For your reference)

When the financial statements of the entity are prepared in a currency other than its
functional currency, a remeasurement will be used to remeasure/translate the
foreign currency to the functional currency. Such process is also termed as the
Temporal Method.

5.5 Exchange differences

The treatment of exchange differences are recognised as a separate component of
equity under the closing rate method.
(a)

Exchange differences are not recognised in profit or loss because the

changes in exchange rates have little or no direct effect on the present and
future cash flows from operations.

(b)

On disposal of the foreign operations, the cumulative amount of the

exchange differences deferred in the separate component of equity is
recognised in profit and loss. (not tested)

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5.6 Share capital and pre-acquisition reserves

It should be noted that no matter which translation method is used, the share
capital and pre-acquisition reserves of the foreign operations should be
translated at the exchange rate in effect on the date of acquisition.
Example 4 & 5: (Closing rate method)
i)
ii)

Solution (A), assume hyperinflationary economy

Solution (B), assume non-hyperinflationary economy

5.7 Disclosure requirements

Refer to FRS 21, par 51-57
"The End"

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