ACC 5116 – ACCOUNTING FOR SPECIAL TRANSACTIONS

PAS 21 The Effects of Changes in Foreign Exchange Rates

Overview

PAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign currency
transactions and operations in financial statements, and also how to translate financial statements into a
presentation currency. An entity is required to determine a functional currency (for each of its operations
if necessary) based on the primary economic environment in which it operates and generally records
foreign currency transactions using the spot conversion rate to that functional currency on the date of the
transaction.

Objective of PAS 21

The objective of PAS 21 is to prescribe how to include foreign currency transactions and foreign
operations in the financial statements of an entity and how to translate financial statements into a
presentation currency. [PAS 21.1] The principal issues are which exchange rate(s) to use and how to
report the effects of changes in exchange rates in the financial statements. [PAS 21.2]

Key definitions [PAS 21.8]

Functional currency - the currency of the primary economic environment in which the entity operates.
(The term 'functional currency' was used in the 2003 revision of PAS 21 in place of 'measurement currency'
but with essentially the same meaning.)

Presentation currency - the currency in which financial statements are presented.

Exchange difference - the difference resulting from translating a given number of units of one currency
into another currency at different exchange rates.

Foreign operation - a subsidiary, associate, joint venture, or branch whose activities are based in a
country or currency other than that of the reporting entity.

Foreign currency transactions

A foreign currency transaction should be recorded initially at the rate of exchange at the date of the
transaction (use of averages is permitted if they are a reasonable approximation of actual). [PAS 21.21-
22]

Exchange differences arising when monetary items are settled or when monetary items are translated at
rates different from those at which they were translated when initially recognized or in previous financial
statements are reported in profit or loss in the period, with one exception. [PAS 21.28] The exception is
that exchange differences arising on monetary items that form part of the reporting entity's net
investment in a foreign operation are recognized, in the consolidated financial statements that include
the foreign operation, in other comprehensive income; they will be recognized in profit or loss on disposal
of the net investment. [PAS 21.32]

Accounting for Foreign Currency Transactions

An exchange rate is a measure of how much of one currency may be exchanged for another currency and
several terms are used to describe exchange rates.

1. A direct quote measures how much of the domestic currency must one exchanged to receive one
unit of a foreign currency, (i.e. Peso: Foreign Currency) Indirect quote measure how many units of
a foreign currency will be received for one unit of domestic currency, (i.e. Foreign Currency: Peso)
2. A currency may either strengthen (gain) or weaken (lose) relative to another currency.
A strengthening of a currency means that the directly quoted amount decreases and the indirectly
quoted amount increases. The opposite would be true for a weakening currency.
3. Buying and selling rates of exchange respectively represent what a currency broker is willing to
pay to acquire or sell a currency.
4. A spot rate indicates the number of units of a currency that would be exchanged for one unit of
another currency on a given date.
 5. A forward rate establishes, at one point in time, the number of units of one currency to be
exchanged for one unit of another currency at a specified future date. On a given date, different
forward rates may exist for the same currency, depending on how far in the future an exchange is
to take place.
a. The agreement to exchange currencies at a future date is called a forward contract.
b. A premium or discount refers to when the forward rate is greater than or less than the
spot rate respectively.

ILLUSTRATIVE PROBLEM 1

Giannis Jewels, Inc., a Philippine dealer of jewelries had the following transactions with foreign entities
where each transaction is denominated in the local currency unit of the country in which the foreign
entity is located:

Case 1. On November 2, 2021, Giannis purchased goods from Hongkong at a price of 40,000 Hongkong
dollars when the direct exchange rate was 1 Hkg$ = P4.50. The account has not been settled as of
December 31, 2021, when the exchange rate has decreased to 1Hkg$ = P4.00.

Case 2. On November 28, 2021, Giannis sold goods to a Taiwan Company at a price of 20,000 NT Dollars
when the direct exchange rate was 1 NT dollar = P1.80. The account has not been settled as of December
31, 2021, when the exchange rate has increased to 1 NT dollar = P1.90.

Case 3. On December 1, 2021, Giannis purchased goods from Japan at a price of 60,000 yen when the
direct exchange rate was 1 yen = P0.40. The account has not been settled as of December 31, 2021, when
the exchange rate has increased to 1 yen = P0.45.

Case 4. On December 1, 2021, Giannis sold goods to Indonesian Company at a price of 2,500,000 Baht
when the direct exchange rate was 1 Baht = P0.003. The account has not been settled as of December 31,
2021, when the exchange rate has decreased to 1 Baht = P0.0025.

Required: For each of the following independent cases, determine the December 31, 2021 balances of
the appropriate accounts (Accounts Receivable or Accounts Payable) and the Foreign Exchange
Gain/(Loss) for the year ended December 31, 2021 for each of the cases. Write “NA” for “not applicable”
in the space provided below if that account is not relevant to the specific case.

Accounts Accounts Forex

Receivable Payable Gain/Lloss)
Case 1
Case 2
Case 3
Case 4

ILLUSTRATIVE PROBLEM 2

Nikola, Inc. had the following transactions for the year 2021:

1. On May 1, Nikola purchased goods from a Japanese company for a Philippine peso value of
P800,000, to be paid on June 20. The exchange rates were:
May 1 1 yen = P0.40
June 30 1 yen = P0.45

2. On July 1, Nikola sold products to a Hongkong customer for a Philippine peso equivalent of
P500,000, to be received on August 10. The exchange rates were:
July 1 1 hkg dollar = P5.20
August 10 1 hkg dollar = P5.22

Required:

1. Assume the two transactions are denominated in Philippine peso. Prepare the entries required for
the dates of the transactions and their settlement in Philippine peso.

2. Assume the two transactions are denominated in the applicable local currency units of the foreign
entities. Prepare the entries required for the dates of the transactions and their settlement in the
local currency units of the Japanese company (yen) and the Hongkong customer (Hkg dollar)
 EXERCISES

1. If one (1) Euro can be exchanged for P69.25 Philippine peso, the indirect exchange rate of Euro per Philippine peso is:
a. 0.014 Euro c. 6.825 Euro
b. 6.925 Euro d. 6.725 Euro

2. In October 2021, United Corporation obtained a loan amounting to US $ 120,000 for the purchase of machinery and
equipment. By the end of the year, one-half of the loan was still unpaid and a ten per cent decrease has taken place. If the
foreign loan payable account is correctly reported in the balance sheet at P1,848,000, the rate of exchange at the time the
loan was obtained must have been:
a. $1.00 = P27.00 c. $1.00 = P29.00
b. $1.00 = P28.00 d. $1.00 = P30.00

3. Craft Corp. sold metal crafts to a US firm for $70,000 and pertinent information on exchange conversion rates related to
this transaction were as follows:
Conversion Rate
(Peso to US$)
Nov. 4 Receipt of order P27.40
Nov. 22 Date of shipment 27.50
Dec. 31 Balance sheet date 27.60
Jan. 6 Date of collection 27.00

The sale would be appropriately recorded at:

a. 1,890,000 c. 1,925,000
b. 1,918,000 d. 1,932,000

4. The White Co. has the Philippine pesos as sits functional currency. On October 16, 2019, White ordered some inventory
from a foreign supplier and agreed a purchase price of 160,000 local currency units (LCU). The inventory was received on
November 15, 2019.

At December 31, 2019, the inventory remained on hand and the trade payable balance for the inventory purchase
remained outstanding. The supplier was paid on January 27, 2020 and the inventory was sold on January 31, 2020. The
following information about exchange rates is available:
October 16, 2019 P1.00 = 2.60 LCU
November 15, 2019 P1.00 = 2.50 LCU
December 31, 2019 P1.00 = 2.40 LCU
January 27, 2020 P1.00 = 2.25 LCU

According to PAS 21, The Effects of Changes in Foreign Exchange Rates, at what amount should the trade payable
balance due to the supplier be presented in the statement of financial position at December 31, 2019?
a. 61,538 c. 66,667
b. 64,000 d. 71,111

5. On November 15, 2021, Steph, Inc., a Philippine Company, ordered merchandise FOB shipping point from Japanese
Company for 200,000 yens. The merchandise was shipped and invoiced to Steph on December 10, 2021. Steph paid the
invoice on January 10, 2022. The spot rates for yens on the respective dates are as follows:
November 15, 2021 P.4955
December 10, 2021 4875
December 31, 2021 4675
January10, 2022 4475

In Steph's December 31,2021 income statement, the foreign exchange gain is:
a. 9,600 c. 4,000
b. 8,000 d. 1,600

6. On June 15, 2020, Kawhi Co. purchased merchandise worth 100,000 Swiss francs from its supplier in Switzerland payable
within 30 days under an open account arrangement. Kawhi issued a 30-day, 6% note payable in Swiss francs. On July 15,
2020, Kawhi paid the note in full.

The following information in spot rates is provided:

Buying Selling
June 15,2020 P 24.03 P 24.15
July 15,2020 24.10 24.22

What is Kawhi's foreign exchange gain (loss) for the transaction?

a. (5,040) c. (7,035)
b. 12,075 d. (19,110)