CHAPTER FIVE

ACCOUNTING FOR FOREIGN

EXCHANGE TRANSACTION
Based on IAS 21

PREPARED BY: HASSEN

MUSTEFA
 Foreign currency transactions
• Foreign currency transactions are economic activities denominated
in a currency other than the entity’s recording currency.
• These include:

1. Purchases or sales of goods or services (imports or exports), the

prices of which are stated in a foreign currency

2. Loans payable or receivable in a foreign currency

3. Purchase or sale of foreign currency forward exchange contracts

4. Purchase or sale of foreign currency units

 Cont…
• Foreign currency transactions of an Ethiopian
company denominated in other currencies must
be restated to their Br equivalents before they
can be recorded in the Ethiopian company’s
books and included in its financial statements.

– Translation: The process of restating foreign

currency transactions to their Br equivalent values .
 Foreign Currency Exchange Rates
• Exchange Rate is the ratio of exchange of two currencies.
• Exchange Difference is resulting from translating a given number
of units of one currency in to another currency.
Two Methods of Reporting Exchange Rates
1. Direct Exchange Rate (DER): is the number of local currency units
(LCUs) needed to acquire one foreign currency unit (FCU).
– From the viewpoint of a Ethiopian entity:
Br – equivalent value
DER = 1 FCU
Example: On January 1, 2020, an Ethiopian based company can purchase one
Dollar for Br 30.
DER = Br
Br
30/$30
= 1$
 Cont…
2. Indirect Exchange Rate (IER): is the reciprocal of the direct exchange rate. It
is the number of Foreign currency units (FCUs) needed to acquire one
Local currency unit (LCU).
– From the viewpoint of a Ethiopian entity:
IER
1 FCU
=
Br – equivalent value

Example: On January 1, 2020, an Ethiopian based company can purchase one

Dollar for Br 30. = $ 0.034/
IER = Br
$1
Br 30
 ANALYSIS OF EXCHANGE RATE
DER Increase/IER Decreases
 Weakening of Local currency
 Taking More Local currency to acquire one Foreign Currency.
 One LCU acquiring Fewer FCUs.
 Export Increase and Import Decrease.
DER Decreases/IER Increase
 Strengthening of Local currency
 Taking Less Local currency to acquire one Foreign Currency.
 One LCU acquiring Higher FCUs.
 Export Decrease and Import Increase
 REASON OF EXCHANGE RATE
FLUCTUATION
• Determination of exchange rates
– Exchange rates change because of a number of
economic factors affecting the supply and demand
for a nation’s currency.
– Factors causing fluctuations are a nation’s
• Level of inflation
• Balance of payments
• Changes in a country’s interest rate
• Investment levels
• Stability and process of governance
 TYPES OF EXCHANGE RATES
1. Spot rate: is the exchange rate for immediate delivery of
currencies
2. Current (Closing) Rate: is Spot rate on the entity’s balance
sheet date.
3. Forward Rate: Expectations about the relative value of
currencies are built into the forward rate.
• Spread: The difference between the forward rate and
the spot rate on a given date.
• The spread gives information about the perceived
strengths or weaknesses of currencies.
 TYPES OF CURRENCIES FOR
REPORTING PURPOSE
1. Functional currency: is the currency of the primary
economic environment in which the entity operates.
2. Presentation Currency: is the currency in which the
financial statements are presented.
3. Foreign Currency: is a currency other than the functional
currency of the entity.
4. Local Currency: is the currency of the country in which the
entity operates.
DETERMINATION OF FUNCTIONAL
CURRENCY
 Factors to be consider during determining Functional Currency:-

1. Sales prices for goods and services are denominated and settled.

2. The currency of competitive forces and regulations.

3. the currency that mainly influences labor, material and other costs.
 Factors that provide evidence of an entity’s functional currency:

1. the currency in which funds from financing activities (i.e. issuing

debt and equity instruments) are generated.
2. currency in which receipts from operating activities are usually
retained.
 Cont…

Note:
 When the above indicators are mixed and the functional currency
is not obvious, management uses its judgment to determine the
functional currency that most faithfully represents the economic
effects of the underlying transactions, events and conditions
 once determined, the functional currency is not changed unless
there is a change in those underlying transactions, events and
conditions.
FOREIGN CURRENCY IMPORT AND
EXPORT TRANSACTIONS
1. Transaction date: Record the purchase or sale transaction at
the Local Currency Units using the spot direct exchange rate on
this date.
2. Balance sheet date: Adjust the payable or receivable to its
Local Currency Units, end-of-period value using the current direct
exchange rate.
• Recognize any exchange gain or loss for the change in rates
between the transaction and balance sheet dates.
3. Settlement date: Adjust the foreign currency payable or
receivable for any changes in the exchange rate between the
balance sheet date (or transaction date) and the settlement date,
recording any exchange gain or loss as required.
• Record the settlement of the foreign currency payable or
receivable
 EXAMPLE 1

On October 1, 2010, ABC Company, an Ethiopian Company,

acquired goods from Martin, an American company, for
$2,000,000.00. ABC prepared Financial Statement at year end
on December 31, 2010. Settlement of the payables was made
on April 1, 2011.
Spot rates
October ….........…..1$ = Br 30
December 31......…1$ = Br 34
April 1…………………..1$ = Br
32
 Solution
ABC
October 1 Purchase/Inventory……..Br 60,000,000.00
Account Payable………Br 60,000,000.00
($2,000,000 * Br 30/$ = Br 60,000,000)

December 31 Loss on Foreign Exchange Transaction …….Br 8,000,000.00

Account Payable………………………………….Br
8,000,000
($2,000,000 * Br 34/$ = Br 68,000,000)

April 1 Account Payable……….Br 4,000,000.00

Gain on Foreign Exchange Transaction…..Br 4,000,000.00

Account Payable………..Br 64,000,000.00

Cash……………………………………………Br
64,000,000.00
($2,000,000 * Br 32/$ = Br 64,000,000.00)
 EXAMPLE 2
Suppose ethio telecom buys a large consignment of
goods from a supplier in Egypt. The order is placed on 1
April and the agreed price is 124,250 Egypt Dollar. At
the time of delivery the rate of foreign exchange was
Birr 1.00 to 3.50 Egypt Dollar.
Required
Show the initial recognition
What will the entries be if the exchange rate is 3.55
when payment is made on may 1?.
 Solution
Initial recognition- ethio telecom will recognize the purchase using its functional currency (Birr)
by applying the spot exchange rate when the purchase was made (Birr 1.00 to 3.50 Egypt Dollar)

Inventory account (124,250 ÷ 3.5)....................Br 35,500

Payables account.........................................Br 35,500

When ethio telecom comes to pay the supplier, it needs to obtain some foreign currency. By this
time, however, if the rate of exchange has altered to 3.55 to 1, the cost of raising €124,250 would
be (÷ 3.55) 35,000. The company would need to spend only 35,000 to settle a debt for inventories
'costing' 35,500. Since it would be administratively difficult to alter the value of the inventories
in the company's books of account, it is more appropriate to record a profit on conversion of 500.

Account Payable..................................Br 500

Gain on Foreign Exchange Transaction...................Br 500

Account Payable.............................Br 35,000

Cash...........................Br 35,000
 Example 3
Ethio telecom, whose year end is Dec. 31, buys some
goods from Sudanese company on Sep. 30. The invoice
is 40,000 Sudanese Dollar (SD) and is due for
settlement in equal installment on Nov. 30 and Jan. 31.
The spot exchange rate is:
Sudanese Dollar (SD) Ethiopian
Birr
September 30 1.6 1
November 30 1.8 1
December 31 1.9 1
January 31 1.85 1
 Solution
September 30: 40,000 SD * 1 Br
Br 25,000
1.6 SD
Purchase/Merchandise Inventory……..25,000
Account
Payables………………………….25,000 Br
November 30: 20,000 SD * 1 Br 11,111.11
1.8 SD
Account Payable………………….12,500
 Solution
December 31: 20,000 SD * 1 Br Br
1.9 SD 10,526.316
 12,500 – 10,526.316 = 1,973.684
Account Payables ………….……1,973.684
Gain on Forex Transaction……………….1,973.684
January 31: 20,000 SD * 1 Br
1.85 SD
Br 10,810.81
 10,810.81 – 10,526.316 = 284.494
 Loss on Forex Transaction…………………284.494
Account Payable…………………. 284.494
 Account Payable ………………………………………10,810.81

Cash…………………………………………………...10,810.81