Lesson 11

Exchange Losses and Gains

Li, Jialong

2011-2-26

Currency Exchange Loss/Gain Overview

Australian accounting standard AASB121 The Effects of Changes in Foreign Exchange

Rates contains the guidelines to be followed by an Australian company dealing with foreign currency transactions.

Australian companies engage in transactions with overseas entities. These transactions include:

• Purchase or sale of goods with payment in foreign currency

• Loans to and from a foreign entity with interest income and repayments to be made in foreign currency

Currency Exchange Loss/Gain Overview

These transactions need to be recorded in the books of the Australian company in Australian dollars. This will be done by using the exchange rate in effect at the date of the transactions. This exchange rate is called the spot rate.

Exchange rates fluctuate all the time. With a purchase or a sale there is usually a time lapse between the date of purchase/ sale and the date of payment. The exchange rate applying on the payment date will probably be different to the rate applying on the purchase/ sale date. Any difference will result in an exchange gain or loss.

Hedging

If a company is concerned about possible exchange losses, it can take steps to prevent or minimise the loss by entering into a hedge arrangement. Hedging is an insurance technique, with the company looking for protection against future adverse exchange fluctuations.

Hedging

The simplest form of hedging is to purchase the foreign currency as soon as the commitment is known and invest the amount with a bank in the foreign country until the settlement is due. This has the disadvantage of tying up large amounts of money for a considerable time and the business cannot use for other things.

Hedging

Another type of hedging is the forward rate agreement. This is an agreement today to pay a bank or other financial body a fixed amount of foreign currency at a fixed rate. This means that is the currency rises or falls the bank wears the burden or gain.

Foreign Exchange Gains and Losses

If the balance date is different from the purchases/sale dates the exchange differences must be calculated and these differences are recorded by the business as gains/losses and these gains or losses will change the Profit and loss of the business accordingly.

There are two types of gains and losses on foreign exchange:

• Unrealised (recorded for a period of income but not yet actually happened)

• Realised (actually happened to the business)

Foreign Exchange Gains and Losses

Translation of financial statements forForeign Exchange Gains and Losses Translation is the process whereby financial

information recorded in one currency is expresses in another currency.

AASB 121 defines the following terms for translation: • Functional currency – The currency of the primary

economic environment in which the entity operates. • Presentation currency – The currency in which the

financial report is presented. An entity may elect to present its financial statements

in any currency. However the standard stipulates that is the presentation currency is different to the Australian currency the entity shall disclose the reason and justification for not using $AUD.

Example taken from AAS 201A below

The main principles of translating financial statements

• Assets and liabilities are translated at the closing exchange rate at the date of the Balance Sheet

• Income and expenses are translated at exchange rates at the date of the transaction

• Resulting exchange differences from the above are recognised as a separate component in equity called foreign currency translation reserve.

The Exchange rate to use in defined by the ATO under the General translation rule or the published in the Schedule of Average rates by the ATO.

Review Questions

Accounting Standards for foreign Exchange overview

Hedging

Exchange ATO Rules

Translation of Financial Statements

Exercises

Exercise 11.1-11.2

Reading and Resources

Student Notes Lesson 11

The End of Lesson 11