Audit and Technical Partner Leavitt Walmsley Associates Ltd
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AIA guide to foreign currency transactions

27th Apr 2010
Audit and Technical Partner Leavitt Walmsley Associates Ltd
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Steve Collings offers expert advice on reporting exchange differences arising from foreign currency transactions.

Most entities undertake foreign currency transactions during their normal course of business, but confusion often lies in how to deal with exchange differences arising from foreign currency transactions. This article takes a look at the rules governing foreign currency transactions.

SSAP 20 and FRS 23

In current UK GAAP, there are two standards relevant to foreign currency transactions – SSAP 20 ‘Foreign Currency Translation’ and FRS 23 ‘The Effects of Changes in Foreign Exchange Rates’.

FRS 23 should only be used by entities who are listed on a recognised stock exchange and who also apply FRS 26 ‘Financial Instruments: Recognition and Measurement’. It was issued in December 2004 as part of a ‘package’ of standards which comprise:

  • FRS 23 ‘The Effects of Changes in Foreign Exchange Rates’
  • FRS 24 ‘Financial Reporting in Hyperinflationary Economies’
  • FRS 25 ‘Financial Instruments: Disclosure and Presentation’
  • FRS 26 ‘Financial Instruments: Recognition and Measurement’.

As most companies in the United Kingdom are unlisted entities, this article will concentrate on the provisions laid down in SSAP 20.

The objective of translation according to SSAP 20 is to:
‘Produce results which are generally compatible with the effects of rate changes on a company’s cash flows and its equity and should ensure that the financial statements present a true and fair view of the results of management’s actions.’

Transactions and balances
Entities undertake foreign currency transactions at varying points throughout the reporting period and therefore transactions should be translated at the rate of exchange at the date on which the transaction occurred. An average rate for a period can be used provided that exchange rates have not fluctuated significantly. If transactions are entered into using contracted rates, then those contracted rates should be used. In situations where forward contracts are entered into, transactions may be translated at the rate of exchange in the forward contract.

Monetary assets and liabilities (e.g. cash and bank balances, loans and amounts receivable and payable) should be translated using the exchange ruling at the balance sheet date. Where rates of exchange are fixed under specific terms of the relevant transactions, the rates in the terms should be used.

Profit or loss on translation
When an entity translates their foreign currency into the functional currency of their enterprise, any resulting profit or loss on exchange should be recognised in an entity’s profit and loss account.

Consolidated financial statements
So far we have addressed the issues at individual entity level, but SSAP 20 also deals with issues relating to group financial statements.

The ‘closing rate/net investment method’ requires a foreign enterprise to translate its balance sheet into the reporting currency of the investing entity using the foreign exchange rate ruling at the balance sheet date. Amounts reported in the profit and loss account should be translated at the closing rate or by way of an average rate.

SSAP 20 recognises that the use of a closing rate may achieve its objective of preparing financial statements which give a true and fair view, but it also recognises that the an average rate might reflect more fairly the profits and losses as they arise throughout a reporting period.

SSAP 20 permits either method to be used, provided that the method selected is consistently applied from one reporting period to the next.

The standard does not have a definitive method of calculating an average rate, and SSAP 20 at paragraph 18 suggests factors that need to be considered when devising such a method, such as the entity’s internal accounting procedures and the extent of seasonal variances. Where average rates are used then the differences which arise should be dealt with in reserves.

The ‘temporal’ method

SSAP 20 refers to a method of translation known as the ‘temporal’ method. This method is used where the affairs of a foreign enterprise are so closely interlinked with that of the investing entity that the foreign entity’s results are regarded as being dependant on the economic environment of the investing entity as opposed to its own currency.

The temporal method is identical to the method used for dealing with individual entity foreign exchange transactions and can be found in paragraphs 4 to 18 of SSAP 20.

SSAP 20 does give examples of where the temporal might be deemed more appropriate than the closing rate/net investment method as follows:

  • Where the foreign enterprise acts as a selling agency receiving stocks of goods from the investing company and remitting the proceeds back to the company.
  • Where the foreign enterprise produces a raw material or manufactures parts or sub-assemblies which are then shipped to the investing company for inclusion in its own products.
  • Where the foreign entity is located overseas for tax, exchange control or similar reasons to act as a means of raising finance for other companies in the group.

Steve Collings FMAAT FCCA DipIFRS is the audit and technical manager at LWA Ltd and a partner in He is also the author of ‘The Core Aspects of IFRS and IAS’ and lectures on financial reporting and auditing issues.



Replies (3)

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By frances_1
28th Apr 2010 12:33

'..where forward contracts are entered into, transactions may be

A company buys forward by about 7 months to cover expected purchase orders for the next season.  At the time the currency is bought forward the purchase orders have not been made, so the currency requirements are estimated, and are bought in large lumps to be drawn down over a period of time for flexibility.  When the purchase invoice is due for payment a round sum of currency is drawn down from the forward contract into the company's foreign currency bank account.  At any one time this bank account may contain currency from more than one draw down, possibly at different exchange rates, so it isn't possible to directly relate the invoice to a specific forward contract.

As the company buys the currency forward specifically to cover the purchase invoices, it would like to reflect those invoices in its accounts at the rate of exchange achieved at the time the currency was reserved.  If this was done using the average exchange rate of all the forward contracts entered into for that season's orders, would this comply with SSAP20?


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By Ayesha Bham
28th Apr 2010 12:47

forward contracts
When I contracted for a company who used to do this they used average rates. Reading steve's article this also agrees that an average rate can be used as long as there are no major fluctuations in the rates.

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By maria01
03rd Aug 2014 14:49

unrealised exchange rates on foreign currency bank balances

Hi, question if anyone can answer, I appreciate that FX should be held within the area it relates to. but what about unrealized bank balances fx where in the P&L should that be disclosed, sales, cost, overheads, after operating profit?

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