Accounting for Foreign currency Transactions part 1

Main ideas / lessons conveyed

Definition of foreign currency transactions

• A foreign currency transaction is a transaction whose settlement is required in a foreign currency, regardless of where the parties are located.
• In general, foreign currency transactions expose an entity to exchange rate risk, which can create foreign exchange gains or losses.

How to determine whether a transaction is “foreign currency”

From the perspective of the Philippine (domestic) entity

A transaction is not a foreign currency transaction (no exchange rate gain/loss for the Philippine firm) if:

• A Philippine firm deals with another domestic operation but settlement is in pesos.
• A Philippine firm deals with a foreign corporation but settlement is in pesos.

A transaction is a foreign currency transaction (foreign exchange gain/loss matters) if:

• A Philippine firm deals with a foreign corporation and settlement is in the foreign corporation’s currency (i.e., not pesos).

From the perspective of the foreign corporation (mirrored principle)

• If settlement is in the foreign corporation’s currency, then it is not a foreign currency transaction for that foreign corporation (exchange gains/losses are not recognized by them).
• If settlement is in pesos, then it is a foreign currency transaction for that foreign corporation (exchange gains/losses are recognized).

Translation/conversion basis for accounting

• Domestic companies translate/convert foreign currency amounts using BSP exchange rates for:
  • Translation purposes, including the correct use of direct vs. indirect exchange rates.

Key concepts: Direct vs. Indirect exchange rates (with formulas)

Direct exchange rate

• Meaning: number of local currency units (pesos) needed to acquire one unit of foreign currency.
• Formula (example):
  • If 1 FC = 25 pesos, then direct rate = 25.
• Conversion rule to pesos:
  • Peso amount = Foreign currency units × Direct exchange rate
• Example:
  • 20,000 foreign currency × 25 pesos/FC = 500,000 pesos

Indirect exchange rate

• Meaning: the reciprocal of the direct exchange rate—i.e., number of foreign currency units per 1 peso.
• Relationship to direct rate:
  • Indirect rate = 1 / (Direct exchange rate)
• Conversion rule (to pesos using indirect rate):
  • Peso amount = Foreign currency units / Indirect exchange rate

Example from subtitles:

• If 1 FC = 25 pesos, then indirect = 1/25 = 0.04 FC per peso
• 20,000 FC ÷ 0.04 = 500,000 pesos

Additional example:

• Indirect rate: 1 peso = 0.20 foreign currency
• 20,000 FC ÷ 0.20 = 100,000 pesos
• This corresponds to direct of 5 pesos per FC (since 1/0.20 = 5)
• Converting back: 100,000 pesos ÷ 5 = 20,000 FC (consistent)

Effect of exchange rate movements (conceptual implications)

• When direct exchange rate decreases / indirect increases → “strengthening” of peso

  • Fewer pesos are needed to acquire foreign currency.
  • Implied: importing becomes cheaper in peso terms.
  • Implied: exporters may earn less profit when measured in pesos.

• When direct exchange rate increases / indirect decreases → “weakening” of peso

  • More pesos are needed to acquire foreign currency.
  • Implied: exporters benefit.
  • Implied: importers are disadvantaged.

Relevant exchange rates and the “three important dates”

Types of rates mentioned

• Spot rate (relevant to transactions)
  • Applicable to immediate delivery.
• Forward rate
  • Rate for exchange at a future date.
• For the accounting treatment described, only spot rates are emphasized.

Three important dates in foreign exchange accounting

1. Transaction date

   • Date when the purchase/sale of goods or services occurs.
   • Translate the foreign currency amount to pesos using the spot rate on the transaction date (described as “historical rate” for later comparisons).

2. Balance sheet date (closing date)

   • Date when financial statements are prepared.
   • Foreign currency monetary items must be retranslated using the closing spot rate.
   • Differences from using the transaction date rate are recognized as foreign exchange gain/loss and presented in profit or loss.

3. Settlement date

   • Date when payment/receipt is made.
   • Final translation uses the spot rate at settlement date.
   • Additional gain/loss may arise from changes between the balance sheet date and settlement date.

Method of accounting for foreign exchange gain/loss (as described)

Monetary vs. non-monetary items

• Monetary items

  • Assets/liabilities to be received/paid in a fixed or determinable number of foreign currency units.
  • Examples implied: cash to be received/paid; receivables/payables denominated in foreign currency.
  • Treatment:
    • Adjusted at the balance sheet date to pesos using the current/closing spot rate.
    • Exchange differences → foreign exchange gain or loss in profit or loss.

• Non-monetary items

  • Examples: inventories, equipment, investments, equity securities.
  • Treatment:
    • Not adjusted the same way as monetary items.
    • If measured at fair value, adjustments may be recognized based on fair value changes (exchange effects may be reflected in OCI in that scenario).

Recognition of foreign exchange gain/loss over time

• Recognize exchange differences as spot rates change between:
  • transaction date ↔ balance sheet date ↔ settlement date.

Gain/loss direction based on increasing/decreasing exchange rates

• Exporting transaction (foreign currency receivable)

  • Exchange rate increases → transaction gain
  • Exchange rate decreases → transaction loss

• Importing transaction (foreign currency payable)

  • Exchange rate increases → transaction loss
  • Exchange rate decreases → transaction gain

Exchange rates used: buying vs. selling spot rates (rule given)

Exchange rates are classified as:

• Buying spot rate (bid)
• Selling spot rate (offer)

Rule based on role:

• If the domestic entity is an exporter (effectively seller of foreign currency) → use the buying rate.
• If the domestic entity is an importer (effectively buyer of foreign currency) → use the selling rate.

Freight terms and how they affect the transaction date

• Freight terms determine the transaction date (when the sale/purchase is recognized).

Examples:

• FOB shipping point
  • Exporter (seller): sale recorded when goods are shipped.
  • Importer (buyer): purchase recorded when goods are shipped.
• FOB destination
  • Exporter (seller): sale recorded when goods reach the destination.
  • Importer (buyer): purchase recorded when goods reach the destination.

The subtitles conclude that sample problems and recording of inquiry/export/import transactions will be discussed in the next video.

Speakers / sources featured

• No specific named speakers are identified.
• Source referenced: BSP (Bangko Sentral ng Pilipinas) for exchange rates.