Lesson 11 Exchange Losses and Gains

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Lesson 11 Exchange Losses and Gains

• Li, Jialong
• 2011-2-26

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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

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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.

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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.

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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.

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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.

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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)

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Foreign Exchange Gains and Losses
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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.

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Example taken from AAS 201A below
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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.

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Review Questions

• Accounting Standards for foreign Exchange
  overview
• Hedging
• Exchange ATO Rules
• Translation of Financial Statements

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Exercises

• Exercise 11.1-11.2

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Reading and Resources

• Student Notes Lesson 11

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The End of Lesson 11