Lesson 1 – Accounting for Foreign Currency Transactions

Technical Competencies & Learning Outcomes

• CPA Technical Competencies addressed

  • 1.2.2 – Evaluates treatment for routine transactions

  • 1.3.2 – Prepares routine financial-statement note disclosure

• Learning outcomes for Lesson 1

  • Describe what constitutes a foreign currency transaction

  • Explain how to perform initial measurement of such transactions

  • Explain subsequent measurement of foreign-currency-denominated assets and liabilities

  • Explain derecognition of those items

  • Identify presentation and disclosure requirements (IAS 21)

  • Contrast IFRS (IAS 21) and ASPE (ASPE 1651) guidance

Snapshot – IAS 21 Three-Step Model

• Step 1 – Determine functional currency

  • Defined as “the currency of the primary economic environment in which the entity operates.”

  • For most Canadian entities: Canadian dollar (CAD).

• Step 2 – Initial measurement

  • Translate the foreign-currency amount using the spot (transaction-date) exchange rate.

  • If transactions occur evenly over a period and rates are relatively stable ➔ average rate may be used.

• Step 3 – Subsequent measurement

  • a) Monetary items

  • Translate at the closing rate (spot rate at SFP date).

  • Resulting gains/losses ➔ recognized in profit or loss.

  • b) Non-monetary items

  • If carried at historical cost ➔ do not update for FX changes.

  • If carried at fair value ➔ use rate at date of most recent revaluation.

• Required disclosures (IAS 21)

  • Entity’s functional currency

  • Amount of FX gain/loss in the Statement of Comprehensive Income (SCI)

  • If functional currency changed: nature & rationale

Definitions & Core Concepts

Foreign Currency Transaction

• A transaction denominated in a currency other than the entity’s functional currency.

• Examples

  • Canadian company sells inventory to an Italian customer requesting payment in Euros.

  • Canadian company buys inventory from a U.S. supplier and must pay in USD.

• Objective: measure the CAD impact and integrate with other financial information.

Exchange-Rate Quotations

• Direct quotation (Canadian dollar equivalent method)

  • Gives number of \text{C\$} needed to buy 1 unit of foreign currency.

  • Example: \text{US\$}1 = \text{C\$}1.4100 ➔ paying \text{C\$}1{,}410{,}000 for \text{US\$}1{,}000{,}000.

• Indirect quotation (foreign currency equivalent method)

  • Gives number of foreign units per \text{C\$}1.

  • Example: \text{C\$}1 = \text{US\$}0.7092 (reciprocal of direct quote).

• Conversion

  • If \text{C\$}1 = \text{US\$}0.7092 then \text{US\$}1 = \dfrac{\text{C\$}1}{0.7092} = \text{C\$}1.4100.

Functional vs Presentation Currency

• Functional currency: entity’s primary economic environment.

• Presentation currency: currency in which FS are presented (may differ under IFRS).

Initial Measurement (Step 2)

• Record using transaction-date spot rate \big(\text{or average rate if criteria met}\big).

• Revenues/expenses that accrue evenly (e.g., interest) ➔ use average rate for the period.

• Any difference between translated interest expense/income and translated cash paid/received ➔ report as FX gain/loss in SCI.

Example — Inventory Purchase (Canadian Ltd.)

• 15 Dec: Purchased inventory from USA Inc. for \text{US\$}100{,}000.

  • Spot: \text{US\$}1 = \text{C\$}1.25.

  • JE (15 Dec):

  • \text{DR Inventory }(100{,}000 \times 1.25)=\text{C\$}125{,}000

  • \text{CR Accounts payable }\text{C\$}125{,}000

Subsequent Measurement (Step 3)

Monetary vs Non-Monetary Items

• Monetary Items

  • Cash, receivables, payables, loans—fixed/determinable cash flows.

  • Translate at closing rate each reporting date.

  • FX gains/losses ➔ profit or loss.

• Non-Monetary Items

  • Inventory, PPE, intangibles, prepaid expenses, unearned revenue.

  • Historical cost model ➔ keep original translated CAD cost; no FX adjustment until derecognition.

  • Fair-value model ➔ see separate section below.

Detailed Monetary Example — Stephanie Inc. Loan (¥)

• Borrowed ¥100{,}000{,}000 on 1 Jan Y1 at ¥1 = \text{C\$}0.0110.

  • JE (1 Jan Y1): \text{DR Cash }\text{C\$}1{,}100,000;\ \text{CR Loan Payable }\text{C\$}1{,}100,000.

• Year 1 interest (10 %): ¥10{,}000{,}000.

  • Average Y1 rate: ¥1 = \text{C\$}0.0100 ⟹ \text{C\$}100,000 interest expense.

  • Cash paid using 31 Dec Y1 spot ¥1 = \text{C\$}0.0095 ⟹ \text{C\$}95,000.

  • FX gain =100,000-95,000=\text{C\$}5,000.

• Loan revaluation at 31 Dec Y1: 100{,}000{,}000 \times (0.0095-0.0110)= -\text{C\$}150,000 (gain).

• Year 2: Average rate 0.0117; closing 0.0120 ➔ resulting FX losses \text{C\$}3,000 (interest) + \text{C\$}250,000 (loan).

Detailed Mixed Example — Canadian Ltd. (Inventory vs Payable)

• Inventory (non-monetary) stays at \text{C\$}125,000.

• Accounts payable revalued at 31 Dec:

  • Closing rate: \text{US\$}1 = \text{C\$}1.21.

  • New payable =100{,}000\times1.21=\text{C\$}121,000.

  • JE: \text{DR A/P }4,000;\ \text{CR FX gain }4,000.

Non-Monetary Items Measured at Fair Value

• Translate using spot rate on revaluation date (becomes the new historical rate until next revaluation).

• FX component embedded within revaluation gain/loss.

  • If revaluation gain/loss is in profit or loss ➔ FX component in P&L.

  • If in OCI ➔ FX component in OCI.

Example — ABC Traders’ Swiss Land (CHF)

• 1 Jun Y2 purchase: \text{CHF}1,300,000 \times 1.45 = \text{C\$}1,885,000.

• 31 Dec Y2 revaluation: \text{CHF}1,650,000 \times 1.41 = \text{C\$}2,326,500.

  • Total gain =2,326,500-1,885,000=\text{C\$}441,500 (includes FX loss portion).

  • JE: \text{DR Land }441,500;\ \text{CR OCI – revaluation gain }441,500.

Derecognition of Foreign-Currency Items

• Monetary items: first update to spot rate at derecognition date; then derecognize normally.

• Non-monetary items: no FX adjustment; treat as normal derecognition (e.g., COGS, disposal).

Combined Derecognition Example — Canadian Ltd. (Continuation)

• Exchange rates: 15 Dec 1.25 | 31 Dec 1.21 | 15 Jan 1.20.

• 15 Jan – update A/P:

  • New A/P =100{,}000\times1.20=\text{C\$}120,000.

  • FX gain =121,000-120,000=\text{C\$}1,000.

  • JE: \text{DR A/P }1,000;\ \text{CR FX gain }1,000.

• Pay A/P: \text{DR A/P }120,000;\ \text{CR Cash }120,000.

• Sell inventory for \text{C\$}160,000:

  • \text{DR A/R }160,000;\ \text{DR COGS }125,000;\ \text{CR Revenue }160,000;\ \text{CR Inventory }125,000.

• T-Account for A/P confirms balance reduced to 0 before payment.

Presentation & Disclosure (IAS 21 § 52–57)

• Disclose:

  • Functional currency of the entity

  • Amount of FX gain/loss in SCI

  • If functional currency changed: original & new currency and rationale

• After translation, foreign-currency amounts are presented together with domestic amounts; no separate line items are required.

IFRS vs ASPE (IAS 21 vs ASPE 1651)

• Overall guidance is very similar.

• Key difference – non-monetary items at fair value

  • IFRS (IAS 21) – use rate on revaluation-date (date fair value determined).

  • ASPE 1651 – explicitly states: use balance-sheet-date rate to translate the foreign-currency fair value.

  • Practical impact often minimal because many fair-value measurements occur at period end.

ASPE Example — Import Co. Equipment Purchase (€)

• Equipment invoiced 29 Apr Y1 (f.o.b. shipping point), delivered & paid 28 May Y1.

• Exchange rates: 29 Apr €1 = \text{C\$}1.50 | 28 May €1 = \text{C\$}1.56.

• Initial recognition (29 Apr)

  • \text{DR Equipment }(200,000 \times 1.50)=\text{C\$}300,000

  • \text{CR A/P }\text{C\$}300,000

• Update & pay on 28 May

  • FX loss: 200,000\times(1.56-1.50)=\text{C\$}12,000.

  • JE 1: \text{DR FX loss }12,000;\ \text{CR A/P }12,000.

  • JE 2: \text{DR A/P }312,000;\ \text{CR Cash }312,000.

• Amortization (calendar year)

  • Useful life 5 yrs, no residual.

  • Months in use during Y1: May 28 → Dec 31 = 7 months.

  • Expense =\dfrac{300,000}{5}\times\dfrac{7}{12}=\text{C\$}35,000.

  • JE: \text{DR Amortization expense }35,000;\ \text{CR Accumulated Amortization – Equipment }35,000.

Ethical, Practical & Exam-Tip Highlights

• Accurate FX translation is critical to faithfully represent monetary obligations and to avoid mis-stated profit.

• Always separate translation effect (FX gains/losses) from economic gains/losses (e.g., price changes in inventory).

• Watch the date of recognition vs cash settlement date; FX gains/losses arise in the intervening period.

• For exams, clearly identify whether an item is monetary or non-monetary—this drives subsequent treatment.

• Under ASPE, remember the balance-sheet-date rule for non-monetary fair-value items; under IFRS, use date of revaluation.

Quick Reference Formulae & Conventions

• Direct Quote (CAD per FCU): \text{FC}1 = \text{C\$}x

• Indirect Quote (FCU per CAD): \text{C\$}1 = \text{FC}y; convert to direct by x = \dfrac{1}{y}.

• Monetary Revaluation Adjustment: \text{FX Gain/Loss} = (\text{FC Balance})\times(\text{New Rate} - \text{Old Rate}).

• Interest Accrual (average rate): \text{FC Principal} \times \text{Interest %} \times \text{Avg. Rate}.

• Amortization in ASPE Example: \text{Cost} / \text{Useful Life} \times \text{Fraction of Year}.

Summary Checklist

1. Identify entity’s functional currency.

2. Translate foreign-currency transactions at transaction-date spot rate (or average where allowed).

3. At each reporting date:

   • Monetary items ➔ closing rate; recognize P&L FX gains/losses.

   • Non-monetary items

     • Historical cost ➔ no update.

     • Fair value ➔ IFRS: revaluation-date rate | ASPE: balance-sheet date rate.

4. On derecognition:

   • Update monetary items to spot rate, then settle.

   • Recognize associated FX gains/losses immediately.

5. Disclose functional currency, total FX gains/losses, and any change in functional currency (with rationale).

6. Remember key IFRS/ASPE difference for non-monetary fair-value items.

These notes capture all substantive details, numerical illustrations, journal entries, and standard-setting differences required for mastery of Accounting for Foreign Currency Transactions – Lesson 1.