ACCOUNTING FOR SPECIAL TRANSACTIONS

PAS 21 The Effects of Changes in Foreign Exchange Rates

Overview

PAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign currency transactions
and operations in financial statements, and also how to translate financial statements into a presentation currency. An
entity is required to determine a functional currency (for each of its operations if necessary) based on the primary
economic environment in which it operates and generally records foreign currency transactions using the spot
conversion rate to that functional currency on the date of the transaction.

Objective of PAS 21

The objective of PAS 21 is to prescribe how to include foreign currency transactions and foreign operations in the
financial statements of an entity and how to translate financial statements into a presentation currency. [PAS 21.1]
The principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in
the financial statements. [PAS 21.2]

Key Definitions

Functional currency - the currency of the primary economic environment in which the entity operates. (The term
'functional currency' was used in the 2003 revision of PAS 21 in place of 'measurement currency' but with essentially
the same meaning.)

Presentation currency - the currency in which financial statements are presented.

Exchange difference - the difference resulting from translating a given number of units of one currency into another
currency at different exchange rates.

Foreign operation - a subsidiary, associate, joint venture, or branch whose activities are based in a country or
currency other than that of the reporting entity.

Monetary items – money held and assets and liabilities to be received or paid in fixed or determinable amount of
money. The essential feature of a monetary item is a right to receive or an obligation to deliver a fixed or determinable
amount of money.

Nonmonetary Items – by the process of exclusion, are those items that cannot be classified as monetary.
Nonmonetary items are so called because their peso amounts reported in the FS differ from the amounts that are
ultimately realizable or payable. The essential feature of a nonmonetary item is the absence of a right to receive or an
obligation to deliver a fixed or determinable amount of money.

Examples of Monetary and Non-Monetary Items

MONETARY ASSETS: Cash, Accounts Receivable, Notes Receivable, Allowance for Doubtful Accounts, Advanced to
Employees, Financial Assets at Amortized Cost, Prepaid Interests, Advances to Suppliers, Long-Term Receivables

NONMONETARY ASSETS: Inventories, Prepaid Rent, Prepaid Insurance, FVTPL, FVTOCI, PPE, Accumulated
Depreciation, Intangibles

MONETARY LIABILITIES: Accounts Payable, Notes Payable, Accrued Expenses, Cash Dividend Payable, Bonds
Payable

NONMONETARY LIABILITIES: Advances from Customers, Deferred Revenue

OTHER NONMONETARY ITEMS: Share Capital, Share Premium, NCI

Note that Retained Earnings should not be classified as either monetary or nonmonetary

Foreign Currency Transactions

A foreign currency transaction should be recorded initially at the rate of exchange at the date of the transaction (use of
averages is permitted if they are a reasonable approximation of actual). [PAS 21.21-22]

Exchange differences arising when monetary items are settled or when monetary items are translated at rates different
from those at which they were translated when initially recognized or in previous financial statements are reported in
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profit or loss in the period, with one exception. [PAS 21.28] The exception is that exchange differences arising on
monetary items that form part of the reporting entity's net investment in a foreign operation are recognized, in the
consolidated financial statements that include the foreign operation, in other comprehensive income; they will be
recognized in profit or loss on disposal of the net investment. [PAS 21.32]

Accounting for Foreign Currency Transactions

An exchange rate is a measure of how much of one currency may be exchanged for another currency and several
terms are used to describe exchange rates.

1. A direct quote measures how much of the domestic currency must one exchange to receive one unit of a
foreign currency, (i.e. Peso: Foreign Currency) Indirect quote measure how many units of a foreign currency
will be received for one unit of domestic currency, (i.e. Foreign Currency: Peso)

2. A currency may either strengthen (gain) or weaken (lose) relative to another currency.
A strengthening of a currency means that the directly quoted amount decreases and the indirectly quoted
amount increases. The opposite would be true for a weakening currency.

3. Buying and selling rates of exchange respectively represent what a currency broker is willing to pay to acquire
or sell a currency.

4. A spot rate indicates the number of units of a currency that would be exchanged for one unit of another
currency on a given date.

5. A forward rate establishes, at one point in time, the number of units of one currency to be exchanged for one
unit of another currency at a specified future date. On a given date, different forward rates may exist for the
same currency, depending on how far in the future an exchange is to take place.
a. The agreement to exchange currencies at a future date is called a forward contract.
b. A premium or discount refers to when the forward rate is greater than or less than the spot rate
respectively.

ILLUSTRATIVE PROBLEM 1

Giannis Jewels, Inc., a Philippine dealer of jewelries had the following transactions with foreign entities where each
transaction is denominated in the local currency unit of the country in which the foreign entity is located:

Case 1. On November 2, 2021, Giannis purchased goods from Hongkong at a price of 40,000 Hongkong dollars when
the direct exchange rate was 1 Hkg$ = P4.50. The account has not been settled as of December 31, 2021, when the
exchange rate has decreased to 1Hkg$ = P4.00.

Case 2. On November 28, 2021, Giannis sold goods to a Taiwan Company at a price of 20,000 NT Dollars when the
direct exchange rate was 1 NT dollar = P1.80. The account has not been settled as of December 31, 2021, when the
exchange rate has increased to 1 NT dollar = P1.90.

Case 3. On December 1, 2021, Giannis purchased goods from Japan at a price of 60,000 yen when the direct
exchange rate was 1 yen = P0.40. The account has not been settled as of December 31, 2021, when the exchange
rate has increased to 1 yen = P0.45.

Case 4. On December 1, 2021, Giannis sold goods to Indonesian Company at a price of 2,500,000 Baht when the
direct exchange rate was 1 Baht = P0.003. The account has not been settled as of December 31, 2021, when the
exchange rate has decreased to 1 Baht = P0.0025.

Required: For each of the following independent cases, determine the December 31, 2021 balances of the
appropriate accounts (Accounts Receivable or Accounts Payable) and the Foreign Exchange Gain/(Loss) for
the year ended December 31, 2021 for each of the cases. Write “NA” for “not applicable” in the space provided below
if that account is not relevant to the specific case.

Accounts Accounts Forex Gain/Loss)

Receivable Payable
Case 1
Case 2
Case 3
Case 4

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ILLUSTRATIVE PROBLEM 2

Nikola, Inc. had the following transactions for the year 2021:

1. On May 1, Nikola purchased goods from a Japanese company for a Philippine peso value of P800,000, to be
paid on June 20. The exchange rates were:
May 1 1 yen = P0.40
June 30 1 yen = P0.45

2. On July 1, Nikola sold products to a Hongkong customer for a Philippine peso equivalent of P500,000, to be
received on August 10. The exchange rates were:
July 1 1 hkg dollar = P5.20
August 10 1 hkg dollar = P5.22

Required:

1. Assume the two transactions are denominated in Philippine peso. Prepare the entries required for the dates of
the transactions and their settlement in Philippine peso.

2. Assume the two transactions are denominated in the applicable local currency units of the foreign entities.
Prepare the entries required for the dates of the transactions and their settlement in the local currency units of
the Japanese company (yen) and the Hongkong customer (Hkg dollar)

EXERCISES

1. What is the date called when a foreign transaction is originally recorded?

a. Origination date b. Balance sheet date c. Transaction date d. Settlement date

2. Under PAS 21, which of the following statements pertains to functional currency?
a. It refers to the currency of the primary economic environment in which the entity operates.
b. It refers to the currency in which the financial statements are presented.
c. It refers to the currency other than the functional currency of the entity.
d. It refers to the type of currency in a given jurisdiction which a creditor may be compelled to accept.

3. Which of the following items will result to foreign currency transaction gain/loss due to settlement or translation?
a. Foreign currency denominated income statements accounts such as revenue, income, expense or loss.
b. Foreign currency denominated non-monetary assets such as inventory, PPE, intangible asset or prepaid asset.
c. Foreign currency denominated monetary items such as accounts payable, accounts receivable, notes payable,
loans receivable or interest payable.
d. Foreign currency denominated non-monetary liabilities such as unearned revenue, warranty liability, deferred
tax liability.
e. Foreign currency denominated equity accounts such as ordinary shares, preference shares, treasury shares and
share premium.

For Nos. 4 and 5:

Lighthouse Co., a Philippine Corp, sold inventory on credit to Japanese Co. on April 8, 2014. Lighthouse received
payment of 35,000 yen on May 8, 2014. The exchange rate was P1=¥0.65 on April 8 and P1=¥0.70 on May 8.

4. What amount is the amount of Sale to be recognized?

5. What amount of foreign exchange gain or loss should be recognized? (Round off to the nearest peso)?

6. Craft Corp. sold metal crafts to a US firm for $70,000 and pertinent information on exchange conversion rates
related to this transaction were as follows:
Conversion Rate
(Peso to US$)
Nov. 4 Receipt of order P27.40
Nov. 22 Date of shipment 27.50
Dec. 31 Balance sheet date 27.60
Jan. 6 Date of collection 27.00

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 The sale would be appropriately recorded at:
a. 1,890,000 b. 1,918,000 c. 1,925,000 d. 1,932,000

7. If one (1) Euro can be exchanged for P69.25 Philippine peso, the indirect exchange rate of Euro per Philippine
peso is:
a. 0.014 Euro b. 6.925 Euro c. 6.825 Euro d. 6.725 Euro

8. The White Co. has the Philippine pesos as sits functional currency. On October 16, 2019, White ordered some
inventory from a foreign supplier and agreed a purchase price of 160,000 local currency units (LCU). The inventory
was received on November 15, 2019.

At December 31, 2019, the inventory remained on hand and the trade payable balance for the inventory purchase
remained outstanding. The supplier was paid on January 27, 2020 and the inventory was sold on January 31,
2020. The following information about exchange rates is available:
October 16, 2019 P1.00 = 2.60 LCU
November 15, 2019 P1.00 = 2.50 LCU
December 31, 2019 P1.00 = 2.40 LCU
January 27, 2020 P1.00 = 2.25 LCU

According to PAS 21, The Effects of Changes in Foreign Exchange Rates, at what amount should the trade payable
balance due to the supplier be presented in the statement of financial position at December 31, 2019?
a. 61,538 b. 64,000 c. 66,667 d. 71,111

9. On November 15, 2021, Steph, Inc., a Philippine Company, ordered merchandise FOB shipping point from
Japanese Company for 200,000 yens. The merchandise was shipped and invoiced to Steph on December 10, 2021.
Steph paid the invoice on January 10, 2022. The spot rates for yens on the respective dates are as follows:
November 15, 2021 P.4955
December 10, 2021 4875
December 31, 2021 4675
January10, 2022 4475

In Steph's December 31, 2021 income statement, the foreign exchange gain is:
a. 9,600 b. 8,000 c. 4,000 d. 1,600

10. On June 15, 2020, Kawhi Co. purchased merchandise worth 100,000 Swiss francs from its supplier in Switzerland
payable within 30 days under an open account arrangement. Kawhi issued a 30-day, 6% note payable in Swiss
francs. On July 15, 2020, Kawhi paid the note in full.

The following information in spot rates is provided:

Buying Selling
June 15, 2020 P 24.03 P 24.15
July 15, 2020 24.10 24.22

What is Kawhi's foreign exchange gain (loss) for the transaction?

a. (5,040) b. 12,075 c. (7,035) d. (19,110)

Use the following data for questions 11 and 12:

Bulacan Company buys goods from Tokyo Company of Japan, worth 2,500,000 yen. The prevailing exchange rate
is P0.1302136/Yen. Bulacan Company settles the account 60 days later when the exchange rate is going at
P0.118376/Yen.

11. What is the forex gain or loss of Bulacan?

a. P29,594 gain b. P29,594 loss c. P1,920,000 loss d. P1,920,000 gain

12. What is the forex gain or loss of Tokyo?

a. P29,594 gain b. P29,594 loss c. P -0- d. Yen 2,500,000

13. On November 15, 2018, Pasig Company, a Philippine trader ordered merchandise FOB shipping point from a
foreign company for 200,000 local currency units, the currency of the foreign company. The merchandise was
shipped and invoiced to Pasig Company on December 10, 2018. Pasig Company paid the invoice on January 10,
2019. The spot rates for each local currency unit on the respective dates are as follows:
November 15, 2018 P4.955 December 31, 2018 P4.875
December 10, 2018 P4.675 January 10, 2019 P4.475

In Pasig Company’s December 31, 2018 income statement, what is the foreign exchange gain or loss?
a. P40,000 gain b. P40,000 loss c. P16,000 loss d. P16,000 gain

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14. Pangasinan Holdings, Inc. is the parent company of a group of companies. But also does its own trading. It bought
its fixed asset for $36,000 on November 1, 2012 when the exchange rate was P44.00 to $1.00. At December 31,
2012, the supplier of the fixed asset has not been paid and the exchange rate at that time was P46.00 = $1.00.
The company has not taken out a forward exchange contract for this payment to hedge adverse exchange rate
movements.

On the statement of financial position of Pangasinan Holdings, Inc., what will be the year-end value for Accounts
Payable to the creditor?
a. P1,584,000 b. P1,656,000 c. P1,854,000 d. P1,566,000

15. In October 2021, United Corporation obtained a loan amounting to US $ 120,000 for the purchase of machinery
and equipment. By the end of the year, one-half of the loan was still unpaid and a ten per cent decrease has taken
place. If the foreign loan payable account is correctly reported in the balance sheet at P1,848,000, the rate of
exchange at the time the loan was obtained must have been:
a. $1.00 = P27.00 c. $1.00 = P29.00
b. $1.00 = P28.00 d. $1.00 = P30.00

16. Makati Trading sells goods to MBK Co. of Bangkok, for 1,000,000 Baht. The exchange rate at this time is
P0.9875/baht. MBK Co. pays 31 days later when the prevailing exchange rate is P1 = 1 baht.

By reason of exchange fluctuation, how much is the foreign exchange gain or loss if the agreed currency is
Thailand Baht?
a. P12,500 loss b. P12,500 gain c. P12,658 loss d. P12,658 gain

17. Alabang Trading buys goods from Kowloon, Inc. of Hong Kong payable in Hong Kong dollars at a credit term of 60
days. On June 30, 2017, the Statement of Financial Position of Alabang Trading reflects a payable to Kowloon, Inc.
representing purchase of goods worth HK$250,000 when Hong Kong Dollars was going at HK$1 = P1.

What will be Alabang Trading’s foreign exchange gain or loss on June 30, 2017, if the prevailing exchange rate is
HK$0.975/P1?
a. P6,250 loss b. P6,250 gain c. P6,410.25 loss d. P6,410.25 gain

18. X Trading purchased goods from Y, a company based in France for 1,200,000 Euros (€). The exchange rate at this
time is P1 = €12.5. X paid 30 days later when the prevailing exchange rate is P1 = €16.

How much is the foreign currency gain/loss on the books of X and Y respectively?
a. 21,000 gain and 21,000 loss c. 4,200,000 gain and NIL
b. 21,000 gain and NIL d. 4,200,000 gain and 4,200,000 loss