Foreign currency cash flows

Foreign currency cash flows Foreign currency cash flows – IAS 7.25 requires cash flows arising from transactions in a foreign currency to be recorded at the exchange rate between an entity’s functional currency and the foreign currency at the date of the cash flow.

A similar approach is required for cash flows of a foreign subsidiary (IAS 7.26).

IAS 7.27 Foreign currency cash flows notes that cash flows denominated in a foreign currency are dealt with in a manner that is consistent with that required by IAS 21 The Effects of Changes in Foreign Exchange Rates.

Consequently, it is possible to use exchange rates that approximate the exchange rates at the dates of transactions (for example, a monthly rate or, if exchange rates are stable, a quarterly rate). However, the use of the period end rate for transactions that take place during a reporting period is not permitted.

IAS 7.28 deals with unrealised gains and losses arising from transactions in foreign currency, the link opens in a new page to read the text.

This means that unrealized exchange differences in respect of cash and cash equivalents are not classified as operating, investing or financing. Instead, those unrealised exchange differences are presented as a separate, reconciling item, between the opening and closing balances of cash and cash equivalents in the statement of cash flows.

Worked example – foreign currency translation

Background information:

  • Entity A has its head office in its home country (HC) but sells most of its products in an overseas jurisdiction in foreign currency (FC),
  • Most of entity A’s raw material purchases are denominated in FC and its production factory is located in the overseas jurisdiction,
  • The management of entity A has concluded that, for the purposes of its IFRS financial statements, its functional currency is FC,
  • Entity A has a local currency (LC) bank account which is used to pay the salaries and expenses of head office management and various other head office cost,
  • The balance in Entity A’s LC bank account as at 1 January 20X1 was LC25,000,000.

During the year ended 31 December 20X1, the following transactions took place:

  • Entity A paid LC12,500,000 in salaries from its LC account (spread evenly over the year),
  • On 31 August 20X1, entity A acquired computers for its local offices for LC600,000, paid on 30 September 20X1.

Exchange rates between LC and FC during the year were:

Date FC1+LC
1 January 20×1 5.00
31 August 20×1 5.10
30 September 20×1 5.25
31 December 20×1 5.40
Average for the year 20×1 5.28

Entity A considers that the movements in exchange rates during the year were not significant, because not only were the variations in rates at each date specified above small, an analysis shows that changes in exchange rates between these dates were also small and were not volatile.

Consequently, for the purposes of translating the monthly salary payments, the annual average rate will be used.

The example has been simplified, in that an annual average rate has been used for the purposes of translating transactions that take place during the year. It has been assumed that not only has the exchange rate not moved significantly, but that exchange rates between the dates specified above were not volatile; in addition, the monthly payments were all equal.

If, for example, the payments had been made on specific dates for substantially different amounts, and the exchange rates on those dates were significantly different, it would not be appropriate to use an average rate.

In all cases, it is necessary to consider the timing of payments and the exchange rates applicable at each payment date when determining whether a monthly, quarterly or annual average rate can be used as an approximation for the exchange rate at the date of each separate transaction. In practice, it is very unlikely for it to be appropriate for a period of more than three months to be used and in many cases monthly gaps between exchange rate resets will be the maximum possible period.

The LC transactions as recorded in the LC bank account are:

Reporting attribute Date LC FX rate FC
Opening balance Foreign currency cash flows 1/1/20×1 25,000,000 5.00 5,000,000
Payment of salaries Foreign currency cash flows Mid month (12,500,000) 5.28^2 (2.367.424)
Payment for computers ^1 30/09/20×1 (600,000) 5.25 (114,286)
Book balance FC  Foreign currency cash flows (mixed rates)   calculated 2,518,290
Closing balance Foreign currency cash flows 31/12/20×1 11,900,000 5.40 2,203,704
FX translation loss^3                                                                                                               (314,586)

^1 Transaction translated on payment date;

^2 Transaction translated at average rate;

^3 The exchange loss is the restatement of the FC balance at the closing rate at year-end. The movement during the year in FC are at different rates, the loss adjusts the book balance in FC from FC2,518,290 to FC 2,203,704, the value of the LC balance at year-end against year-en rates.

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