Accounting for FX spot deals

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DJP
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Accounting for FX spot deals

Post by DJP »

Hello everyone.

I was wondering if you could shed some light on how your companies are dealing with the recognition and derecognition of FX spot deals.

As you know, there is an accounting policy choice for when to recognise regular-way transactions: trade date or settlement date.

The first question is whether you consider a FX spot deal a regular-way transaction or not. An established (formal) market may not exist for FX transactions, but there are usually conventions for settling these transactions (for example EUR/USD spot deals should not take longer than 2 business days to settle). So, according to IFRS 9 IG B.28, this should be sufficient to consider the deals as regular way transactions.

Nevertheless, buying and selling currencies are purely cash transfers. If a corporate buys or sells a foreign currency, the time that takes to settle the transactions has to do with the payment system used. If I walk into a foreign currency exchange office, I can settle the transaction “on spot”. Therefore, some may take the view that FX deals that take longer than one day to settle are actually very short-term derivatives.

But let’s assume for now that they are regular-way transactions. If settlement date accounting is used, the accounting is quite simple. If trade date accounting is used, and one of the currencies in the currency pair is your functional currency, the accounting also seems straightforward (Deloitte has an example in their manual of accounting). Assuming that your functional currency is the EUR and that you are buying USD and selling EUR, the entries should be:

Trade date
DR Cash USD
CR Payable EUR

Settlement date
DR Payable EUR
CR Cash EUR

However, what if neither currency in the currency pair is your functional currency?

Let’s assume that the functional currency is the EUR and the entity is entering into a USD/GBP FX spot deal (buying USD, selling GBP). Would you basically recognise the USD cash and derecognise the GBP cash on the trade date?
Dr Cash USD
CR Cash GBP

But then what about the entries on the settlement date? There seems to be no journal entries left to be made, because the cash “settlement” has already been recognised on the trade date. This looks a bit weird considering that in the previous example, where one of the currencies is the functional currency, a settlement entry would be made. Because of this weird effect, one could argue that “derivative accounting” seems a bit more logical for FX spot deals. Also, the difference in P&L between revaluing a foreign currency position according to IAS 21 and fair valuing a very short-term FX forward should be immaterial given the very short period between the trade date and settlement date (I appreciate that P&L geography is being disregarded here).

However, there is a small detail. For regular-way transactions, the position in the foreign currency that is being sold should stop being revalued for IAS 21 purposes as from the trade date according to IFRS 9. But if derivative accounting is used, that position will still be fair valued until settlement date. So, there is actually a difference between using derivative accounting and trade date accounting for sold FX positions.

How are you dealing with these transactions in practice?

Thanks.
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Marek Muc
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Re: Accounting for FX spot deals

Post by Marek Muc »

I won't address all your questions here, but let's get started :)

I would expect consistent approach to recognition of movements in cash under trade date accounting. So in your first example (USD/EUR), why do you debit cash account, but credit payables (and not cash)?
DJP
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Re: Accounting for FX spot deals

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The recognition of the payable is in line with the example provided by Deloitte (although in their example they are selling a foreign currency instead of buying it, so they record a receivable). But also please note that this should be the accounting treatment for any other financial asset that you recognise on trade date. You recognise the financial asset on trade date (e.g. a bond) and a payable (because you haven't paid it yet; you do not derecognise cash on trade date). Then on settlement date, you credit cash and derecognise the payable.

The logic should be similar for a foreign currency because cash is also a financial asset. But the weird part is that cash is also the financial asset you use to settle the transaction... So when you are exchanging (buying and selling) two currencies that are not your functional currency, how do you do it? Do you recognise and derecognise both currencies on trade date and there is nothing else to do on settlement date because the transaction has already been settled in your accounting records, or do you actually consider this a very short-term forward contract?
pub_acco
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Re: Accounting for FX spot deals

Post by pub_acco »

If you pay foreign currencies for a stock, you will record the following:
Dr Stock
CR Payable GBP

By analogy you might be able to do this:
Dr Cash USD
CR Payable GBP

But, yeah, at the same time you are selling GBP as well. I’m confused too.
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Marek Muc
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Re: Accounting for FX spot deals

Post by Marek Muc »

I wouldn't recognise cash on trade date... in your example, if you're buying USD and selling EUR, I would recognise this as DR Receivable (USD to be received) and CR Liability (EUR to be paid). But trade date accounting is not something I have experience with. So you're saying that Deloitte suggest recognising movements in cash on trade date?
DJP
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Re: Accounting for FX spot deals

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Yup, their example is the sale of USD in a GBP functional currency entity. On trade date they recognise a receivable for the foreign currency they are selling (in GBP) and immediately derecognise the foreign currency (Cash USD).

But a FX spot transaction consists of selling a currency and buying another. So which currency should be considered the financial asset that is being purchased or sold? One could say that this is driven by the functional currency, so the asset to be sold or purchased is the foreign currency, but again there are cases where the currency pair consists of currencies where neither is the entity's functional currency. Also, foreign currency can be used to settle the purchase of financial assets denominated in foreign currency. For example, if my entity is GBP and I am buying a USD bond -- and if I use trade date accounting --, I will recognise the bond and a payable in USD on the trade date. In this case the USD cash is not being immediately derecognised, which would contradict a bit Deloitte's example (although I appreciate that the type of transaction is different).

More and more I am convinced that FX spot transactions should be treated as short-term FX forwards, because that's what they actually are in theory, although spot and forward are often used as antonyms (but a spot transaction that takes 2 days to settle is not really settled on "spot", is it?). Either that or, if we use trade date accounting, the purchased currency should be recognised and the sold currency derecognised on the trade date, and there is nothing left to do on the settlement date, because in the accountings books the settlement has already taken place.

Anyway, I was just wondering what companies are actually doing in practice. Any input would be highly appreciated.
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Marek Muc
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Re: Accounting for FX spot deals

Post by Marek Muc »

I'm afraid that our forum is still in an too early stage to get a wider practical perspective from other users, but let's see.

In the meantime, I'm looking at an example in IFRS 9 (Guidance on implementing, par. D.2.1). In their example, you purchase a financial asset, trade date is 29 December, settlement date is 4 January. On 29 December , they debit financial asset, but credit financial liabilities, not cash.
DJP
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Re: Accounting for FX spot deals

Post by DJP »

Indeed they are, but they don't specify what financial asset they are purchasing. What if it is cash, which is the case in a FX spot transaction? Cash is also a financial asset, so the same logic in that example applies (and I guess that's where Deloitte is basing their example on). But in a FX spot transaction you exchange cash, one currency flows in and the other flows out. Which one is the asset that is sold or purchased according to the IFRS example? We both agree that either currency is a financial asset, but also the "cash" used to settle the transaction. Tricky, no? :)
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Marek Muc
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Re: Accounting for FX spot deals

Post by Marek Muc »

We don't need to know what kind of asset they purchased in IFRS 9 example. We know that they didn't credit cash, but recognised a financial liability. So it's a substantial difference to Deloitte's approach IMO.
DJP
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Re: Accounting for FX spot deals

Post by DJP »

IFRS 9's example is about the purchase of a financial asset. Deloitte's example is about the sale of a financial asset (foreign currency cash). In one case the financial asset (we don't know which) is recognised against a payable, and in the other the financial asset (cash) is derecognised against a receivable. The logic is exactly the same.
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Marek Muc
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Re: Accounting for FX spot deals

Post by Marek Muc »

ok I focused on the entries that you provided in your examples, but it's true that you said that Deloitte's example is different

this indeed is confusing...

when I read para. B3.1.5 it seems to clearly state that
Trade date accounting refers to (a) the recognition of an asset to be received and the liability to pay for it on the trade date, and (b) derecognition of an asset that is sold, recognition of any gain or loss on disposal and the recognition of a receivable from the buyer for payment on the trade date.
so coming back to your example:
Let’s assume that the functional currency is the EUR and the entity is entering into a USD/GBP FX spot deal (buying USD, selling GBP). Would you basically recognise the USD cash and derecognise the GBP cash on the trade date?
Dr Cash USD
CR Cash GBP
the entries should rather be:
DR Cash USD (an asset to be received)
but CR liability (liability to pay for it on the trade date)

this seems to be technically correct, but it still doesn't feel right to me...

as you said, it would be interesting to know what other members do in real life

maybe the solution to this confusion is not to apply trade date accounting to FX spot deals :)
DJP
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Re: Accounting for FX spot deals

Post by DJP »

Then we would be left with derivative accounting :)
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Marek Muc
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Re: Accounting for FX spot deals

Post by Marek Muc »

true :)

but it should be possible (in most cases at least) not recognise anything between trade date and settlement date due to immaterial impact of the valuation of such a 'derivative'
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