Forex exchange gain/loss IAS 21

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Hasann
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Forex exchange gain/loss IAS 21

Post by Hasann »

Hi guys,

In my country the central bank use pegged currency policy to USD. For example today local currency rate is like that: 1 EUR=2.03 LCY. But the bank sells 1 EUR = 2.08 LCY

IAS 21 says that " The functional currency amount at which transactions denominated in foreign currencies should initially be recognised will be determined by using the exchange rate appropriate to the transaction. This is the
spot rate between the functional currency and the foreign currency at the date of the transaction" [IAS 21:21]


Which rate should I use for record my transaction? the difference between whis exchange rates should be included in the bank charges?
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

Hi, this seems to be a typical bid/ask spread, this is where banks make their profits. From my experience, transactions are recorded using the reference rates announced by a central bank, and then when actual payment is made/received, any difference goes to exchange gains/losses in P&L.
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

Seems the right decision. But how could I reference your thoughts? Cause I did a little search over IAS 21 and could not find exact extracts covering this case.
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

I guess it's practical application of the definition of spot rate in IAS 21, but it's true that I've never tried to reconcile this practical approach to IAS 21.

Note that the bid - ask spread means that your bank quotes different exchange rates for buying and selling currencies, so if you were to use those bank quotes you would end up with different exchange rates for assets and liabilities
pub_acco
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Re: Forex exchange gain/loss IAS 21

Post by pub_acco »

I think at initial recognition the transaction should be measured at the mid quote because you will not actually pay the bid/ask spread unless you convert EUR from/to LCY. You can avoid the spread if you pay for your EUR purchase using the EUR you received for sales. The spread is specific to the exchange at the bank, not to the sales, purchase, receivable, or payable.

I'm not sure if IFRS has a direct provision for spot rates, but this logic is pretty consistent with IFRS 13.25 that says fair value shouldn't be adjusted for transaction costs.
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

Thanks for the answer. Exactly there is no direct manual by IFRS on what is spot rate and how to determine it. Especially determining the spot rate is so complex in countries that use a pegged currency which is determined by Central Bank on daily basis.
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

aren't you able to exchange currency at this pegged rate (+/- bank spreads)?
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

Marek Muc wrote: 13 Mar 2021, 17:02 aren't you able to exchange currency at this pegged rate (+/- bank spreads)?
Only able to get through commercial banks.
Leo
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Re: Forex exchange gain/loss IAS 21

Post by Leo »

Marek is right.

I've never used another rate other than the one given by the central bank.
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exIFRS
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Re: Forex exchange gain/loss IAS 21

Post by exIFRS »

The IFRIC dealt with a kind of related issue a couple of years ago: https://cdn.ifrs.org/-/media/project/de ... ept-18.pdf. Though the issue was slightly different, their comment was (emphasis added):
Paragraph 8 of IAS 21 defines (a) the ‘closing rate’ as the spot exchange rate at the end of the reporting period; and (b) the ‘spot exchange rate’ as the exchange rate for immediate delivery. In the light of those definitions, the Committee concluded that the closing rate is the rate to which an entity would have access at the end of the reporting period through a legal exchange mechanism.
They go on to note:
Similarly, if the foreign operation’s functional currency is not the currency of a hyperinflationary economy, the entity also assesses whether the official
exchange rate(s) represents the exchange rates at the dates of the transactions in applying paragraph 39(b) of IAS 21
.


So you need to use a rate your organisation could access to exchange.
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

thanks exIFRS for this reference

how would you apply this to a typical bid/ask spread of a bank:
say the GBP/EUR average rate is 1.2
bid: 1.18
ask: 1.22

would you use 1.2 at the reporting date, or actual rate offered by you bank? This would mean IMO that you would use different rates for assets and liabilities
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

Thanks exIFRS and Marek.

Generally our clients don't perform Forex in their accounting software due to a number of reasons. While we are auditing we are performing below actions:
1 Taking their FCY bank account and extracting all transactions
2 Taking daily central bank rates ( I mean pegged exchange rates ) which are publicly available
3 Dividing transactions' amount by the Central bank rates
4 and the diff which is related with bank spread are divided between Forex gain/losses and bank charges.

I was always suspicious about this practice. And always wanted to get exact reference how to do in proper way.
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

Hasann wrote: 15 Mar 2021, 15:35 Generally our clients don't perform Forex in their accounting software
what do you mean?
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

I mean as an auditor, we are doing forex gain loss on behalf of audit clients. Simply most chief accountants and finance directors in my country don't know detailed about forex gain/loss and they are just ignoring it.
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Re: Forex exchange gain/loss IAS 21

Post by JRSB »

is the actual vs pegged/quoted rate material, if it's an audit scenario?
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

but does it really matter, in terms of IFRS, whether a currency is pegged or free floating? I don't think so. The question is whether a company is able to access given foreign currency at official rate
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Re: Forex exchange gain/loss IAS 21

Post by JRSB »

yes though it sounds like the finance system uses central rates so it' perhaps that vs actually available rate for consideration
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

IMO the first post suggests that the difference is due to bid-ask spreads only, but maybe OP will enlighten us :)
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exIFRS
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Re: Forex exchange gain/loss IAS 21

Post by exIFRS »

I interpreted the issue as a little broader than bid-ask spread, but if that is all we are talking about I would probably use the guidance in IFRS 13 as appropriate by analogy:
Para 71: This IFRS does not preclude the use of mid-market pricing or other pricing conventions that are used by market participants as a practical expedient for fair value measurements within a bid-ask spread.
Assuming there isn't a wide bid-ask spread.
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

and what if there is a wide bid-ask spread? :) say the currency is illiquid,
would you use different exchange rates for assets and liabilities?
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

Assuming there isn't a wide bid-ask spread.
[/quote]

Let's say real example here, official central bank rate is 1EUR=2.03 LCY
At nearest commercial bank offers this as Bid : 1EUR=1.97LCY, Ask 1EUR=2.09LCY.

At large amounts the exchange matter a lot.
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exIFRS
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Re: Forex exchange gain/loss IAS 21

Post by exIFRS »

Then I think IAS21.26 comes in to play:
When several exchange rates are available, the rate used is that at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date. If exchangeability between two currencies is temporarily lacking, the rate used is the first subsequent rate at which exchanges could be made.
Where there is a material spread you apply the rate to each transaction that would apply if you undertook the transaction, so assets and liabilities will be treated differently.
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Marek Muc
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

I'm still thinking about this TBH,

I like pub_acco's thinkig:
viewtopic.php?p=4160#p4160

the spread is just fancy way of referring to bank commission

I read IAS 21.26 more like "if your central bank says that the exchange rate is 1.2, but the market says its 2.0 (with bid-ask spread at 1.9-2.1), and you are not able to exchange currency at official rate of 1.2, then use the market rate of 2.0 for translation.

I'm more inclined to ignoring bank spreads but still open to discussion ;)
pub_acco
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Re: Forex exchange gain/loss IAS 21

Post by pub_acco »

I've just checked out E&Y's International GAAP book, and it reads even IFRS 13 isn't clear or specific enough about the bid-ask spreads. IFRS 13 doesn't preclude to use the mid price for everything or bid/ask price for assets/liabilities respectively. Fair value isn't supposed to include transaction costs, but still using bid or ask price for fair value measurement is permitted as long as the accounting policy is consistently applied, according to the E&Y book. I guess everything is permitted too under IAS 21, which obviously doesn't come accompanied with as much guidance as IFRS 13.

IMO though just using the mid is pretty fine for entities in developed economies to measure major currencies. It would be a real problem if we were to operate in some restrictive countries where the government enforces different exchange rates to different types of transactions.
Hasann
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Re: Forex exchange gain/loss IAS 21

Post by Hasann »

pub_acco wrote: 16 Mar 2021, 12:44 I've just checked out E&Y's International GAAP book
Would be it possible to share E&Y's International GAAP book with us? I think it would be great source of knowledge for us.
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Re: Forex exchange gain/loss IAS 21

Post by sowmiyanagarajan »

Lot of technical references are given in the response before and this is very helpful. IMO to record transaction central back spot rate or mid rate may be used and for translation at the year end the mid rate suggested by central bank is used . This is based on practical experience.
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Re: Forex exchange gain/loss IAS 21

Post by Marek Muc »

and what were the 'widest' bid-ask spreads that you dealt with?
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Re: Forex exchange gain/loss IAS 21

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