The accounting and reporting of foreign exchange differences is covered by the IAS 21 “The effects of changes in foreign exchange rates”. The accountants are requested to know the principles of this standard so as to account correctly foreign exchange differences resulting from the translation of transactions denominated in currencies different than the reporting currency.
The following definitions relevant for this article are applicable:
1. Presentation currency: This is the reporting currency in which the Financial Statements are presented.
2. Functional currency: This is the currency of the primary economic environment in which the company operates.
3. Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency. Monetary items include bank, debtors, loans, creditors and accruals. The essential feature of a non-monetary item is the absence of a right to receive or obligation to deliver a fixed or determinable number of units of currency. Non-Monetary items include stock, property, plant and equipment, prepayments, intangible assets and provisions that are to be settled by the delivery of a non-monetary asset.
All transactions denominated in a currency other than the presentation currency should be translated into the presentation currency by using the spot rate i.e. the rate at the date of the transaction. Settlement of the liability or receivable during the reporting period will result in a foreign exchange difference (either foreign exchange loss or foreign exchange gain) which should be written off to the Income Statement.
At the end of the reporting period, the balances denominated in foreign currencies should be reported as follows:
1. Monetary items should be translated using the closing rate (i.e. the rate at the date of the reporting period) and any difference is recorded either as unrealized foreign exchange loss or unrealized foreign exchange gain.
2. Non-Monetary items are reported by using the exchange rate at the date of the transaction.
Use of presentation currency other than the functional currency
A Company has the right to choose any currency that fits its needs. In the case the functional currency differs from the presentation currency then its results and financial position are translated into the presentation currency different than the procedure stated above. For example a Cyprus Company with Head Quarters in Cyprus has a branch in UK. The branch prepares its own Financial Statements in British Pounds for reporting purposes in UK. The Cyprus Company prepares its Financial Statements in Euro. The results and financial position of the British branch should be included in the Financial Statements of the Cyprus Company in Euro which means that its financial position and results denominated in British Pounds should be translated in Euro.
The procedure is as follows:
1. Assets and liabilities either monetary or non-monetary should be translated into the reporting currency by using the closing rate (including comparatives).
2. Income and expenses should be translated by using the rate at the date of the transaction (the average rate of the year is allowed).
3. Any difference is recognized within the other comprehensive income.
A taxpayer can elect one of the two following methods, which should be stated in the accounts, for tax treatment of the foreign exchange differences and this treatment should be followed consistently in all fiscal years.
Method 1: Exchange differences of any type, either realized or unrealized, are not adjusted on the computations of chargeable income.
Method 2: Only the realized exchange differences are not adjusted which means that the unrealized foreign exchange loss is treated as non tax deductible expense and the unrealized foreign exchange gain is treated as tax free income.
In Cyprus, in the majority of the cases, the taxpayers elect the second method where they adjust only for the unrealized foreign exchange differences.
We hope you find this article interesting and please feel free to contact us in the case of any questions.
Olesya Rybkina Chrysanthou ACCA
CPV Corporate Services Limited