Purchasing in PKR, paying through $ account IAS 21

[Shahzad09]

Hello everyone,

My question is regarding IAS 21 treatment.
Can best be understood by an example.

Organization functional currency is USD (policy is to convert PKR to USD using last week avg. rates)

If inventory is purchased for PKR 800 and paying through USD bank account

-----------------PKR------Ex.rate used-------------USD
Exchange loss--------------------------------------0.126
Purchases---------800-------80-(last week avg)-------10
----Bank USD----------800---79*--------------------------10.126

*Exchange rate provided by the bank for the payment

<b>OR</b>

------------------PKR------Ex.rate used------------USD----
Purchases---------800---------79*------------------10.126
-----Bank USD---------800-----79*----------------------10.126

Which one is the right treatment in that case ?

Your response will be highly appreciated.

[Shahzad09]

Please help on this topic

[kamranACA]

Shehzad,

It appears that neither the purchase is made in rupee nor the payment is made in rupee. Only one currency (functional currency/reporting currency) i.e. USD is in use for all purposes.

Therefore, in my view second option is correct.

The exchange losses are recognised where some transaction is actually made in other than functional curreny but translated into functional currency for reporting purposes or converted into functional currency for receiving or paying the cash.

Regards,


KAMRAN.

[kamranACA]

Dear,

If purchase transaction was actualy in Pak rupee and there was a gap between booking of purchase entry and eventual payment, the difference will arise and have to be taken to exchange gain or loss.

However, if every thing was in dollars, there would be no exchange difference.

I am clarifying it because there could be some misunderstanding of your question.

Regards,

[Star]

Dear,

If the exchange rate was agreed when the contract of sale was made then what would be the accounting treatement as per IAS-21 regarding exchange loss on the date of purchase and date of payment?

Regards,

*

[kamranACA]

Star,

This is a very critical question since our industry has a practice to use booked foreign currency exchange rates where these have been contracted. Varied practice is also seen in the case where L/Cs receivables (invoices) have been negotiated with banks.

However, speaking strictly in accordance with IAS-21 this practice is incorrect.

The spot rate of transaction date has to be used on initial recognition. On eventual settlement the gain or loss will be taken to P/L account.

Regards,


KAMRAN.

[Star]

Dear all,

I think transactions are first executed then accounting treatement is decided. As you dicussed, the agreement of exchange rate fixation at the time of contract of sale is in convention with IAS-21. Really?

Members are requested to clarify the matter.

Regards,

*

[kamranACA]

Star,

Whenever you will enter into a transaction, involving some other currency, it has to be translated at the spot rate of transaction date.

On eventual settlement or whatever subsequent event, the difference will be taken as exchange gain or loss.

Regards,


KAMRAN.

[Star]

Dear Kamran,

Agreed the differnce shall go to P&L in the form of gain or loss eventually.

I think there is involment of some sort of hedging in the transaction when exchange rate is agreed before the purchase through contract of sale or purchase.

What will be the accounting treatement when such contract of sale fall in one reporting period, purchase transaction in other reporting period and settlement in third reporting period. Reporting period is quarter.

Is the excecution of contract of sale in which exchange rate is fixed invites in the recognition of derivative because exchange rate is hedged through forward contract with seller.


Regards,

*

[kamranACA]

Dear,

I agree that it may be a hedging arrangement but to my understanding it does not go unrecorded between various accoutning periods.

The transaction is initially recorded at spot rate of transaction date, so revenue and receivable is established (in case of sale) or cost and payable is recorded (in case of purchase).

Now on each reporting date the receivable or payable initially established on transaction date has to be re-stated at the spot rate of balance sheet date. The resulting gain or loss is recorded as of that date. You will be doing this at the end of both quarters (out of the three) and eventually if the receivable or payable gets settled in third quarter, the actual gain or loss will be realized and recorded.

The currency hedge arrangement (forward booking) depends upon the date of settlement agreed. If it is not settled on the agreed date, the previous contract of currency settlement is closed resulting actual gain or loss and a new contract is again entered into, if it is considered feasible.

To my understanding the valuation of hedge derivative (as you pointed out) is a difficult issue. In Pakistan even our banks don't have the valuation models to value such derivatives. In most of cases of swap arrangements they rely on the models of foreign valuers and banks. I don't have the required expertise on this issue so I cannot comment in detail. However, I feel even if such valuation would be feasible, it would be immaterial and cost benefit ratio may not suggest doing so.

I guess some one well versed with banking industry may be in a position to point out the solution. May we look forward to Pracs, Goodman, Derivativetrader, XBRL, CFACCA or any other member who may be knowing it in further detail.

Regards,


KAMRAN.

[Shahzad09]

Dear Kamran,

Thanks for taking my question into consideration.

Basically the purchase is made in Rs. and like in EPZ there is a concept of NR cheque, the bank debits your dollar account and issue a Rs. cheque in favour of the supplier. (converting at its treasury exchange rate)

Usually when we enter PKR purchases in our erp, it automatically converts PKR into $ using last week average rate (as per company policy).

Now on the otherside when we credit our usd account for the payment, the actual dollar comes to $10.126 (using bank exchange rate) as mentioned in above example.

So there exist a question, shall we account for exchange gain and loss as there a difference in figures of $ amount ?

(Consider no gap between purchase and payment)

Thanks !

[kamranACA]

Dear,

In my view, there arises no exchange gain or loss if there is no gap between payment and purchase keeping in view the arrangement you have mentioned.

Regards,


KAMRAN.

[Shahzad09]

Dear experts,

In case if payment is made in advance for capital expenditure, will the exchange gain/loss be computed when shipment is received (at the time of recognizing capital asset) ?

[maani]

Hi,

yes, exchange gain / loss will be computed....asset will be measured by applying exchange rate prevailing on the date when risks and rewards will be tranferred....consider this example

01 Mar 2009 Advance made for capital expenditure, functional currency is Rupee and the asset's invoice value is $2....Exchange rate $1=Rs 80

Dr Advances 160
Cr Bank 160

30 Mar 09 Shipment received....Exchange rate $1=Rs 90

Dr Asset 180
Cr Advances 160
Cr Exchange gain 20

[Shahzad09]

Thanks, can you help with the example of prepaid rent

If $12 in advance paid on Jan 1 for a year rent when $/Rs rate was 80, however exchange rate changed to 90 on Jan 31
(functional currency rupees)

(Jan 1) Advance 960
Bank 960

(Jan31) Rent expense 80 (960/12)
Advance 80

Please confirm whether this entry is correct or shall we have to record exchange gain/loss every time we reverse the advance ?