Foreign exchange: exchange rate for accounts purposes
For entities reporting under UK GAAP, foreign exchange transactions will be accounted for in line with one of the following: SSAP 20, FRS 23 (which implements the international standard IAS 21), Section 30 of FRS 102 or where FRS 101 is adopted in line with the requirements of IAS 21.
SSAP20 generally requires a business to record foreign currency transactions (such as sales or purchases of goods or fixed assets) in its accounting records:
- at the date the transaction occurred, and
- using the rate of exchange in operation on that date.
There are, however, exceptions:
- The business can use an average exchange rate provided that exchange rates do not fluctuate significantly in the relevant period. For example, a business that makes a large number of purchases in euros each month might use the average euro/sterling exchange rate for the month to translate all the purchases.
- If the trader has contracted to buy or sell something, and the contract specifies a particular rate of exchange, that exchange rate must be used in the accounts.
- If the business has hedged the transaction with a forward currency contract or a currency swap, the rate of exchange specified in the currency contract may be used to translate the transaction. There is more about currency contracts at BIM39570.
At the end of the period of account, the business is required to retranslate monetary items (money held, and amounts to be received or paid in money) into sterling at the closing rate. ‘Closing rate’ means, broadly, the exchange rate in force on the last day of the period of account.
The approach is very similar for businesses using FRS 23, FRS 102 or FRS 101. A foreign currency transaction is, on initial recognition, translated at the spot rate for the day in question. An average rate for the week or month concerned may be used, although not if exchange rates for the currency concerned fluctuate significantly.
However the accounting standards differ in their treatment of contract rates and rates in forward purchases. SSAP 20 requires that transactions are translated at the contract rate where one exists. In contrast FRS 23, FRS 102, IAS 21 and FRS 101 require the spot rate to be used. SSAP 20 also permits (but does not require) the use of a forward exchange rate where a forward is entered into in contemplation of the item being translated. Such an approach is not permitted under FRS 23, FRS 102, IAS 21 or FRS 101.