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HMRC internal manual

Corporate Finance Manual

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Accounting for corporate finance: foreign exchange: SSAP 20: recognition and the accruals concept

This guidance applies to companies which have adopted SSAP 20 under Old UK GAAP.

Reporting exchange gains and losses: the accruals concept

It might be argued that you shouldn’t recognise exchange gains and losses in the profit and loss account until they are realised, or that you should recognise losses but not profits.

This is more of a problem with long-term than with short-term items. Going back to the first example in CFM26040, the trade debt of €5,000 is likely to be paid shortly after the balance sheet date, so the amount the company receives will probably not be substantially different from £3,250. It therefore makes sense to recognise the exchange gain in the 2004 accounts.

But in the case of a 5-year bank loan, the company cannot be at all certain what €200,000 will be worth in sterling terms when it comes to repay the loan. SSAP20 justifies reflecting both unrealised gains and unrealised losses in the profit and loss account by saying that the translation at the closing rate provides the best available estimate of what it would cost to repay the loan (or to settle any other monetary item). So it accords with the accruals concept to include this ‘best estimate’ in the accounts and to recognise gains and losses on a year-by-year basis.

In addition, there is a link between exchange rates and interest rates (see CFM12100). A company that borrows in euros will pay a different rate of interest from one that borrows in sterling. Thus if a company included foreign currency interest that it pays (or receives on a loan or deposit) in the profit and loss account without including exchange gains or losses on the principal sum, its accounts would reflect only part of its economic situation.

If, however, there are doubts about the convertibility or marketability of the currency - for example, if a company has made a loan in a currency that is subject to exchange controls - prudence wins out over the accruals concept. The company can decide to restrict the exchange gains it recognises in the profit and loss account.

Recognition of unrealised exchange gains and losses on long-term monetary items means that in some cases a company’s profits might vary considerably from year to year because of exchange rate fluctuations alone. This is one reason why many companies hedge foreign exchange risks (see CFM26080).