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HMRC internal manual

# Accounting for corporate finance: foreign exchange: SSAP 20: accounting for a speculative currency contract: example

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

## Example of accounting for a forward currency contract under SSAP20

Yandolay Ltd (which prepares accounts to 31 March, and is not a financial trader) enters into a forward contract on 2 January 2004 to buy \$200,000 on 30 June 2004 at a rate of \$1.66/£. It does this as a pure speculation. Relevant exchange rates are as follows:

 Spot rate Forward rate for 30/6/04 2 January 2004 \$1.68/£ \$1.66/£ 31 March 2004 \$1.64/£ \$1.60/£ 30 June 2004 \$1.58/£ \$1.58/£

The company might, in applying SSAP 20 to its accounts to 31 March 2004, account for the contract at forward rates. It translates the contract on 2 January at the six-month forward rate (the rate at which it is contracted to buy the dollars on 30 June). It also uses the forward rate for 30 June (the three- month forward rate) to translate the contract at 31 March. The calculation of the exchange gain is therefore:

 \$200,000 @ \$1.60/£ = £125,000 \$200,000 @ \$1.66/£ = £120,482 Exchange gain = £ 4,518

In the year to 31 March 2005, the accounts will show a further exchange gain of £1,582:

 \$200,000 @ £1.58/£ = £126,582 \$200,000 @ £1.60/£ = £125,000 Exchange gain = £ 1,582

The total exchange profit over the two years (£6,100) represents the difference between what the company must pay for the dollars under the contract (£200,000 at \$1.66/£ = £120,482) and what it would have had to pay for the dollars in the spot market on 30 June 2004 (£126,582).

If the company accounted for the contract at spot rates, it would need to bring in an exchange gain or loss representing the difference between the spot value at the start of the contract and the contracted rate. In this case:

 Spot value of \$200,000 at start of contract (at \$1.68/£) = £119,048 Value of \$200,000 at contracted rate (\$1.66/£) = £120,482 Exchange loss (‘forward premium’) = £ 1,434

Where dollars (or any other currency) can be bought more cheaply at the spot rate than at the forward rate, they are said to trade at a premium to sterling. The premium - the difference between the spot and the forward rates - represents a loss to the company, because it is locked into buying dollars at a higher price than it would have paid on the spot market at the start of the contract. If the dollars could be bought more cheaply at the forward rate than at the spot rate, the company would have an exchange gain - a ‘forward discount’.

The company will spread the forward premium over the life of the contract. If it does this on a straight-line basis, a loss of £717 will be brought in for the year to 31 March 2004, and an identical amount in the following year.

Thus in the year to 31 March 2004, the exchange profit will be:

 \$200,000 @ \$1.64/£ = £121,951 \$200,000 @ \$1.66/£ = £119,048 Less forward premium (£717) Exchange gain = £ 2,186

In the year to 31 March 2005, it will be:

 \$200,000 @ \$1.58/£ = £126,582 \$200,000 @ \$1.64/£ = £121,951 Less forward premium (£717) Exchange gain = £ 3,914

Again, the economic profit of £6,100 is brought in over the life of the contract.

### Note on IFRS, New UK GAAP and FRS 23 under Old UK GAAP

Companies adopting IFRS, New UK GAAP or FRS 23 under Old UK GAAP rather than SSAP20 would need to account for the speculative forward contract as a derivative at fair value. The fair value movement in a forward currency contract is calculated by reference to the movement in the forward rate between two dates, similar to the forward rate approach outlined above.