Foreign Currency Transactions: Conversion and Reporting
- Graziano Stefanelli
- Jun 20
- 2 min read
Entities operating internationally routinely enter into transactions denominated in currencies other than their functional currency. The recognition, conversion, and reporting of foreign currency transactions and balances are governed by precise rules to ensure assets, liabilities, revenues, and expenses reflect prevailing exchange rates and exposures. This area of accounting requires rigorous application of measurement, revaluation, and disclosure standards under both US GAAP and IFRS.
1. Functional Currency and Transaction Currency
Functional currency is the primary currency of the entity’s operating environment, determined by the currency influencing sales prices, labor, and other costs.
Transaction currency is the currency in which a particular transaction is denominated.
All foreign currency transactions must ultimately be reflected in the entity’s functional currency for financial reporting purposes.
2. Initial Recognition of Foreign Currency Transactions
Foreign currency transactions are recorded at the spot exchange rate between the functional and foreign currency on the transaction date.
Example:
A US-based company purchases inventory for €50,000 on March 1, when the EUR/USD rate is 1.10. The transaction is recorded at $55,000.
Journal Entry:
Dr. Inventory $55,000
Cr. Accounts Payable $55,000
3. Subsequent Measurement and Settlement
a) Monetary Items
Accounts receivable, payable, loans, and other monetary items denominated in a foreign currency are remeasured at the closing rate (spot rate at reporting date) at each balance sheet date.
Exchange differences arising from remeasurement are recognized in profit or loss for the period.
b) Non-Monetary Items
Non-monetary items (e.g., inventory, PPE, intangibles) measured at historical cost are not remeasured after initial recognition. If carried at fair value, remeasurement uses the exchange rate at the date the fair value was determined.
4. Settlement of Foreign Currency Transactions
When a foreign currency liability or receivable is settled, compare the exchange rate at settlement date to the rate at initial recognition or last measurement. The resulting gain or loss is recognized in profit or loss.
Example:
Initial recognition (March): €50,000 at 1.10 = $55,000
Settlement (April): €50,000 at 1.15 = $57,500
Exchange loss: $2,500 recognized in the income statement at settlement.
5. Financial Statement Translation (Foreign Operations)
For subsidiaries or branches with a functional currency different from the reporting entity:
Assets and liabilities: Translated at closing rate at balance sheet date
Income and expenses: Translated at exchange rates at transaction dates (often average rates are used)
Equity items: Translated at historical rates
Translation adjustments are recorded in other comprehensive income (OCI) and accumulated in equity until disposal of the foreign operation.
6. Disclosure Requirements
Entities must disclose:
Amount of exchange differences recognized in profit or loss
Nature and amount of translation adjustments in equity
Methods and rates used for translation
7. Standards Reference
US GAAP: ASC 830 “Foreign Currency Matters”
IFRS: IAS 21 “The Effects of Changes in Foreign Exchange Rates”
8. Example Table: Exchange Rate Impact on Payable
9. Common Pitfalls and Best Practices
Incorrect functional currency determination: Analyze primary operating factors carefully.
Improper remeasurement: Only monetary items are remeasured at period end; non-monetary items are not.
Incomplete disclosures: Clearly separate realized and unrealized exchange differences and include all required notes.
