Having decided to account for foreign currencies, you must then decide on an appropriate accounting policy. The accounting policy determines the method and exchange rates used to calculate foreign currency account balances and report foreign currency exchange differences in management reports – i.e. Balance Sheet and Profit & Loss reports.
At any time, foreign currency nominal ledger account balances (e.g. debtors, creditors, bank accounts denominated in foreign currencies) must be reported in the home currency of your business to be included in your balance sheet. The exchange rates used to convert from foreign currencies to home currency will be the exchange rates prevailing at the balance sheet date.
- On 1st April 2018 A company purchase goods in US Dollars for $1200 at an exchange rate of 1.2 The cost in Sterling is £1000.
- The goods were bought on credit and when paid the exchange rate is 1.25 the cost in Sterling is now £960.00.
Another way to look at these same numbers will help you understand the next topic which introduces currency accounting policies. For simplicity, consider that the above transactions are the only transactions the company has done.
On the invoice and payment date, the company’s Balance Sheet (Bank Account) and Purchases both record a cost of £1000.00.
On the payment date the Balance Sheet (Purchase Ledger has a liability of £1000 which is offset by a payment of £960.00.
How do we treat the difference of £40.00?
Generally Accepted Accounting Policies (GAAP) allow businesses to choose from a variety of different methods of conversion of foreign currency transactions to home currency for management reporting and statutory accounts production. These are:
Balance Sheet Rate: Use the same exchange rates as those used to convert Foreign Currency Balance Sheet accounts to Home Currency. By definition, there will be no exchange difference if this method is adopted.
Set P&L exchange rates to be the same as Balance Sheet exchange rates in Foreign Currency Parameters.
In the example above exchange rate at 1.2 will post both transactions at £1000.00
This assumes that the payment is made in Dollars from a US Dollar account. If the payment is made from a Sterling account there will be an exchange difference created
– Dr. Purchase Ledger $1200 (PL Control account – £1000)
Cr. Bank account £960.00 + Cr. Exchange difference £40.00
Average Rate: Use exchange rates that represent an average of the exchange rates during the reporting period.
set P&L exchange rates to this representative value in Foreign Currency Parameters.
At the end of the period the exchange rate may be 1.125. The example above – invoice at $1200 – £1000 then changes to £1066.67 at the period end – if the payment is made subsequently there will be a posting made to the purchase Ledger account of $1200 – £1066.67.
There is no exchange difference here but the revaluation has created an exchange difference of £133.33. If paid through a Sterling account there could be a further exchange difference.
Transaction Rate: Use exchange rates prevailing and entered at the time of each transaction
Check “Use transaction rate for P&L?” in Foreign Currency Parameters.
The chosen method should be used consistently and applies to monetary – i.e. broadly trading – foreign currency transactions only. For non-monetary foreign currency transactions – e.g. purchase of Fixed Assets – the foreign currency amounts should be converted to home currency at rates prevailing at the time of the transaction and accounted for in home currency. Decide on your chosen conversion method considering trading and market conditions and potential volume of transactions.
Activating Foreign Currency, will immediately impact the way some of the forms display account information, how management reports figures are calculated, how accounts are maintained and how transactions are entered.
To see an explanation of the impact on how accounts are maintained and how transactions are entered, please read Currency – Use The Module.
In this article we aim to explain the impact of the selections made in foreign currency parameters on how the forms display account information and how management reports figures are calculated.
In the following explanation:
- A refers to “Use transaction rate for P&L?” in Foreign Currency Parameters;
- B refers to “Use period-end rates?” in Foreign Currency Parameters.
The nominal ledger enquiry form will convert to home currency depending on the currency parameters and the nominal ledger account type – Balance Sheet (BS) or Profit & Loss (P&L).
Balance Sheet account
- A is ignored (as it applies only to P&L accounts)
- B checked: each record in the form is converted to home currency at the period-end BS rate for that record*
- B unchecked: each record in the form is converted to home currency at the current BS rate from parameters.
- A checked (B ignored): each record in the form is converted to home currency at its transaction rate – i.e. the rate entered at the time the transaction was posted.
- A unchecked, B checked: each record in the form is converted to home currency at the period-end P&L rate for that record*
- A unchecked, B unchecked: each record in the form is converted to home currency at the current P&L rate from parameters.
*In the Nominal Period-End routine (see Period-End Processing), the exchange rates in parameters are archived and identified as the period-end rates for that period.
This carries through into trial balance and management reports and allows the user to employ GAAP in these reports.
So you should choose:
- A if you want the P&L report to be converted at transaction rates.
- B if you want to retain month-end reported figures in management reports.
N.B. this is satisfied by definition for P&L accounts when A is checked as each P&L record will always be converted to home currency at its transaction rate.
The Sales Ledger Account Enquiry form and Purchase Ledger Account Enquiry form displays amounts (totals and each record) in home currency converted at the current BS rate from parameters. These forms are both balance sheet memorandum accounts and the account totals will agree with the account totals on the relevant Nominal Ledger Enquiry form.
They will also agree for each record if B is unchecked.
The Sales Ledger and Purchase Ledger transaction tables in the database are cumulative (i.e. the system retains a complete history of all transactions which may be cleared down at any time at the user’s discretion – see, for example, Cleardown Customer History whereas the nominal and exchange rate transaction tables are routinely cleared down at each nominal year-end.
There will be scenarios, therefore, in which there will not be complete correspondence between the records in the Sales Ledger and Purchase Ledger transaction tables and the records in the Nominal Ledger transaction tables. It is for this reason, the Sales Ledger and Purchase Ledger Account Enquiry forms treat currency values as they do and not in the same way as the Nominal Ledger Enquiry form.
If you need further clarification, please consult your Prelude reseller or an accountant.