Financial Reporting 3rd Edition - (CHAPTER 23 Foreign Currency Transactions and Forward Exchange Contract... )

CHAPTER 23
Foreign currency
transactions and forward
exchange contracts
CHAPTER AIM
This chapter explains how to account for foreign currency transactions in accordance with AASB 121/IAS 21
The Effects of Changes in Foreign Exchange Rates. The chapter also explains how to account for hedging
relationships using forward exchange contracts in accordance with AASB 9/IFRS 9 Financial Instruments.
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

23.1 explain the need to translate foreign currency transactions
23.2 explain how exchange rates function
23.3 prepare entries for the initial measurement of foreign currency items at transaction date
23.4 define and describe monetary and non-monetary items
23.5 describe how foreign exchange differences affect monetary assets or liabilities
23.6 prepare entries for the subsequent measurement of monetary items that are denominated in
foreign currency
23.7 prepare entries for the subsequent measurement of non-monetary items that are denominated in
foreign currency
23.8 explain what is meant by ‘foreign exchange risk’ and the circumstances in which it can arise
23.9 describe a ‘forward exchange contract’
23.10 explain hedge accounting
23.11 describe the disclosures required in the financial report relating to foreign currency transactions.
CONCEPT FOR REVIEW
Before studying this chapter, you should understand and, if necessary, revise:
• accounting for financial instruments.
Copyright © 2019. Wiley. All rights reserved.
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Created from newcastle on 2021-01-25 20:04:50.
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23.1 The need for translation of foreign
currency transactions
LEARNING OBJECTIVE 23.1 Explain the need to translate foreign currency transactions.
An Australian company may engage in operating, investing or financing activities that involve entering
into transactions denominated in a currency other than Australian dollars (A$). Reporting the effects of
such transactions in the original foreign currencies would not be useful to financial report users who are
normally interested in the company’s overall financial position, financial performance and cash flows.
Therefore, it is necessary to translate these effects into a single currency. If the financial statements of the
company are presented in A$, then the financial effects of all transactions have to be recorded and reported
in A$, including transactions denominated in foreign currencies such as United States dollars (US$), New
Zealand dollars (NZ$), pounds (£), euros (€), Chinese yuan (元) or Japanese yen (¥).
Accounting for foreign currency transactions is regulated by AASB 121/IAS 21 The Effects of Changes
in Foreign Exchange Rates. AASB 121/IAS 21 covers the:
• initial measurement of the financial statement elements that arise from foreign currency transactions
• subsequent measurement of assets and liabilities that arise from foreign currency transactions, including
subsequent measurement at the end of a reporting period
• treatment of any exchange differences that arise from the subsequent measurement of assets and
liabilities denominated in foreign currency
• translation of the financial statements of foreign operations (e.g. subsidiaries and associates).
This chapter deals with the translation of the effects of foreign currency transactions, including the initial
and subsequent measurement of financial statement elements that arise from foreign currency transactions
and the treatment of any exchange differences. This chapter also explains how the requirements of
AASB 9/IFRS 9 Financial Instruments apply to accounting for hedging transactions that involve forward
exchange contracts that are designed to protect a firm against losses from fluctuations in foreign exchange
rates. Chapter 24 covers how to translate the financial statements of a foreign operation.
AASB 121/IAS 21 distinguishes between the denomination currency or settlement currency for a
transaction and the measurement currency that applies for accounting purposes. The standard requires
a company to account for a transaction denominated in foreign currency by measuring the transaction in
the company’s functional currency (paragraph 21).
23.1.1 Functional currency

Paragraph 8 of AASB 121/IAS 21 defines the functional currency of a company as:
the currency of the primary economic environment in which the company operates.
The primary economic environment of a company is the one in which the company primarily generates
and expends cash (paragraph 9). Normally, the functional currency of an Australian company is A$ because
the company primarily generates and expends cash in Australia.
In determining the functional currency of an Australian company, AASB 121/IAS 21 (paragraph 9)
gives priority to the following three indicators.
1. The currency that mainly affects the sales prices for its goods and services, which is usually the currency
in which the sales prices are denominated and settled
2. The currency of the country whose competitive forces and regulations mainly determine the sales prices
of its goods and services

3. The currency that mainly influences labour, material and other costs of providing its goods or services,
which is usually the currency in which such costs are denominated and settled
An Australian company that competes for customers in the Australian marketplace by selling locally
manufactured goods or providing services from local employees would generally have A$ as the functional
currency, as that will satisfy all three indicators. An example of an Australian company where A$ is the
functional currency is Ramsay Health Care Limited, a local company providing health care services to
Australian communities.
The functional currency for an Australian company may not be obvious when the three indicators
provide mixed results. An Australian company may produce commodities from mines in the Pilbara region
of Western Australia (e.g. gold, copper, aluminium, lead, nickel, tin, zinc, silver and iron ore), but the
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792 Financial reporting

commodity prices may be denominated in US$. In this case, the US$ is the currency that mainly affects
sales prices, while the A$ is the currency that mainly affects costs.
If the three main indicators yield mixed results, AASB 121/IAS 21 requires management to use its
judgement to determine the functional currency that most faithfully represents the economic effects of the
underlying transactions, events and conditions (paragraph 12). In exercising this judgement, paragraph 10
suggests that management may consider the following two additional indicators.
• The currency in which funds from issuing debt and equity instruments are generated
• The currency in which receipts from operating activities are banked and retained
An example of an Australian company that yields mixed results based on the three main indicators is
Fortescue Metals Group Limited (Fortescue), which mines iron ore in Western Australia, predominantly
for Chinese customers. Fortescue noted in its 2018 annual report that management have determined that
the functional currency is US$.
The functional currency of an Australian company determined to be A$ or some other currency would
remain the same from one reporting period to the next unless the company’s underlying transactions, events
and conditions changed in such a way as to justify a change in the functional currency (AASB 121/IAS 21
paragraph 13).
23.1.2 Types of foreign currency transactions

AASB 121/IAS 21 describes a foreign currency transaction as a transaction that is denominated
or requires settlement in a foreign currency (paragraph 20). In this regard, any currency other than
the company’s functional currency is a foreign currency (paragraph 8). An Australian company with
a functional currency of A$ may enter into various foreign currency transactions with other entities
as follows.
• Buy or sell goods or services at prices denominated in a foreign currency.
• Acquire or dispose of plant and equipment at prices denominated in a foreign currency.
• Borrow or lend funds where the amounts payable or receivable are denominated in a foreign currency.
For example, an Australian company may import materials for use in a manufacturing process
(e.g. a dress maker and fashion house that imports silk from a French supplier for the price of €200 000).
Alternatively, an Australian food producer may export cheese to Japan for the price of ¥400 000. Qantas
Airways Limited may acquire a new aeroplane from the Boeing Company in the United States at the price
of US$72 000 000. An Australian company may borrow £500 000 to purchase land in the West Midlands
of England and subsequently pay interest of £25 000 p.a.
In each case, the Australian company must recognise the financial effects of the foreign currency
transaction by translating the foreign currency amounts (i.e. €200 000, ¥400 000, US$72 000 000,
£500 000 and £25 000) into the functional currency of A$. The translation is based on the exchange
rate between the foreign currency and the functional currency.
LEARNING CHECK
A company must account for a transaction denominated in foreign currency by measuring the
transaction in the company’s functional currency, which for an Australian company is commonly A$.
The functional currency is the currency of the primary economic environment in which the company
operates. The primary economic environment is the one in which the company primarily generates and
expends cash.
A foreign currency transaction involves a currency other than the functional currency.
An Australian company with a functional currency of A$ enters into a foreign currency transaction if
it imports or exports goods in a currency other than A$ or borrows or lends funds in a currency other
than A$.
23.2 Exchange rates

LEARNING OBJECTIVE 23.2 Explain how exchange rates function.
A person who has travelled outside their country of residence would be aware that foreign currency can
be bought or sold through banks or other financial institutions (that act as foreign exchange dealers) at
specified exchange rates. A person departing Australia will exchange Australian dollars (A$) to buy foreign
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CHAPTER 23 Foreign currency transactions and forward exchange contracts 793

currency such as euros (€), pounds (£) or US dollars (US$). A person returning to Australia may exchange
foreign currency for A$. AASB 121/IAS 21 describes an exchange rate as the ratio of exchange for
two currencies (paragraph 8). A spot exchange rate is the exchange rate for immediate delivery at a
particular point in time whereas the closing rate is the spot exchange rate at the end of the reporting period
(paragraph 8).
Foreign exchange dealers may quote the exchange rates using the indirect form of quotation, which sets
out the equivalent amount of foreign currency for one unit of local currency. In Australia, this form is also
preferred by the media in the presentation of financial news. For Australia, an example of the indirect form
of quotation is as follows.
Indirect form: A$1.00 equals US$0.6961/0.7754
The exchange rate shown in the indirect form above sets out the prices for buying and selling A$1.00
as follows.
• US$0.6961 is the buying rate for A$1.00, being the price the foreign exchange dealer will pay to buy
A$1.00 from a customer.
• US$0.7754 is the selling rate for A$1.00, being the price the foreign exchange dealer will ask to sell
A$1.00 to a customer.
Accordingly, a person travelling to the United States will sell A$ (and buy US$) based on the exchange
rate of A$1.00 equals US$0.6961. A person returning from the United States will sell US$ (and buy A$)
based on the exchange rate of A$1.00 equals US$0.7754. The difference between the buying (bid) and
selling (ask) rates is known as the bid–ask spread and it provides a profit margin to the foreign exchange
dealer for acting as the medium through which market participants buy and sell currencies.
An alternative approach is to present exchange rates using the direct form of quotation that sets out the
equivalent amount of local currency for one unit of foreign currency. For Australia, an example of the
direct form of quotation is as follows.
Direct form: US$1.00 equals A$1.2897/1.4366
The exchange rate shown in direct form sets out the prices for buying and selling US$1.00 as follows.
• A$1.2897 is the buying rate for US$1.00, being the price the foreign exchange dealer will pay to buy
US$1.00 from a customer.
• A$1.4366 is the selling rate for US$1.00, being the price the foreign exchange dealer will ask to sell
US$1.00 to a customer.
As a foreign exchange dealer buying US$ with A$ is essentially selling A$ in the process, the rates
shown in the direct form of quotation are the reciprocals of the relevant exchange rates shown in the
indirect form of quotation; that is, 1 US$0.6961 equals A$1.4366 and 1 US$0.7754 equals A$1.2897. The
foreign exchange dealer that buys A$ at the rate of A$1.00 equals US$0.6961 is essentially selling US$
at the rate of US$1.00 equals A$1.4366. The foreign exchange dealer that sells A$ at the rate of A$1.00
equals US$0.7754 is essentially buying US$ at the rate of US$1.00 equals A$1.2897. In general, the:
• buying rate under the indirect form of quotation is the inverse of the selling rate under the direct form
of quotation
• selling rate under the indirect form of quotation is the inverse of the buying rate under the direct form
of quotation.
The application of exchange rates to translate foreign currency balances into A$ is demonstrated next by
a simple example. Assume an Australian company has a foreign currency payable of US$5000 that must
be translated into A$ using the exchange rates shown in this section. In the first instance, it is necessary
to determine whether the buying or selling rate should be used for the purpose of the translation. The
liability balance denominated in US$ means that the Australian company has an obligation to pay US$,
which means it needs to sell A$ to get the US$ necessary to settle its obligation; therefore, it will need to
find a foreign exchange dealer willing to buy A$ and sell US$. In this case, the relevant exchange rate for
translation is either the foreign exchange dealer’s buying rate for A$ (in the indirect form of quotation)
or their selling rate for US$ (in the direct form of quotation). Accordingly, the translation of the foreign
currency payable of US$5000 proceeds as follows.
Translation of foreign currency payable

Indirect: US$5000 ÷ 0.6961 equals A$7183
Direct: US$5000 × 1.4366 equals A$7183
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This example highlights a rule of thumb that can be relied on when translating foreign currency balances;
that is, translation is a process of division if rates are expressed in indirect form (A$1.00 = US$ equivalent)
and multiplication if rates are expressed in direct form (US$1.00 = A$ equivalent).
In contrast, an Australian company with a foreign currency receivable of US$5000 has an asset balance
denominated in US$ and a right to receive US$. In this case, the Australian company wanting A$ will need
to consider selling US$ received to buy A$ and therefore will need to find a foreign exchange dealer willing
to sell A$ and buy US$. The relevant exchange rate for translation is then either the foreign exchange
dealer’s selling rate for A$ (in the indirect form of quotation) or the buying rate for US$ (in the direct
form of quotation). Accordingly, the translation of the foreign currency receivable of US$5000 proceeds
as follows.
Translation of foreign currency receivable
Indirect: US$5000 ÷ 0.7754 equals A$6448
Direct: US$5000 × 1.2897 equals A$6448
In the remainder of this chapter and in the end-of-chapter questions, exchange rates may be expressed
using either the indirect or direct form of quotation. In order to keep the focus on the key translation issues,
however, a single rate rather than separate selling and buying rates is normally shown.
LEARNING CHECK
An exchange rate is the ratio of exchange for two currencies. A spot exchange rate is the rate
for immediate delivery at a point in time. The closing exchange rate is the rate at the end of the
reporting period.
Exchange rates can be quoted in indirect form for one unit of local currency (e.g. A$1.00) or in direct
form for one unit of foreign currency (e.g. US$1.00).
Exchange rates are usually quoted by the foreign currency dealer showing a buying/bid rate and
selling/ask rate.
A foreign currency amount can be translated into A$ by dividing the foreign currency amount by the
rate of exchange expressed in indirect form.
A foreign currency amount can be translated into A$ by multiplying the foreign currency amount by the
rate of exchange expressed in direct form.
23.3 Initial measurement at the transaction date

LEARNING OBJECTIVE 23.3 Prepare entries for the initial measurement of foreign currency items at
transaction date.
The logical question that arises in accounting for foreign currency transactions is: which exchange rates
should be used to translate the foreign currency balances?
Consistent with historical cost accounting, the financial statement items that arise from a foreign
currency transaction should be measured on initial recognition using the historical exchange rate at the
date of the transaction; that is, the spot exchange rate at the date of the transaction. Paragraph 21 of
AASB 121/IAS 21 requires that a foreign currency transaction be recorded on initial recognition in
A$ by applying the spot exchange rate at the date of the transaction to the foreign currency amount.
The requirement to translate at the transaction date applies to all foreign currency transactions. The
requirement means that each asset, liability or item of equity that arises from entering into a foreign
currency transaction must be initially recognised and measured using the spot exchange rate at the date of
the transaction. The spot exchange rate also applies to any items of revenue or expense that are attributable
to the transaction.
The general principle applicable to the acquisition or disposal of an asset is that the date of the transaction
depends on when control of the future economic benefits embodied in the asset are obtained from or
transferred to another entity. AASB 102/IAS 2 Inventories (paragraph 6) indicates that inventories are
recognised only if the definition of an asset in the Conceptual Framework is satisfied. AASB 116/IAS 16
Property, Plant and Equipment (paragraph 7) states that the initial recognition of an item arises only when
it is probable that the future economic benefits will flow to the entity and the cost can be measured reliably.
In relation to revenue recognition in the case of sale of goods to customers, AASB 15/IFRS 15 Revenue
from Contracts with Customers requires an entity to satisfy performance obligations and transfer control
of the asset to the customer.
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In most instances, the terms of agreements between a company and its foreign customers or suppliers
will determine the date of the transaction for the sale or purchase of goods. A free on board (FOB) clause
is usually included in contracts stipulating who has title to the goods during shipment. A contract that
is FOB destination means that the seller retains ownership while the goods are in transit and ownership
changes only at the point when the buyer has received the goods into its stores. A contract that is FOB
shipping point means that the seller retains ownership of the goods only to the point when the goods are
placed on the ship. In this case, ownership changes at the point when the seller transfers the goods to the
specific carrier agreed with the buyer. Another contract variant is FOB origin, which means the seller bears
responsibility for the goods while the goods remain in the country of origin.
A simple example demonstrates the initial recognition and measurement of financial statement items at
the transaction date. At 1 May 2022, a company acquires a machine on credit terms from a foreign supplier
for a price of US$300 000 when the prevailing exchange rate is US$1.00 = A$1.20. In accordance with
paragraph 21 of AASB 121/IAS 21, the journal entry of the company to record the purchase of the machine
is as follows.
2022
May 1 Machine (cost) Dr 360 000
Payable to foreign supplier Cr 360 000
(Initial recognition of machine and payable at transaction
date using spot rate, US$300 000 × 1.20)
A practical issue concerns how to deal with a multitude of purchase transactions in the same foreign
currency during the reporting period. In these circumstances, the spot rate on the transaction date may be
replaced by an average exchange rate for the period when those multiple transactions took place, identified
as the transaction period. Paragraph 22 of AASB 121/IAS 21 allows an average exchange rate to be applied
against the total transactions in a foreign currency for the period provided that exchange rates have not
fluctuated significantly. An example would be the translation of all inventories purchases made in US$
during the month of February 2022 using the average exchange rate with the A$ for that month. In effect,
the translation of the total inventories purchases for the month using the average exchange rate should not
be materially different from the total derived from translating each separate purchase transaction in the
month using the relevant daily exchange rates.
If revenues or expenses denominated in foreign currency are earned or incurred evenly during a period
(e.g. interest revenue or expense), they are translated using the average rate for that period. It should be
noted that revenues and expenses denominated in foreign currency are not to be remeasured after the
initial recognition. This is in accordance with accrual accounting that recognises the revenues when they
are earned and expenses when they are incurred.
LEARNING CHECK
The financial statement items that arise from a foreign currency transaction should be measured on
initial recognition using the historical exchange rate at the date of the transaction; that is, the spot
exchange rate at the date of the transaction.
The date of the transaction depends on when control of the future economic benefits embodied in the
asset are obtained from or transferred to another entity.
The terms of agreements between a company and its foreign customers or suppliers will determine the
date of the transaction for the sale or purchase of goods.
When dealing with a multitude of purchase transactions in the same foreign currency during the
reporting period, the spot rate on the transaction date may be replaced by an average exchange rate
for the transaction period.
If revenues or expenses denominated in foreign currency are earned or incurred evenly during a period,
they are translated using the average rate for that period.
23.4 Monetary and non-monetary items

LEARNING OBJECTIVE 23.4 Define and describe monetary and non-monetary items.
Subsequent measurement of financial statement items resulting from a foreign currency transaction
depends on whether the items are monetary or non-monetary items.
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AASB 121/IAS 21 defines monetary items as units of currency held and assets and liabilities to be
received or paid in a fixed or determinable amount of currency (paragraph 8). A monetary item therefore
refers to cash or another item that constitutes a claim to cash or an obligation to pay cash. An Australian
company with a functional currency of A$ could have monetary items denominated in foreign currency,
such as:
• cash at bank of US$60 000
• accounts payable of €200 000
• accounts receivable of ¥400 000
• payable for plant purchase of US$72 000 000
• borrowings of £500 000
• interest payable of £20 000.
Monetary items should not be confused with financial assets. Shares held in companies listed on the
Australian Securities Exchange (ASX) are financial assets and can easily be converted into cash through
sale. The shares held, however, do not represent a claim to a fixed number of dollars or currency and
therefore do not constitute a monetary item. In contrast, foreign currency borrowings is a monetary item
because it represents an obligation to pay a fixed number of foreign currency units, even if exchange rate
movements cause the obligation measured in A$ to vary.
A non-monetary item is an asset or liability that is not a monetary item. Examples of non-monetary
items include inventories and property, plant and equipment.
LEARNING CHECK
Monetary items are units of currency held and assets and liabilities to be received or paid in fixed or
determinable amounts of currency.
Not all financial assets are monetary items.
Non-monetary items are assets and liabilities that are not monetary items.
23.5 Foreign exchange differences for monetary items

LEARNING OBJECTIVE 23.5 Describe how foreign exchange differences affect monetary assets or liabilities.
AASB 121/IAS 21 defines a foreign exchange difference as the difference resulting from translating a
given number of units of one currency into another currency at different exchange rates (paragraph 8).
Exchange differences arise whenever a foreign currency balance is remeasured using an exchange rate
that is different to the one applied previously.
23.5.1 Realised and unrealised gains or losses from

exchange differences
Foreign currency transactions that involve the recognition of a monetary asset or liability usually give rise
to a foreign exchange difference because the monetary item is settled after its initial recognition when
exchange rates have changed. An example is a credit sale of inventories to a customer for US$100 where
the sale and cash receipt occur during the same financial period. Assume that at the date of the transaction
the spot rate is US$1.00 = A$1.20, but at the date of settlement (cash receipt) the spot rate has changed
to US$1.00 = A$1.50. Figure 23.1 illustrates that a realised exchange gain of $30 results within a single
reporting period.
A realised exchange gain that is attributable to a single reporting period is recognised in profit or loss
for that period and does not present any special accounting problem given that it occurs in the same period
as the sales transaction. A realised exchange gain, however, may relate to more than one reporting period.
An example is where a credit sale transaction occurs in a reporting period, but the date of cash receipt
belongs to the next reporting period. Assume that at the date of the transaction the spot rate is US$1.00
= A$1.20, at the end of the reporting period the spot rate is US$1.00 = A$1.40 and at the date of cash
settlement the spot rate is US$1.00 = A$1.50. Figure 23.2 illustrates a realised gain that relates to two
reporting periods.
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FIGURE 23.1 Realised foreign exchange gain in a single reporting period
Beginning of period Date of transaction Date of settlement End of period

1 July 2022 30 June 2023
Accounts receivable Cash receipt

US$100 × 1.20 US$100 × 1.50
A$120 A$150
Realised foreign
exchange gain A$30
FIGURE 23.2 Realised exchange gain across two reporting periods
Date of transaction End of period Date of settlement End of period

30 June 2023 30 June 2024
Accounts receivable Accounts receivable Cash receipt

US$100 × 1.20 US$100 × 1.40 US$100 × 1.50
A$120 A$140 A$150
Realised foreign exchange gain A$30
The issue that arises if a realised exchange difference does not occur in a single reporting period is
whether unrealised exchange gains and losses should be recognised. The question turns on how monetary
items are translated at the end of the reporting period. If a receivable of US$100 at 30 June 2023 is
translated using the spot rate of 1.40, then an unrealised exchange gain of A$20 (A$140 less A$120) must
be recognised for the year. AASB 121/IAS 21 mandates this approach and requires that exchange gains
and losses be immediately recognised in the profit or loss as they arise. This is known as the ‘immediate
recognition method’ of accounting for exchange gains and losses. The immediate recognition method is
consistent with accrual accounting because the accounting for exchange gains and losses is not dependent
on a cash transaction. It should be noted though that the immediate recognition method treats the financing
arrangement for a foreign currency transaction as a separate matter from the underlying transaction; that
is, the measurement of a foreign currency receivable is separate from the recognition and measurement of
the sale that gave rise to the receivable.
23.5.2 The relationship between exchange rates and

exchange differences
The illustrations in figures 23.1 and 23.2 highlight that the nature of foreign exchange differences depends
on the foreign currency monetary item and how exchange rates change. In the example shown, the
translated A$ amount of the US$ receivable increases as the direct exchange rate for US$1.00 increases
from A$1.20 to A$1.50 and results in a foreign exchange gain of A$30. Consider the position of a
receivable for US$100 if the direct exchange rate for US$1.00 decreased from A$1.40 to A$1.30 (US$
decreases in value relative to A$). In this case, the translated amount of the receivable would decrease
from A$140 to A$130 and result in a foreign exchange loss of A$10. Alternatively, a payable for US$100
would decrease from A$140 to A$130 and result in a foreign exchange gain of A$10.
It is possible to generalise the relationships between foreign currency monetary items, exchange rate
changes and exchange differences. Figure 23.3 sets out these relationships.
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FIGURE 23.3 Changes in rates and translated amounts and resultant exchange differences
Foreign currency monetary item

Change in exchange rate Payable US$ Receivable US$
Increase in direct rate US$1 = A$# US$ appreciates Increase in A$ amount Increase in A$ amount
Decrease in indirect rate A$1 = US$# (increases) in value ⇒ Exchange loss ⇒ Exchange gain
compared to A$
Decrease in direct rate US$1 = A$# A$ appreciates Decrease in Decrease in
Increase in indirect rate A$1 = US$# (increases) in value A$ amount A$ amount
compared to US$ ⇒ Exchange gain ⇒ Exchange loss
If the change in the exchange rate shows that the foreign currency increases in value relative to the
functional currency (either by an increase in the direct rate of quotation or, equivalently, a decrease in the
indirect rate):
• a monetary asset denominated in foreign currency will increase when translated into the less valuable
functional currency, giving rise to a foreign exchange gain as the company is effectively entitled to
receive more units of functional currency
• a monetary liability denominated in foreign currency will increase when translated into the less valuable
functional currency, giving rise to a foreign exchange loss as the company is effectively asked to pay
more units of functional currency.
If the change in the exchange rate shows that the foreign currency decreases in value relative to the
functional currency (either by a decrease in the direct rate of quotation or, equivalently, an increase in the
indirect rate):
• a monetary asset denominated in foreign currency will decrease when translated into the more valuable
functional currency, giving rise to a foreign exchange loss as the company is effectively entitled to
receive less units of functional currency
• a monetary liability denominated in foreign currency will decrease when translated into the more
valuable functional currency, giving rise to a foreign exchange gain as the company is effectively asked
to pay less units of functional currency.
LEARNING CHECK
Foreign exchange differences arise whenever a foreign currency balance is measured using an
exchange rate that is different to the one applied at initial measurement or at the end of a reporting
period.
A realised exchange difference arises on the cash settlement of a monetary asset or liability based
on the change in the exchange rate from initial recognition to cash settlement of the monetary asset
or liability.
An unrealised exchange difference arises on the remeasurement of a monetary asset or liability at the
end of the reporting period.
Exchanges gains (losses) on a monetary asset arise if there is an increase (decrease) in the direct rate
of exchange or decrease (increase) in the indirect rate of exchange.
Exchanges gains (losses) on a monetary liability arise if there is a decrease (increase) in the direct rate
of exchange or an increase (decrease) in the indirect rate of exchange.
23.6 Subsequent measurement of foreign currency

monetary items
LEARNING OBJECTIVE 23.6 Prepare entries for the subsequent measurement of monetary items that are
denominated in foreign currency.
Accounting for transactions that involve foreign currency monetary items can potentially involve three
stages based on the date of the transaction, the end of the reporting period and the date of cash settlement.
Figure 23.4 illustrates the three stages.
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FIGURE 23.4 Three stages in accounting for foreign currency monetary items
Stage 1 Stage 2 Stage 3

Date of transaction End of reporting period Date of cash settlement
Record transaction at Remeasure monetary item Remeasure monetary item

the spot rate, including at the closing rate. at the spot rate.
initial recognition of Recognise resulting exchange Recognise resulting
monetary item. difference in profit or loss of exchange difference in profit
the period it arises. or loss of the period it arises.
Record cash settlement of
monetary item at spot rate.
In the first stage, the financial statement elements that arise on the transaction date, including any
monetary items, are initially recognised and measured using the spot exchange rate. In the second stage,
the monetary item that is outstanding at the end of the reporting period is subsequently measured using
the closing exchange rate. In the third stage, the monetary item is subsequently measured at its settlement
date using the spot exchange rate. The exchange differences that results from these remeasurements are
recognised as exchange gains or losses in the profit or loss of the period in which they arise. The cash
settlement of the monetary item is also recorded using the spot exchange rate at the settlement date.
The three stages shown in figure 23.4 provide a general guide to accounting for monetary items
denominated in foreign currency. The three stages do not apply if the cash settlement of the monetary
item occurs before the end of the reporting period. In this case, there is a remeasurement of the monetary
item at the settlement date but not at the end of the reporting period; that is, only the first and third stages
would apply. The first stage was addressed in section 23.3. The other stages are addressed next.
23.6.1 Measurement of foreign currency monetary items at the

end of the reporting period
Paragraph 23(a) of AASB 121/IAS 21 requires that foreign currency monetary items outstanding at the
end of the reporting period be translated using the closing exchange rate. This requirement means that a
foreign currency monetary item is remeasured from its translated amount at the date of initial recognition
to the translated amount based on the spot exchange rate at the end of the reporting period. In effect, the
foreign currency monetary item is restated to its realisable amount in A$ at the end of the reporting period.
The subsequent measurement of a foreign currency monetary item at the end of the reporting period
results in an exchange difference if the relevant exchange rate has changed after initial measurement at the
date of the transaction. The exchange difference equals the change in the number of A$ that are equivalent
to the foreign currency amount. AASB 121/IAS 21 generally requires that an exchange difference resulting
from the subsequent measurement of a monetary item be recognised in the profit or loss in the period that it
arises (paragraph 28). A simple example demonstrates the subsequent measurement of a foreign currency
monetary item and recognition of the exchange difference at the end of the reporting period.
At 1 May 2023, a company acquires a machine on credit terms from a foreign supplier for a price
of US$300 000 when the prevailing exchange rate is US$1.00 = A$1.20. At the end of the reporting
period, on 30 June 2023, the exchange rate is US$1.00 = A$1.60. In accordance with AASB 121/
IAS 21 (paragraphs 23 and 28), the journal entry to remeasure the outstanding foreign currency monetary
item at 30 June 2023 is as follows.
2023
June 30 Foreign exchange loss Dr 120 000
Payable to foreign supplier Cr 120 000
(Increase in foreign currency payable at the end of the
reporting period using closing rate, US$300 000 × 1.60 less
US$300 000 × 1.20)
The journal entry for the subsequent measurement of the foreign currency payable increases the A$
amount by A$120 000 from A$360 000 at the date of the transaction to A$480 000 at the end of the
Pdf_Folio:800

reporting period. The increase in the monetary liability gives rise to a foreign exchange loss of A$120 000
that is recognised in the profit or loss of the period. The foreign exchange loss is an unrealised loss because
it relates to an outstanding monetary item at the end of the reporting period. A realised foreign exchange
difference will occur in a future period when the monetary item is settled in cash.
23.6.2 Measurement of foreign currency monetary items

at settlement date
Paragraph 29 of AASB 121/IAS 21 indicates that a foreign currency monetary item must also be
remeasured at settlement date. The need for subsequent measurement arises because settlement involves
the receipt or payment of foreign currency at a particular date; that is, cash is received or paid. In A$ terms,
the amount of cash received or paid is determined by the foreign currency amount translated at the spot
exchange rate at the date of settlement. The A$ amount of the monetary item in the accounting records
has to correspond with the cash received or paid at the time of settlement. Accordingly, it is necessary to
remeasure the foreign currency monetary item using the spot exchange rate at the date of settlement.
If the settlement date occurs in the same reporting period as the transaction date, then the monetary
item will have been previously measured at the transaction date. If the settlement date occurs after the
end of a reporting period (as shown in figure 23.4), then the monetary item will have been previously
measured at the end of that reporting period. The subsequent measurement of a foreign currency monetary
item at settlement date results in an exchange difference relative to the previous measurement if the
exchange rate changes. The exchange difference from subsequent measurement of a foreign currency
monetary item at settlement date is generally recognised in the profit or loss in the period that it arises
(AASB 121/IAS 21 paragraph 28). A simple example demonstrates the subsequent measurement of a
foreign currency monetary item at settlement date, the recognition of the resulting exchange difference
and the cash settlement of the monetary item.
On 1 May 2023, a company acquires a machine on credit terms from a foreign supplier for a price of
US$300 000 when the prevailing exchange rate is US$1.00 = A$1.20. On that day, the company recognises
an accounts payable in A$ of A$360 000 (US$300 000 × 1.20). At the end of the reporting period, on
30 June 2023, the exchange rate is US$1.00 = A$1.60. As a result, the company recognises an increase in
the accounts payable to A$480 000 (US$300 000 × 1.60). On 15 July 2023, the foreign supplier account
is paid in full when the exchange rate is US$1.00 = A$1.50. Before settlement is recognised, the amount
in the accounts payable must be remeasured based on the exchange rate existing at settlement date. In
accordance with paragraphs 28 and 29 of AASB 121/IAS 21, the journal entry to remeasure the foreign
currency monetary item at settlement date is as follows.
2023
July 15 Payable to foreign supplier Dr 30 000
Foreign exchange gain Cr 30 000
(Decrease in foreign currency payable at settlement date
using spot rate, US$300 000 × 1.50 less US$300 000 × 1.60)
The journal entry for the measurement of the foreign currency payable at settlement date decreases
the A$ amount by A$30 000 from A$480 000 recognised at the end of the previous reporting period to
A$450 000 at the date of settlement. The decrease in the monetary liability gives rise to a foreign exchange
gain of A$30 000 that is recognised in the profit or loss of the period.
The cash settlement of the foreign payable is a foreign currency cash flow. Paragraph 25 of
AASB 107/IAS 7 Statement of Cash Flows requires that a foreign currency cash flow is translated at
the spot exchange rate at the date of the cash flow. Accordingly, the journal entry to record the cash
settlement of the foreign currency payable at the settlement date is as follows.
2023
Cash at bank Cr 450 000
(Cash payment for settlement of foreign currency payable at
settlement date using spot rate, US$300 000 × 1.50)
Pdf_Folio:801

On the transaction date of 1 May 2023, a monetary liability of A$360 000 is booked. At the settlement
date of 15 July 2023, the monetary liability is settled by a cash payment of A$450 000. The realised
exchange difference, therefore, is a loss of $90 000. In accounting for the foreign currency monetary
item, however, exchange differences are recognised before realisation. An exchange loss of $120 000
is recognised at the end of the reporting period at 30 June 2023 and an exchange gain of $30 000 is
recognised at the settlement date of 15 July 2023. The net amount of the two recognised exchange
differences reconciles to the realised exchange loss of $90 000 (i.e. $120 000 loss and $30 000 gain equate
to a net loss of $90 000).
The timing of the recognition of exchange differences is a key feature of AASB 121/IAS 21. An
unrealised exchange loss of $120 000 is recognised in the annual reporting period ended 30 June 2023
and then an exchange gain of $30 000 is recognised in the annual reporting period ended 30 June 2024.
In accordance with the accrual basis of accounting, the standard recognises exchange differences in the
reporting periods in which the exchange differences arise. Recognition of foreign exchange gains or losses
does not depend on cash transactions.
It is worth noting that the two journal entries for the subsequent measurement of the foreign currency
monetary item and the cash payment at the settlement date can be combined into a single journal entry, if
desired, as follows.
2023
(Subsequent measurement and settlement of foreign currency
payable at settlement date)
23.6.3 Illustrative examples

This section further demonstrates the stages of accounting shown in figure 23.4 using a variety of examples
in respect of the recognition and measurement of foreign currency monetary items. All of examples relate
to Oz Ltd, an Australian company listed on the ASX, which prepares general purpose financial statements
at 30 June each year. Assume Oz Ltd uses a periodic inventories system.
ILLUSTRATIVE EXAMPLE 23.1
Exporting goods on credit terms

On 13 May 2023, Oz Ltd sells inventories to a US customer, Reagan Inc., for an agreed price of
US$40 000. On 12 August 2023, Oz Ltd receives cash in full payment of the sales invoice. Relevant
exchange rates are as follows.
13 May 2023 — transaction date A$1 = US$0.74

30 June 2023 — end of the reporting period A$1 = US$0.77
12 August 2023 — settlement date A$1 = US$0.80
The accounts receivable balance (i.e. the monetary item) is translated at the spot exchange at the three
dates as follows.
Date Accounts receivable in A$ Increase/(decrease)

13 May 2023 US$40 000 ÷ 0.74 = $54 054
30 June 2023 US$40 000 ÷ 0.77 = $51 948 ($2 106)
12 August 2023 US$40 000 ÷ 0.80 = $50 000 ($1 948)
The journal entries of Oz Ltd to record the initial recognition and measurement of the accounts
receivable together with its subsequent measurement and settlement are as follows.
Pdf_Folio:802

Journals for the year ending 30 June 2023
2023
May 13 Accounts receivable Dr 54 054
Sales revenue Cr 54 054
(Initial recognition and measurement of accounts receivable
at transaction date using spot rate, US$40 000 ÷ 0.74)
Accounts receivable Cr 2 106
(Decrease in accounts receivable at end of reporting period
using closing rate, US$40 000 ÷ 0.77 less US$40 000 ÷ 0.74)
2023
Aug. 12 Foreign exchange loss Dr 1 948
(Decrease in accounts receivable at settlement date using
spot rate, US$40 000 ÷ 0.80 less US$40 000 ÷ 0.77)
Aug. 12 Cash at bank Dr 50 000
(Cash receipt on settlement of customer account using spot
rate, US$40 000 ÷ 0.80)
Brief observations concerning this example are as follows.

(a) Oz Ltd’s statement of financial position at 30 June 2023 includes accounts receivable of $51 948
(i.e. $54 054 − $2106). Oz Ltd’s statement of profit or loss and other comprehensive income for the
year to 30 June 2023 includes a foreign exchange loss of $2106.
(b) Oz Ltd’s statement of profit or loss and other comprehensive income for the year to 30 June 2024
includes a foreign exchange loss of $1948.
(c) Oz Ltd incurs a realised foreign exchange difference on the accounts receivable equal to a loss of
$4054 (i.e. $54 054 − $50 000) and this includes the exchange losses recognised for the years ended
30 June 2023 and 30 June 2024 amounting to $2106 and $1948 respectively.
(d) Oz Ltd’s recognition of the foreign exchange differences is consistent with the movement in exchange
rates during the reporting periods. The A$ appreciates in value relative to the US$ and therefore the
accounts receivable of US$40 000 decreases in A$ value, giving rise to foreign exchange losses.
Importing goods on credit terms

Oz Ltd purchases raw materials from a New
Zealand company, Clark Ltd, for the agreed
price of NZ$500 000. The purchase contract is
FOB destination. On 15 May 2023, Oz Ltd orders
the materials. On 20 May 2023, Clark Ltd ships
the materials. On 15 July 2023, Oz Ltd receives
the materials into its factory. On 10 September
2023, Oz Ltd pays for the materials. Relevant
15 July 2023 — transaction date NZ$1 = A$0.88

10 September 2023 — settlement date NZ$1 = A$0.80
Pdf_Folio:803

The accounts payable balance (i.e. the monetary item) is translated at the spot exchange rates at the
two dates as follows.
Date Accounts payable in A$ Increase/(decrease)

15 July 2023 NZ$500 000 × 0.88 = $440 000
10 September 2023 NZ$500 000 × 0.80 = $400 000 ($40 000)
The journal entries of Oz Ltd to record the initial recognition and measurement of the accounts payable
and its subsequent measurement and settlement are as follows.
2023
July 15 Raw materials Dr 440 000
Accounts payable Cr 440 000
(Initial recognition and measurement of accounts payable
at transaction date using spot rate, NZ$500 000 × 0.88)
Sept. 10 Accounts payable Dr 40 000
(Decrease in accounts payable at the settlement
date using spot rate, NZ$500 000 × 0.88 less
NZ$500 000 × 0.80)
(Cash payment for settlement of supplier account using
spot rate, NZ$500 000 × 0.80)

(a) Oz Ltd recognises the purchase of raw materials when the goods are in its factory based on the FOB
destination contract.
(b) Oz Ltd does not have an outstanding monetary item in respect of the foreign currency transaction at
the end of a reporting period. In this case only translations at the transaction date and settlement date
are relevant.
(c) The exchange rate movements after the date of acquisition of the raw materials have no bearing on
the measurement of raw materials cost. The cost of the raw materials in A$ terms is the historical cost
in NZ$ translated at the historical exchange rate when the raw materials were purchased.
(d) Oz Ltd’s profit or loss for the year to 30 June 2024 includes the foreign exchange gain of $40 000.
Consulting revenue and foreign currency bank account

Oz Ltd provides consulting services to the Italian company, Berlusconi SpA, over the period 1 April 2023
to 30 April 2023 in return for €20 000 per day. On 30 April 2023, Oz Ltd receives a cheque of €600 000 in
full payment for the services provided and deposits it into a new bank account denominated in €. There
are no other transactions in € and the balance of the bank account at 30 June 2023 remains at €600 000.
Relevant exchange rates are as follows.
30 April 2023 — date of cash receipt A$1 = €0.78

Average for April 2023 — transaction period A$1 = €0.77

30 June 2023 — end of the reporting period A$1 = €0.80
The cash at bank balance (i.e. the monetary item) is translated at the spot exchange rates at the
two dates as follows.
Date Cash at bank in A$ Increase/(decrease)

30 April 2023 €600 000 ÷ €0.78 = $769 231
30 June 2023 €600 000 ÷ €0.80 = $750 000 ($19 231)
Pdf_Folio:804

The journal entries of Oz Ltd to record the initial recognition and measurement of the cash receipt
for consulting services and the subsequent measurement of the bank balance denominated in euros are
as follows.
2023
April 30 Cash at bank Dr 769 231
Foreign exchange loss Dr 9 990
Consulting revenue Cr 779 221
(Recognition of consulting revenue for April 2023 using
average rate, €600 000 ÷ 0.77, and initial recognition
and measurement of cash at bank using spot rate,
€600 000 ÷ 0.78)
(Decrease in cash at bank at the end of the reporting period
using closing rate, €600 000 ÷ 0.80 less €600 000 ÷ 0.78)

(a) Oz Ltd’s statement of financial position at 30 June 2023 includes a foreign currency cash balance equal
to $750 000 (i.e. $769 231 − $19 231). Oz Ltd’s statement of profit or loss and other comprehensive
income for the year to 30 June 2023 includes net foreign exchange losses of $29 221 (i.e. $9990 +
$19 231).
(b) Oz Ltd’s euros bank account at the end of the reporting period is a monetary item and is measured at
the closing exchange rate (i.e. €600 000 ÷ 0.80).
(c) Oz Ltd recognises the consulting revenue on an accruals basis over the period the revenue was
generated by translating at the relevant average exchange rate. In contrast, the revenue from the sale
of inventories or plant is generated on the date of the sale transaction.
Foreign currency borrowings

On 1 July 2022, Oz Ltd enters a loan agreement with the Bank of England plc to borrow £300 000 for a
period of 5 years. The interest on the borrowings is payable half-yearly in arrears at the fixed interest rate
of 6% p.a. with interest payments of £9000 (£300 000 × 6% × ½ year) due on 31 December and 30 June
each year. Oz Ltd prepares half-yearly reports and its reporting periods end 30 June and 31 December
each year. The following exchange rates are applicable for the annual financial period to 30 June 2023.
1 July 2022 — date of transaction A$1 = £0.60

Average July–Dec 2022 — interest period A$1 = £0.62
31 December 2022 — end of the reporting period A$1 = £0.64
Average Jan–June 2023 — interest period A$1 = £0.59
30 June 2023 — end of the reporting period A$1 = £0.56
The bank borrowings balance (i.e. the monetary item) is translated at the spot exchange rates at the
three dates as follows.
Date Bank borrowings in A$ Increase/(decrease)

1 July 2022 £300 000 ÷ £0.60 = $500 000
31 December 2022 £300 000 ÷ £0.64 = $468 750 ($31 250)
30 June 2023 £300 000 ÷ £0.56 = $535 714 $66 964
The journal entries of Oz Ltd to record the initial recognition and measurement of the borrowings, the
interest on the borrowings and the subsequent measurement of the borrowings at the end of the reporting
periods are as follows.
Pdf_Folio:805

Journals for 1 July to 31 December 2022
2022
July 1 Cash at bank Dr 500 000
Borrowings (non-current) Cr 500 000
(Initial recognition and measurement of borrowings at
transaction date using spot rate, £300 000 ÷ 0.60)
Dec. 31 Interest expense Dr 14 516
Foreign exchange gain Cr 453
(Recognition of interest expense for the December half-year
using average rate, £9000 ÷ 0.62, and cash payment for
interest using the spot rate, £9000 ÷ 0.64)
Dec. 31 Borrowings (non-current) Dr 31 250
(Decrease in borrowing at end of reporting period using
closing rate, £300 000 ÷ 0.64 less £300 000 ÷ 0.60)
Journals for 1 January to 30 June 2023
2023
June 30 Interest expense Dr 15 254
Foreign exchange loss Dr 817
(Recognition of interest expense for the June half-year using
average rate, £9000 ÷ 0.59, and cash payment for interest
using the spot rate, and £9000 ÷ 0.56)
(Increase in borrowing at end of reporting period using
closing rate, £300 000 ÷ 0.56 less £300 000 ÷ 0.64)

(a) Oz Ltd’s statement of financial position at 30 June 2023 includes foreign currency borrowings equal to
$535 714 (i.e. £300 000 ÷ 0.56). Oz Ltd’s statement of profit or loss and other comprehensive income
for the year to 30 June 2023 includes financing charges of $30 134 (i.e. $14 516 − $453 + $15 254 +
$817) and a net foreign exchange loss of $35 714 (i.e. $31 250 − $66 964).
(b) Oz Ltd recognises interest expense for a reporting period on an accruals basis by translating at the
relevant average exchange rate.
(c) In this example, the payment of interest corresponds with the end of the reporting periods. In other
cases, an amount for interest payable may be recognised at the end of each reporting period and, as
a monetary item, it would be translated using the applicable closing rate.
(d) In this example, there are no repayments of loan principal until the end of the 5-year term. If the
borrowings were partly repaid before the end of the 5-year term, then the requirement to remeasure
the monetary item at settlement date applies. Each time principal is repaid it is necessary to restate
the outstanding amount of the borrowings before the repayment using the spot rate.
LEARNING CHECK
Accounting for transactions that involve foreign currency monetary items can potentially involve
two subsequent measurements after the date of the transaction: at the end of the reporting period
and at the date of cash settlement.
At the end of the reporting period, a foreign currency monetary item is remeasured using the closing
exchange rate and any resulting foreign exchange difference is recognised in profit or loss.
At the date of settlement, a foreign currency monetary item is remeasured using the spot exchange
rate and any resulting foreign exchange difference is recognised in profit or loss.
Pdf_Folio:806

23.7 Subsequent measurement of foreign currency
non-monetary items
LEARNING OBJECTIVE 23.7 Prepare entries for the subsequent measurement of non-monetary items that
are denominated in foreign currency.
AASB 121/IAS 21 (paragraph 23(b)) requires that a non-monetary item measured in terms of historical
cost in a foreign currency be translated using the exchange rate at the date of the historical transaction.
The subsequent measurement of a non-monetary item will not give rise to any exchange differences
if the original translated cost continues to apply. This section explains three scenarios where exchange
differences do affect the measurement of a non-monetary asset. The first scenario is exchange differences
in the nature of interest costs that relate to a ‘qualifying asset’. The second scenario is exchange differences
on a non-monetary asset that is subsequently measured at fair value rather than historical cost. The third
scenario is the recognition of inventories write-downs and impairment losses on other assets.
23.7.1 Qualifying assets

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended
use (AASB 123/IAS 23 paragraph 5). Examples of qualifying assets are:
• inventories that require a substantial period of time to bring them to a saleable position
• assets resulting from development and construction activities in the extractive industries
• manufacturing plants
• power generation facilities
• investment properties.
In accordance with paragraph 8 of AASB 123/IAS 23 Borrowing Costs, the cost of a qualifying asset
includes borrowing costs that are directly attributable to the acquisition, construction or production of that
asset. Borrowing costs are interest and other costs that are incurred in borrowing funds. Borrowing costs
attributable to a qualifying asset are capitalised until the construction of the asset is complete and it is
ready for use. Borrowing costs may include foreign exchange differences on foreign currency borrowings
to the extent that they are regarded as an adjustment to interest costs (paragraph 6). Figure 23.5 illustrates
the required accounting approach.
FIGURE 23.5 Borrowing costs and qualifying assets
Date of borrowing for Date asset ceases to be End of reporting period

qualifying asset a qualifying asset 30 June 2023
1 July 2022 31 December 2022
Foreign exchange difference Foreign exchange difference

on interest costs included in on interest costs included in
cost of qualifying asset the profit or loss of the period
In the example included in figure 23.5, foreign exchange differences in the nature of interest costs are
included in the cost of the qualifying asset up until 31 December 2022. After this date, there is no longer
a qualifying asset and the foreign exchange differences are recognised immediately in the profit or loss of
the period. The required approach is demonstrated by illustrative example 23.5.
Foreign exchange borrowings on a qualifying asset

On 1 July 2022, Oz Ltd enters a loan agreement with the Bank of England plc to borrow £300 000 and
uses the funds to acquire components for construction of a manufacturing plant. By 31 December 2022,
when the plant is ready to use, further costs of A$100 000 have been paid to finish its construction.
The interest on the borrowings is payable half-yearly in arrears at the fixed interest rate of 6% p.a. with
interest payments of £9000 (£300 000 × 6% × ½ year) due on 31 December and 30 June each year.
Pdf_Folio:807

Oz Ltd prepares half-yearly reports and its reporting periods end 30 June and 31 December each year.
The following exchange rates are applicable for the annual financial period to 30 June 2023.
1 July 2022 A$1 = £0.60

Average July–Dec 2022 A$1 = £0.62
31 December 2022 A$1 = £0.64
Average Jan–June 2023 A$1 = £0.59
30 June 2023 A$1 = £0.56
The journal entries of Oz Ltd to record the cost of the qualifying asset and the interest costs on the
borrowings are as follows.
Journals for 1 July to 31 December 2022
2022
July 1 Plant under construction Dr 500 000
(Initial recognition and measurement of borrowings
at transaction date using spot rate, £300 000 ÷ 0.60
= $500 000)
Dec. 31 Plant under construction Dr 14 063
(Capitalisation of interest costs for the December half-year
comprised of interest expense, £9000 ÷ 0.62 = $14 516,
and foreign exchange gain, £9000 ÷ 0.62 less £9000 ÷ 0.64
= $453)
Dec. 31 Plant under construction Dr 100 000
(Additional costs paid to finalise construction of the
manufacturing plant)
Dec. 31 Plant (cost) Dr 614 063
Plant under construction Cr 614 063
(Reclassification of asset on the date it ceases to be
a qualifying asset, $500 000 + $14 063 + $100 000
= $614 063)
Journal for 1 January to 30 June 2023
2023
June 30 Interest expense Dr 15 254
Foreign exchange loss Dr 817
(Recognition of interest expense for the June half-year,
£9000 ÷ 0.59 = $15 254 and foreign exchange loss,
£9000 ÷ 0.59 less £9000 ÷ 0.56 = $817)
As illustrated in illustrative example 23.4, journal entries are also required for the subsequent measure-
ment of the foreign currency borrowings at 31 December 2022 and 30 June 2023. These journals are
omitted from the analysis here in order to focus on how the cost of the qualifying asset is determined.
23.7.2 Revalued assets

In accordance with paragraph 23 of AASB 121/IAS 21, non-monetary items that are measured at fair value
in a foreign currency are translated using the exchange rate at the date that the fair value is determined. In
this case, exchange differences on the asset can arise because exchange rates have changed from the date
of acquiring the asset (or from the date of a previous revaluation) to the date of the current revaluation.
AASB 121/IAS 21 requires that any exchange difference attributable to the revaluation is recognised
consistently with the gain or loss on revaluation. If a gain or loss on revaluation of land is recognised in
other comprehensive income, then any foreign exchange component of that gain or loss is also recognised
in other comprehensive income (paragraph 30). The required approach is demonstrated by illustrative
example 23.6.
Pdf_Folio:808

Foreign exchange differences on a revalued asset

On 15 July 2022, Oz Ltd acquires land in California for a cash consideration of US$800 000. Subsequently
at 15 May 2023, Oz Ltd revalues the land to its fair value of US$1 200 000. A revaluation gain before income
tax of US$400 000 is to be brought to account in other comprehensive income for the year to 30 June
2023. Relevant exchange rates and translated amounts are as follows.
15 July 2022 A$1 = US$0.80 Land US$800 000 ÷ 0.80 = $1 000 000
15 May 2023 A$1 = US$0.75 Land US$1 200 000 ÷ 0.75 = 1 600 000
Revaluation gain on land $ 600 000
The journal entries of Oz Ltd to record the initial recognition and measurement of the land at cost and
subsequent measurement at fair value are as follows.
2022
July 15 Land Dr 1 000 000
Cash at bank Cr 1 000 000
(Initial recognition and measurement of land at
transaction date using spot rate)
2023
May 15 Land Dr 600 000
Gain on revaluation (OCI) Cr 600 000
(Revaluation of land to fair value using the spot rate at
the date of revaluation)
There are two components included in the gain on revaluation of the land of $600 000:
• the translated revaluation gain on the land; that is, US$400 000 ÷ 0.75 = $533 333
• a foreign exchange gain on the land; that is, US$800 000 ÷ 0.75 less US$800 000 ÷ 0.80 = $66 667.
In accordance with AASB 121/IAS 21 both components are recognised in other comprehensive income.
A similar approach would apply if the revaluation of land to fair value involved a loss on revaluation instead
of a gain. In this case, however, the loss on revaluation and any exchange differences are recognised in
the profit or loss rather than in other comprehensive income. The accounting standard requirements for
the revaluation of property, plant and equipment are covered in further detail in chapter 5.
23.7.3 Inventories write-downs and impairment

Paragraph 25 of AASB 121/IAS 21 notes that the carrying amount for certain non-monetary assets must
be determined after making a comparison between the asset’s carrying amount (i.e. book value) and some
other value. In the case of inventories, the required measurement rule in AASB 102/IAS 2 Inventories
(paragraph 9) is the lower of cost and net realisable value. If inventories on hand is to be sold in a
foreign currency, then the net realisable value of the inventories in the functional currency (e.g. A$) is
determined as the net realisable value in foreign currency translated by the spot exchange rate at the date
this value is determined (AASB 121/IAS 21 paragraph 25). The effect of the translation could result in
an inventories write-down in the functional currency (e.g. A$) whereas there would be no write-down of
inventories if measurement was presented in the foreign currency. This point is demonstrated by illustrative
example 23.7.
Foreign exchange differences on inventories write-downs

On 1 January 2023, Oz Ltd acquires inventories for a cash consideration of US$80 000. The inventories
are still on hand at 30 June 2023 and have a net realisable value of US$80 000; that is, equal to the original
cost in US$. Relevant exchange rates and translated amounts are as follows.
Pdf_Folio:809

1 January 2023 A$1 = US$0.72 Inventories US$80 000 ÷ 0.72 = $111 111
30 June 2023 A$1 = US$0.77 Inventories US$80 000 ÷ 0.77 = 103 896
Inventories write-down $ 7 215
The journal entries of Oz Ltd to record the initial recognition and measurement of the inventories at cost
and subsequent measurement at realisable value are as follows.
2023
Jan. 1 Inventories Dr 111 111
(Initial recognition and measurement of inventories at
June 30 Inventories write-down expense Dr 7 215
Inventories Cr 7 215
(Remeasurement of inventories to net realisable value at
the end of the reporting period)
Similarly, AASB 136/IAS 36 Impairment of Assets may require impairment testing where the carrying
amount of an asset is compared to its recoverable amount in foreign currency translated into functional
currency (e.g. A$). The recoverable amount of an asset is the higher of its fair value less costs to sell and its
value in use (AASB 136/IAS 36 paragraph 6). These values would be translated using the spot exchange
rate at the date the recoverable amount calculation is made (paragraph 54). The accounting standard
requirements for the recognition of impairment of assets are covered in further detail in chapter 7.
LEARNING CHECK
Borrowing costs including foreign exchange differences are included in the initial measurement of a
qualifying asset; that is, an asset that necessarily takes a substantial period of time to get ready for its
intended use.
A non-monetary asset revalued to fair value is translated using the spot exchange rate at the date of
the revaluation.
Inventories written down to net realisable value are translated using the spot exchange rate at the date
of the write-down.
Recoverable amount is calculated for assets subject to impairment testing. The recoverable amount is
translated using the spot exchange rate at the date of the recoverable amount calculation.
23.8 Foreign exchange risk

LEARNING OBJECTIVE 23.8 Explain what is meant by ‘foreign exchange risk’ and the circumstances in
which it can arise.
Foreign exchange risk (also known as foreign currency risk or simply currency risk) is the risk that
an entity’s financial position, financial performance or cash flows will be affected by fluctuations in
exchange rates.
In an accounting context, foreign exchange risk may relate to:

• recognised assets and liabilities
• unrecognised firm commitments to buy or sell an asset
• a forecast or planned transaction to buy or sell an asset.
Examples of a recognised asset include an accounts receivable from the sale of goods denominated in a
foreign currency or a loan receivable from lending funds denominated in foreign currency. Examples of a
recognised liability include an accounts payable from purchasing goods denominated in foreign currency
or borrowings denominated in foreign currency. The nature of foreign exchange risk for recognised assets
and liabilities is highlighted in the illustrative examples in section 23.6. In illustrative example 23.1, as
an exporter of goods, Oz Ltd recognises an account receivable of $54 054 at the date of sale, but due
to the fluctuation in the A$/US$ exchange rate it only collects $50 000 from the customer at the date of
settlement, resulting in a foreign exchange loss of $4054.
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A firm commitment means the entity has entered a binding agreement for the exchange of a specified
quantity of resources at a specified price on a specified future date (AASB 9/IFRS 9 Appendix A). An
unrecognised firm commitment is a firm commitment that the entity is yet to recognise for accounting
purposes. In general, a binding agreement is not recognised for accounting purposes if the parties to the
agreement have not performed their commitments under the agreement; that is, the agreement is equally
proportionately unperformed. An unrecognised firm commitment becomes a recognised asset or liability at
the point in time where the execution of the agreement has transferred control of resources or resulted in a
present obligation. An Australian company may have a firm commitment to purchase an asset in 2 months’
time for a specified amount in foreign currency; for example, an agreement to purchase new plant from a
foreign supplier for US$500 000. The company does not recognise the firm commitment for accounting
purposes because the agreement is unperformed; that is, the risks and rewards of plant ownership are yet to
be transferred. Nonetheless, there is a foreign exchange risk associated with the firm commitment because
the A$/US$ exchange rate may fluctuate before the date of recognition of the asset. Assume that before
the US$500 000 asset purchase is recognised the exchange rate fluctuates from US$1.00 = A$1.40 to
US$1.00 = $1.50. The financial effect from the date of the firm commitment to the date of recognition is
that the A$ cost of the plant increases by $50 000 from $700 000 to $750 000.
A forecast transaction is an uncommitted but anticipated future transaction (AASB 9/IFRS 9
Appendix A). A highly probable forecast transaction is a forecast transaction where the odds are
significantly in favour of the transaction taking place. Examples of highly probable forecast transactions
include planned sales or purchases of goods denominated in foreign currency in the forthcoming period
where the plans are consistent with the entity’s experience from prior periods. An Australian company
may have planned to make export sales to customers in the United States of US$900 000 in the coming
year. The sales cannot be recognised for accounting purposes until the transactions occur. Consequently,
there is a foreign exchange risk that the annual export sales in A$ will be significantly higher or lower
than envisaged at the start of the year because of fluctuations in the A$/US$ exchange rate.
An Australian company may take action or enter into arrangements with the objective of mitigating
foreign exchange risk — in particular, the possible adverse financial effects of fluctuations in exchange
rates. These actions or arrangements are known as hedging transactions for foreign exchange risk. The
most common form of hedging transaction is entering into forward exchange contracts.
LEARNING CHECK
Foreign exchange risk is the risk that an entity’s financial position, financial performance or cash flows
will be affected by fluctuations in exchange rates.
Foreign exchange risk may relate to recognised assets and liabilities, unrecognised firm commitments
or planned foreign currency transactions.
23.9 Forward exchange contracts

LEARNING OBJECTIVE 23.9 Describe a ‘forward exchange contract’.
23.9.1 The nature of a forward contract

A forward exchange contract is an agreement between two parties to exchange a specified quantity of
one currency for another at a specified exchange rate on a specified future date. The specified exchange rate
in the contract is known as the forward rate. In accordance with AASB 9/IFRS 9 Financial Instruments
(Appendix A), a forward exchange contract is a derivative because it is a contract with three characteristics:
1. its value changes in response to changes in an underlying item, being changes in exchange rates
2. it requires no initial investment
3. it is settled at a future date.
The advantage of using a forward exchange contract is the ease of acquisition and its flexibility. Contracts
are readily available from financial institutions and can be arranged for settlement at specific dates and for
specific amounts of foreign currency. An Australian company may enter a forward exchange contract to
buy or sell foreign currency in exchange of A$ for speculative reasons or to protect itself from foreign
exchange risk. When a company enters into a foreign exchange contract to protect itself from foreign
exchange risk, the contract will act as a hedge.
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If an Australian company enters a forward exchange contract to buy foreign currency, then the
following apply.
• The company has a contractual obligation to provide A$ at the settlement date and that obligation is a
liability fixed at the forward rate.
• The company has a contractual right to receive foreign currency at the settlement date and that right is
an asset that is realised at the spot rate at the end of the contract.
• The company’s contractual obligation (at the forward rate) and contractual right (at the spot rate at the
end of the contract) are settled on a net basis at the end of the contract.
If the Australian company enters a forward exchange contract to sell foreign currency, then the
following apply.
• The company has a contractual right to receive A$ at the settlement date and that right is an asset fixed
at the forward rate.
• The company has a contractual obligation to provide foreign currency at the settlement date and that
obligation is a liability that is realised at the spot rate at the end of the contract.
• The company’s contractual right (at the forward rate) and contractual obligation (at the spot rate at the
end of the contract) are settled on a net basis at the end of the contract.
23.9.2 The fair value of a forward contract

The fair value of a forward contract at a point in time equals the discounted amount of the gain or loss that
would result if another forward contract with the same settlement date as the original contract was entered
into at that point in time. Therefore, the fair value is determined by the difference between the forward
rate of the original contract and the forward rate of a new contract available in the market at a particular
point in time with the same settlement date as the original contract. It should be noted that the fair value
of a forward contract at the date of contract inception is $nil.
The fair value of a forward contract is demonstrated using an example of an Australian com-
pany that enters an agreement with a financial institution to buy US$100 000 at the forward rate of
US$1.00 = A$1.30. The contract is entered into on 1 October 2022 for the settlement date of 31 March
2023. Figure 23.6 shows the spot and forward exchange rates relevant to this 6-month forward contract to
buy US$100 000.
FIGURE 23.6 Spot rates versus forward rates
Spot rate Forward rate (for 31/3/2023)

1 October 2022 — date of contract inception US$1 = A$1.30 US$1 = A$1.35
31 December 2022 — end of reporting period US$1 = A$1.32 US$1 = A$1.36
31 March 2023 — date of contract settlement US$1 = A$1.33 US$1 = A$1.33
Figure 23.6 highlights that the forward rate will usually differ from the spot rate at the date of entering
the contract. The difference between the forward and spot rates at 1 October 2022 is explained by the
theory of interest rate parity as follows.
(1 + Australian 6-month interest rate)
Forward rate A$1.35 = × Spot rate A$1.30
(1 + United States 6-month interest rate)
In this example, the forward rate is priced higher than the prevailing spot rate at the date of entering the
contract so that the company is willing to pay a premium to fix the rate of exchange at a future date. At
1 October 2022, the company can buy US$100 000 at the spot rate for A$130 000; however, if it wishes to
buy US$100 000 at the 6-month forward rate the cost is set to A$135 000. It is also possible that the forward
rate at the date of entering the contract is set at a discount over the spot rate. This would be the case if the
company could buy US$100 000 at a 6-month forward rate less than A$1.30. At the date of entering the
contract, there may be a premium or discount; however, the fair value of the contract at inception is $nil.
Figure 23.6 also highlights that spot and forward rates fluctuate across time. At 31 December 2022, the
forward rate for exchange for 31 March 2023 is A$1.36, meaning that in order to buy US$100 000, an
entity would have to pay A$136 000 at 31 March 2023. This indicates that the original forward contract
is more valuable for the company than the current available contract as it allows the company to buy
US$100 000 by paying only A$135 000 at 31 March 2023. As such, the fair value at 31 December 2022
of the forward contract entered into on 1 October 2022 is the present value of A$1000 (A$136 000 –
A$135 000, or US$100 000 × (1.36 – 1.35)). Accordingly, the fair value of a forward contract after
Pdf_Folio:812

inception is determined as the present value of the difference between the foreign currency position at
the original forward rate (A$135 000) and the foreign currency position at the forward rate applicable at
the date of measurement (A$136 000).
Figure 23.6 also shows that on 31 March 2023, the settlement of forward contract to buy US$100 000
at A$1.35 results in realised exchange loss calculated by reference to the spot rate at that date. At the
date of settlement, the company has an obligation to buy US$100 000 for the payment of A$135 000 (at
the original forward rate of A$1.35); however, the foreign currency to be received only has a value of
A$133 000 (at the spot rate of A$1.33). The fair value of the contract is a net loss of A$2000, which
equates to the realised exchange loss on the contract.
In the example, it is apparent that the value of the forward contract changes through time with
fluctuations in forward rates, spot rates and interest rates. Assume a 0% discount rate for fair value
calculations to simplify the analysis. The fair values of the forward contract to buy US$100 000 through
time are as follows: at 1 October 2022 $nil, at 31 December 2022 positive A$1000, and at 31 March 2023
negative A$2000.
The change in the fair value of a forward contract between two dates is based on the difference between
the forward rates for contracts with the same settlement dates entered into at those two dates. In the
example, the change in the fair value of the forward contract between 31 December 2022 and 31 March
2023 is negative A$3000, which is US$100 000 × (1.33 – 1.36). Nevertheless, the change in the fair value
of a forward contract can be expressed as comprising:
• the change in the spot element of the forward contract (referred to as the intrinsic value of the forward
contract) equal to the change in spot rates multiplied by the foreign currency
• the change in the forward element of the forward contract (referred to as the time value of the forward
contract) equal to the change in premium or discount multiplied by the foreign currency.
In the example, the change in the fair value between 31 December 2022 and 31 March 2023 of negative
A$3000 can be expressed as US$100 000 × (1.33 – 1.32) + US$100 000 × (0 – 0.04). In general, the
change in fair value of a forward contract between two dates can be expressed per unit of foreign currency
as follows.
FV2 − FV1 = FR2 − FR1 = (SR2 − SR1 ) + (FR2 − SR2 ) − (FR1 − SR1 ) = (SR2 − SR1 ) + (P2 − P1 )
where:
FV1 and FV2 , FR1 and FR2 , SR1 and SR2 , and P1 and P2 are denoting the fair values, forward rates,
spot rates and premiums over the two dates.
Figure 23.7 shows the change in the fair value of forward contract to buy US$100 000 by reference to
the change in the spot and forward elements.
FIGURE 23.7 Spot and forward elements of the change in fair value of a forward contract
Change in Change Change in

Forward rate Premium contract in spot forward
Date Spot rate (for 31/3/23) (discount) fair value element element
1 Oct. 2022 A$1.30 A$1.35 A$0.05 $nil — —
31 Dec. 2022 A$1.32 A$1.36 A$0.04 A$0.01 A$0.02 (A$0.01)
31 Mar. 2023 A$1.33 A$1.33 $nil (A$0.03) A$0.01 (A$0.04)
Change in rates (A$0.02) A$0.03 (A$0.05)
Foreign currency US$ 100 000 100 000 100 000
Change in fair value (A$2 000) A$3 000 (A$5 000)
The calculation of the fair value of forward contracts to sell foreign currency should take into
consideration that any increase in the forward rates expressed using the direct from of quotation is reflecting
an increase in the value of the foreign currency; as the contract obligates the company to sell foreign
currency based on the fixed rate set at the inception of the contract, that indicates a potential loss for
the company and therefore a decrease in the fair value of the contract. Therefore, all the differences that
indicate gains and increases in value for forward contracts to buy foreign currency will indicate losses and
decreases in value for forward contracts to sell foreign currency.
23.9.3 Accounting where there is no hedging relationship

Paragraph AG18 of AASB 132/IAS 32 Financial Instruments: Presentation states that the contractual
right and obligation of a forward contract constitutes a financial asset or financial liability respectively.
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AASB 9/IFRS 9 requires that a financial asset or financial liability that is a derivative (e.g. a forward
exchange contract) be subsequently measured at fair value (paragraphs 4.1.4 and 4.2.1) at the end of each
reporting period and right before settlement. The gain or loss on a forward exchange contract measured
at fair value is recognised in profit or loss unless it is part of a hedging relationship (paragraph 5.71).
Accounting for a forward exchange contract where there is no hedging relationship is demonstrated in
illustrative examples 23.8 and 23.9.
Forward contract to buy

foreign currency
On 1 October 2022, Oz Ltd enters a for-
ward exchange contract to buy US$100 000 in
6 months’ time at 31 March 2023. The contract
is entered into for speculative purposes as the
management of Oz Ltd believe that future eco-
nomic conditions will lead to an appreciation in
the US$ relative to the A$. Relevant exchange
rates are as follows.

1 October 2022 — date of contract inception US$1 = A$1.30 US$1 = A$1.35
Assume a discount rate of 0% to simplify the fair value calculations. The fair value at a point in time
can be determined as the number of units of foreign currency subject to the contract multiplied by the
difference between the forward rate at that point in time and the forward rate of the original contract.
Equivalently, it can be calculated as the difference between the contract right and the contract obligation
at that point in time. The forward rates at different points in time are considered to estimate the spot
rate at the end of the contract and therefore the contract right is calculated based on them. The contract
obligation is fixed at the forward rate set at the contract inception. Therefore, the fair values of the forward
contract across the three dates are as follows.
Date Contract right (varies) Contract obligation (fixed) Fair value Change
1 Oct. 2022 US$100 000 × 1.35 = $135 000 US$100 000 × 1.35 = $135 000 $nil —
31 Dec. 2022 US$100 000 × 1.36 = $136 000 US$100 000 × 1.35 = $135 000 $1 000 $1 000
31 Mar. 2023 US$100 000 × 1.33 = $133 000 US$100 000 × 1.35 = $135 000 ($2 000) ($3 000)
The journal entries of Oz Ltd are as follows. Please note that there is no entry recorded at the date of
contract inception as the fair value of contract is $nil.
2022
Oct. 1 No entry
Dec. 31 Forward contract Dr 1 000
Gain on forward contract Cr 1 000

(Subsequent measurement of forward contract to buy
US$100 000 at the end of the reporting period)
2023
Mar. 31 Loss on forward contract Dr 3 000
Forward contract Cr 3 000
(Subsequent measurement of forward contract to buy
US$100 000 at settlement date)
Mar. 31 Forward contract Dr 2 000
Cash Cr 2 000
(Settlement of forward contract to buy US$100 000 resulting in
realised exchange loss of $2000)
Pdf_Folio:814

Forward contract to sell foreign currency

On 1 July 2022, Oz Ltd enters a forward exchange contract to sell US$100 000 in 9 months’ time at
31 March 2023. The contract is entered into for speculative purposes as the management of Oz Ltd
believe that future economic conditions will result in the US$ declining in value relative to the A$. Relevant

1 July 2022 — date of contract inception US$1 = A$1.40 US$1 = A$1.45
Assume a discount rate of 0% for fair value calculations to simplify the analysis. The fair value at a point
in time can be determined as the number of units of foreign currency subject to the contract multiplied by
the difference between the forward rate of the original contract and the forward rate at that point in time.
Equivalently, it can be calculated as the difference between the contract right and the contract obligation
at that point in time. The forward rates at different points in time are considered to estimate the spot rate
at the end of the contract and therefore in this case the contract obligation to provide US$ is calculated
based on them. The contract right to receive A$ is fixed at the forward rate set at the contract inception.
Therefore, the fair values of the forward contract across the three dates are as follows.
Date Contract right (fixed) Contract obligation(varies) Fair value Change

1 Oct. 2022 US$100 000 × 1.45 = $145 000 US$100 000 × 1.45 = $145 000 $nil —
31 Dec. 2022 US$100 000 × 1.45 = $145 000 US$100 000 × 1.42 = $142 000 $3 000 $3 000
31 Mar. 2023 US$100 000 × 1.45 = $145 000 US$100 000 × 1.33 = $133 000 $12 000 $9 000
The journal entries of Oz Ltd are as follows.

2022
July 1 No entry
(Subsequent measurement of forward contract to sell
US$100 000 at the end of the reporting period)
2023
Mar. 31 Forward contract Dr 9 000
(Subsequent measurement of forward contract to sell
US$100 000 at settlement date)
Mar. 31 Cash Dr 12 000
(Settlement of forward contract to sell US$100 000 resulting
in realised exchange loss of $12 000)
LEARNING CHECK
A forward exchange contract is an agreement between two parties to exchange a specified quantity of
one currency for another at a specified exchange rate known as the forward rate.
A forward contract has the following three characteristics: (1) its fair value changes with changes in
exchange rates; (2) it requires no initial outlay; and (3) it is settled at a future date on a net basis.
A forward exchange contract to buy foreign currency involves a right to receive foreign currency and
an obligation to pay A$ that is fixed at the forward rate.
A forward exchange contract to sell foreign currency involves a right to receive A$ fixed at the forward
rate and an obligation to provide foreign currency.
The fair value of a forward contract at a point in time equals the discounted amount of the gain or loss
that would result if another forward contract with the same settlement date as the original contract was
entered into.
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The fair value of a forward exchange contract to buy foreign currency at a point in time is calculated
as the number of foreign currency units multiplied by the difference between the forward rate at that
point in time and the forward rate of the original contract. Any increases after the contract inception
in the forward rate expressed using the direct form of quotation increases the fair value of the forward
exchange contract to buy foreign currency.
The fair value of a forward exchange contract to sell foreign currency at a point in time is calculated
as the number of foreign currency units multiplied by the difference between the forward rate of the
original contract and the forward rate at that point in time. Any increases after the contract inception
in the forward rate expressed using the direct form of quotation decreases the fair value of the forward
exchange contract to sell foreign currency.
A forward exchange contract that is not associated with hedging activity is measured at fair value at
the end of the reporting period and at settlement date, with any resulting gain or loss recognised in the
profit or loss.
23.10 Forward exchange contracts with hedging

LEARNING OBJECTIVE 23.10 Explain hedge accounting.
A forward contract is a financial instrument that may be used to manage or hedge against foreign exchange
risk. A forward contract is a hedging instrument used to mitigate the possible adverse effects of changes
in exchange rates on a hedged item arising from a foreign currency transaction. When there is a hedge, the
foreign exchange gains or losses on one transaction (e.g. hedge contract — the hedging instrument) will
offset losses or gains on another (e.g. accounts payable for inventory purchase — the hedged item).
23.10.1 Hedging relationships that qualify for hedge accounting

According to paragraph 6.4.1 of AASB 9/IFRS 9, hedge accounting applies to hedging relationships that
meet the following three conditions.
1. The hedging relationship consists of eligible hedging instruments and hedged items.
2. The hedging relationship meets hedge effectiveness requirements.
3. The hedging relationship is formally designated and documented.
Eligible hedging instruments and hedged items

Paragraph 6.2.1 of AASB 9/IFRS 9 allows the hedging instrument in a hedging relationship to be a
derivative measured at fair value through profit or loss; for example, a forward contract to buy or sell
foreign currency. In order to qualify as an eligible hedging instrument, a forward contract must have been
entered into with a party external to the reporting entity (paragraph 6.2.3). The forward contract may
be designated as a hedging instrument in its entirety or in some proportion based on its intrinsic value
(paragraph 6.2.4).
The hedged item in a hedging relationship includes any of the following (paragraph 6.3.1):
• a recognised asset or liability in the statement of financial position
• an unrecognised firm commitment
• a highly probable forecast transaction.
A brief discussion of each of those items was included in section 23.8, which addressed foreign exchange
risk. Only assets, liabilities, firm commitments or highly probable forecast transactions that are with
external parties to the reporting entity can be designated as hedged items (paragraph 6.3.5). The hedged
item can be a single item or a group of items; for example, a planned purchase transaction or a series of
planned purchase transactions denominated in foreign currency (AASB 9/IFRS 9 paragraph 6.3.1). In the
case of a group of items there are additional conditions for eligibility, including that the items in the group
are managed on a group basis for risk management purposes (paragraph 6.6.1). A hedged item must also
be reliably measurable (paragraph 6.3.2).
Hedge effectiveness
In accordance with paragraph B6.4.1 of AASB 9/IFRS 9, the hedge effectiveness of a forward contract
means the extent to which changes in the fair value of the forward contract offset changes in the fair value
or cash flows of the hedged item.
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Hedge effectiveness is ascertained from the following.
• There is an economic relationship between the hedging instrument and the hedged item.
• The effect of credit risk does not dominate the economic relationship between the hedging instrument
and the hedged item.
• The hedge ratio of the hedging relationship reflects actual quantities and is consistent with the purpose
of hedge accounting.
An economic relationship between a forward exchange contract and the hedged item would normally
be indicated by the values of each moving in an opposite direction when exchange rates change (AASB 9/
IFRS 9 paragraph B6.4.3). The hedge ratio refers to the relationship between the quantity of the hedging
instrument and the quantity of the hedged item in terms of their relative weighting, for example, a forward
contract to buy US$80 000 for a planned purchase transaction of US$100 000 has a hedging ratio of 80%
(AASB 9/IFRS 9 Appendix A).
An entity must assess whether a hedging relationship meets the hedging effectiveness requirements at
the inception of the hedging relationship, at the end of each reporting period and whenever there is a
significant change in hedging circumstances (AASB 9/IFRS 9 paragraph B6.4.12). The details on how to
assess hedging effectiveness are beyond the scope of this chapter.
Formal designation and documentation

A hedging relationship has to be formally designated and documented at its inception to qualify for hedge
accounting. Under paragraph 6.4.1(b) of AASB 9/IFRS 9, the documentation must identify:
• the hedging instrument
• the hedged item
• the entity’s risk management objective and strategy for undertaking the hedge
• the nature of the risk being hedged
• how the entity will assess whether the hedging relationship meets the hedge effectiveness requirements,
including the analysis of sources of hedge ineffectiveness and how the hedge ratio is determined.
23.10.2 Accounting for hedging relationships

Hedge accounting applies to the following three types of hedging relationships (AASB 9/IFRS 9
paragraph 6.5.2):
1. a fair value hedge
2. a cash flow hedge
3. a hedge of a net investment in a foreign operation.
This section explains accounting for a fair value hedge and a cash flow hedge where the hedging
instrument is a forward contract. Accounting for a hedge of the net investment in a foreign operation
is beyond the scope of the chapter.
A fair value hedge is a hedge of the exposure to changes in the fair value of a recognised asset or liability
or an unrecognised firm commitment or some component thereof that is attributable to a particular risk and
could affect profit or loss (AASB 9/IFRS 9 paragraph 6.5.2(a)). Examples of a fair value hedge of foreign
exchange risk using a forward contract are:
• a forward contract to buy US$ hedging recognised accounts payable in US$
• a forward contract to buy US$ hedging recognised borrowings in US$
• a forward contract to buy US$ hedging an unrecognised firm commitment to purchase goods in US$
• a forward contract to sell US$ hedging recognised accounts receivable in US$
• a forward contract to sell US$ hedging a recognised loan receivable in US$

• a forward contract to sell US$ hedging an unrecognised firm commitment to sell goods in US$.
A cash flow hedge is a hedge of the exposure to the variability in future cash flows that is attributable
to a particular risk that is associated with all, or some component of, a recognised asset or liability or a
highly probable forecast transaction and could affect profit or loss (AASB 9/IFRS 9 paragraph 6.5.2(b)).
A hedge of the foreign exchange risk of an unrecognised firm commitment may also be treated as a cash
flow hedge (paragraph 6.5.4). In contrast to a fair value hedge, a cash flow hedge relates to the future
cash flows associated with a recognised asset or liability or a future transaction rather than changes in
the fair value of a hedged item. Examples of a cash flow hedge of foreign exchange risk using a forward
contract are:
• a forward contract to buy US$ hedging a highly probable purchase of inventories in US$
• a forward contract to buy US$ hedging future interest payments on variable rate debt in US$
Pdf_Folio:817

• a forward contract to buy US$ hedging an unrecognised firm commitment to purchase goods in US$
• a forward contract to sell US$ hedging a highly probable sale of inventories in US$
• a forward contract to sell US$ hedging future interest receipts on a variable rate loan receivable in US$
• a forward contract to sell US$ hedging an unrecognised firm commitment to sell goods in US$.
Accounting for a fair value hedge of a recognised monetary item

Paragraph 6.5.8(a) of AASB 9/IFRS 9 requires that when accounting for a fair value hedge, the gain or
loss on the subsequent measurement of the hedging instrument — the forward contract — is recognised
in profit or loss if the hedged item is a recognised monetary asset or liability; for example, an accounts
receivable or accounts payable. The profit or loss for the period therefore includes the exchange loss (gain)
on a foreign currency monetary item together with the gain (loss) on a forward contract. The required hedge
accounting approach is demonstrated in illustrative example 23.10.
Fair value hedge of a recognised monetary item

On 1 June 2023, Oz Ltd purchases inventories for US$500 000 with the invoice to be paid on 1 September
2023. On the same date as the inventories purchase, Oz Ltd enters into a forward exchange contract to
buy US$500 000 on 1 September 2023. Assume a discount rate of 0% for fair value calculations to simplify
the analysis. Relevant exchange rates are as follows.

1 June 2023 US$1 = A$1.43 US$1 = A$1.47
30 June 2023 US$1 = A$1.39 US$1 = A$1.42
1 Sept. 2023 US$1 = A$1.50 US$1 = A$1.50
The accounts payable of US$500 000 is translated at spot rates and the right under the forward contract
to buy US$500 000 is measured at forward rates as follows.
Accounts payable Gain/(loss) Contract fair value Gain/(loss)

Date spot rate spot rate forward rate forward rate
1 June 2023 $715 000 — — —
30 June 2023 $695 000 $20 000 ($25 000) ($25 000)
1 Sept. 2023 $750 000 ($55 000) $15 000 $40 000
Realised gain/(loss) ($35 000) $15 000
It should be noted that the changes in the spot exchange rates increase the A$ amount of the accounts
payable by $35 000 from the transaction date to the settlement date (i.e. $750 000 − $715 000). Similarly,
the fair value of the forward contract increases by $15 000 from the transaction date to the settlement date.
In this hedging relationship, the exchange loss incurred on the accounts payable is offset by the gain on
the forward contract. The net effect of the hedging relationship is a loss of $20 000 (i.e. $35 000 loss net
of $15 000 gain). This net effect is guaranteed at the date the forward contract is entered into (i.e. contract
obligation fixed at $735 000 net of accounts payable $715 000) and is given by the premium at the contract
inception multiplied by number of units of foreign currency. In the absence of the forward contract, the
loss arising on the recognised liability (the accounts payable) would have been $35 000.
The journal entries of Oz Ltd for the year to 30 June 2023 are as follows.
2023
June 1 Inventories Dr 715 000
(Initial recognition and measurement of accounts payable at
June 30 Accounts payable Dr 20 000
(Foreign exchange gain on remeasurement of accounts
payable to spot rate recognised in profit or loss)
June 30 Loss on forward contract Dr 25 000
(Loss on forward contract on remeasurement to fair value
recognised in profit or loss)
Pdf_Folio:818

At 30 June 2023, the end of the reporting period, the statement of financial position will include liabilities
in respect of accounts payable of $695 000 and a forward contract of $25 000. The journal entries of
Oz Ltd for the year to 30 June 2024 are as follows.
2023
Sept. 1 Foreign exchange loss Dr 55 000
(Foreign exchange loss on remeasurement of accounts
payable to spot rate recognised in profit or loss)
(Cash settlement of the account)
Sept. 1 Forward contract Dr 40 000
(Gain on forward contract on remeasurement to fair value
Sept. 1 Cash at bank Dr 15 000
(Cash settlement of the contract)
In this example, it is apparent that the gains and losses on the remeasurement of the accounts payable
and forward contract are immediately recognised in the profit or loss. The total gains and losses recognised
for accounting purposes reconcile to the realised exchange loss on the accounts payable and the realised
gain on the fair value of the forward contract (i.e. $20 000 − $25 000 − $55 000 + $40 000 = −$35 000 +
$15 000).
Accounting for a fair value hedge of an unrecognised firm commitment

Recall that a firm commitment is a binding agreement for the exchange of a specified quantity of resources
at a specified price on a specified future date or dates, while an unrecognised firm commitment is a firm
commitment that has not been recognised in the financial statements.
Paragraph 6.5.8(a) of AASB 9/IFRS 9 requires that in accounting for a fair value hedge, the gain
or loss on the subsequent measurement of the hedging instrument — the forward contract — is also
recognised in profit or loss if the hedged item is an unrecognised firm commitment. In addition, the
change in the fair value of the unrecognised firm commitment is recognised as an asset or liability with a
corresponding gain or loss recognised in the profit or loss (paragraph 6.5.8(b)). An example is a forward
contract hedging an unrecognised firm commitment to purchase plant from a foreign supplier. The fair
values of the forward contract and unrecognised firm commitment change through time after the entity
has entered into these arrangements. Subsequently, the acquisition of the plant is recognised after the
contractual obligations in respect of the purchase have been met. The initial measurement of the plant at
cost includes the cumulative change in the fair value of the firm commitment previously recognised as an
asset or liability (paragraph 6.5.9). The required hedge accounting approach is demonstrated in illustrative
example 23.11.
Fair value hedge of an unrecognised firm commitment

On 1 April 2023, Oz Ltd enters into a firm commitment with a foreign supplier to buy a machine
for US$500 000. The ownership of the machine and the consideration for the purchase are transferred on
31 July 2023. On the same day as entering the firm commitment, Oz Ltd enters into a forward exchange
contract to buy US$500 000 on 31 July 2023. Assume a discount rate of 0% for fair value calculations to
simplify the analysis. Relevant exchange rates are as follows.
1 April 2023 US$1 = A$1.41 US$1 = A$1.46
30 June 2023 US$1 = A$1.39 US$1 = A$1.42
31 July 2023 US$1 = A$1.48 US$1 = A$1.48
In order to measure fair values of the firm commitment to expend US$500 000 and the forward contract
to buy US$500 000 forward rates are applied as follows.
Pdf_Folio:819

Commitment Gain/(loss) Contract fair Gain/(loss)
Date (outlay) forward rate forward rate value forward rate forward rate
1 Apr. 2023 $730 000 — — —
30 June 2023 $710 000 $20 000 ($20 000) ($20 000)
31 July 2023 $740 000 ($30 000) $10 000 $30 000
Realised gain/(loss) ($10 000) $10 000
The required accounting approach is to separately recognise the financial effects of the changes in the
fair value of the forward contract and the firm commitment. The journal entries of Oz Ltd for the year
ending 30 June 2023 are as follows.
2023
June 30 Loss on forward contract Dr 20 000
June 30 Unrecognised firm commitment Dr 20 000
Gain on unrecognised firm commitment Cr 20 000
(Gain on unrecognised firm commitment arising from change
in fair value)
At 30 June 2023, the end of the reporting period, the statement of financial position will include a
liability in respect of the forward contract of $20 000 and an asset for an unrecognised firm commitment of
$20 000. The journal entries of Oz Ltd for the year to 30 June 2024 are as follows.
2023
July 31 Forward contract Dr 30 000
July 31 Cash at bank Dr 10 000
(Cash settlement of the contract)
July 31 Loss on unrecognised firm commitment Dr 30 000
Unrecognised firm commitment Cr 30 000
(Loss on unrecognised firm commitment arising from change
in fair value)
July 31 Machine (cost) Dr 730 000
Unrecognised firm commitment Dr 10 000
(Recognition of cumulative changes in the fair value of the
unrecognised firm commitment into the cost of acquisition
of machine)
The nature of this hedging relationship is that the forward contract to buy US$500 000 locks in the
A$ cost of the machine purchase at $730 000. If the forward contract had not been entered into, the
machine cost recognised on the transaction date of 31 July 2023 would be $740 000.
A similar approach applies to the recognition of revenue arising from meeting a firm commitment to sell
goods. The measurement of the revenue is adjusted to include the cumulative change in the fair value of
the firm commitment that was previously recognised as an asset or liability. Assume Oz Ltd has:
• a firm commitment to sell goods to a customer on 31 July 2023 for US$500 000
• a forward exchange contract to sell US$500 000 based on the forward rate of US$1.00 = A$1.46 due
for settlement on 31 July 2023.
Oz Ltd would recognise sales revenue of $730 000 (i.e. US$500 000 × 1.46) after including the
cumulative change in the fair value of the firm commitment to the date of the sale transaction. In this
case, the hedging relationship locks in the A$ amount recognised for the revenue and gross profit on the
transaction. In the absence of the hedge, revenue recognised would be $740 000 (i.e. US$500 000 × 1.48).
It should be noted, however, that if the spot rate on 31 July 2023 was US$1.00 = A$1.40, then the revenue
recognised would be only $700 000 (i.e. US$500 000 × 1.40).
Pdf_Folio:820

Accounting for a cash flow hedge of a highly probable forecast transaction
Recall that a highly probable forecast transaction is a forecast transaction where the odds are significantly
in favour of the transaction taking place.
Paragraph 6.5.11(b) of AASB 9/IFRS 9 requires that in accounting for a cash flow hedge, the gain or
loss on the subsequent measurement of the hedging instrument — the forward contract — is included in
other comprehensive income and recognised to a cash flow hedge reserve in equity. If a hedged forecast
transaction results in the recognition of a non-financial asset or non-financial liability, then the amount in
the cash flow hedge reserve is removed and included in the initial measurement of that asset or liability
(paragraph 6.5.11(d)(i)). In other cases, the amount in the cash flow reserve is reclassified subsequently to
profit or loss in the same period or periods that the hedged future cash flows affect the profit or loss; for
example, in the period that a forecast sale transaction occurs (paragraph 6.5.11(d)(ii)). The required hedge
accounting approach is demonstrated in illustrative example 23.12.
Cash flow hedge of a highly probable forecast transaction

On 1 April 2023, Oz Ltd enters into a forward exchange contract to sell US$500 000 on 31 July 2023.
The forward contract is designated as a hedge for a sales transaction of US$500 000 that Oz Ltd expects
to have with a US customer on 31 July 2023. The sales transaction is highly probable based on past
experience. Assume a discount rate of 0% for fair value calculations to simplify the analysis. Relevant

1 April 2023 US$1 = A$1.41 US$1 = A$1.46
30 June 2023 US$1 = A$1.39 US$1 = A$1.42
31 July 2023 US$1 = A$1.48 US$1 = A$1.48
In order to measure fair values of the hedged item (i.e. the future sale transaction) and the forward
contract to sell US$500 000, forward rates are applied as follows.
Forward contract
Hedged future sale Gain/(loss) (obligation) Gain/(loss)
Date forward rate forward rate forward rate forward rate
1 Apr. 2023 $730 000 — $730 000
30 June 2023 $710 000 ($20 000) $710 000 $20 000
31 July 2023 $740 000 $30 000 $740 000 ($30 000)
Realised gain/(loss) $10 000 ($10 000)
The required accounting approach is to include the changes in the fair value of the forward contract in a
cash flow hedge reserve and then reclassify the amount into the profit or loss when the sales transaction
occurs. The journal entries of Oz Ltd are as follows.
2023
June 30 Forward contract Dr 20 000
Gain on forward contract to reserve (OCI) Cr 20 000
recognised to cash flow hedge reserve)
At 30 June 2023, the end of the reporting period, the statement of financial position will include an
asset of $20 000 in respect of the forward contract and a cash flow hedge reserve of $20 000 in equity.
The journal entries of Oz Ltd for the year to 30 June 2024 are as follows.
Pdf_Folio:821

2023
July 31 Loss on forward contract to reserve (OCI) Dr 30 000
recognised to cash flow hedge reserve and cash settlement
of the contract)
July 31 Accounts receivable Dr 740 000
Reclassification adjustment from reserve (OCI) Cr 10 000
Sales revenue Cr 730 000
(Reclassification adjustment of the cumulative changes in
the cash flow hedge on recognition of the sale)
The nature of this hedging relationship is that the forward contract to sell US$500 000 locks in the A$
amount to be recognised in the profit or loss when the sale occurs at $730 000 (i.e. US$500 000 × 1.46).
The balance in the cash flow reserve after the reclassification adjustment is $nil. The profit or loss for
the period includes the sale and the reclassification adjustment. AASB 9/IFRS 9 is silent about how the
reclassification adjustment should be reported in the profit or loss. In this example, the reclassification
adjustment is included as part of the sales revenue for the period rather than reported as a separate item;
that is, the reclassification adjustment of $10 000 reduces the sales revenue recognised.
A similar approach applies to the recognition of inventories arising from a highly probable purchase
transaction. The measurement of the inventories is adjusted to include the cumulative change in the fair
value of the forward contract that is included in the cash flow reserve. Assume Oz Ltd has:
• a planned purchase of inventories on 31 July 2023 for US$500 000
• a forward exchange contract to buy US$500 000 based on the forward rate of US$1.00 = A$1.46 due
for settlement on 31 July 2023.
Oz Ltd would recognise inventories of $730 000 (i.e. US$500 000 × 1.46) after the inclusion of a
reclassification adjustment for an exchange gain of $10 000. In this case, the hedging relationship
locks in the A$ amount recognised for inventories. In the absence of the hedge, the inventories would
be recognised at $740 000 (i.e. US$500 000 × 1.48). It should be noted, however, that if the spot
rate on 31 July 2023 was US$1.00 = A$1.90, then the inventories recognised would be $950 000
(i.e. US$500 000 × 1.9).
LEARNING CHECK
A forward contract may be used as a hedging instrument to mitigate the possible adverse effects of
changes in exchange rates on a hedged item arising from a foreign currency transaction.
Hedge relationships that qualify for hedge accounting include forward exchange contracts that hedge a
recognised monetary asset or liability, an unrecognised firm commitment or a highly probable forecast
transaction. The hedging relationship must meet hedge effectiveness requirements and be formally
designated and documented at inception.
A fair value hedge includes a hedge of the exposure to changes in the fair value of a recognised
monetary asset or liability or an unrecognised firm commitment attributable to foreign exchange risk.
In accounting for a fair value hedge of a recognised monetary asset or liability, the gain or loss from the
subsequent measurement of the forward contract is recognised in the profit or loss.
In accounting for a fair value hedge of an unrecognised firm commitment, the gain or loss from the
subsequent measurement of the forward contract is recognised in the profit or loss. The change in the
fair value of the unrecognised firm commitment is likewise recognised in the profit or loss.
A cash flow hedge includes a hedge of the exposure to variability in cash flows attributable to foreign
exchange risk in respect of a recognised asset/liability or highly probable forecast transaction or an
unrecognised firm commitment.
In accounting for a cash flow hedge, the gain or loss on the subsequent measurement of the forward
contract is included in other comprehensive income and recognised in a cash flow hedge reserve in
equity. When the hedged item is recognised, the amount to the cash flow hedge reserve is removed
and included in the initial measurement of an asset or liability or reclassified to profit or loss in the same
period or periods that the hedged future cash flows affect the profit or loss.
Pdf_Folio:822

23.11 Disclosures
LEARNING OBJECTIVE 23.11 Describe the disclosures required in the financial report relating to foreign
currency transactions.
Paragraph 52 of AASB 121/IAS 21 requires that the financial report disclose:
• the amount of exchange differences recognised in the profit or loss for the period other than those that
relate to financial instruments measured at fair value through profit or loss
• the net exchange differences recognised in other comprehensive income and accumulated in a separate
component of equity and reconciliation of such exchange differences at the beginning and end of
the period.
If there is a change in the functional currency, that fact and the reason for the change must also be
disclosed (AASB 121/IAS 21 paragraph 54).
LEARNING CHECK
The disclosures required in relation to foreign currency transactions and forward exchange contracts
are described in paragraphs 52 and 54 of AASB 121/IAS 21.
Pdf_Folio:823

SUMMARY
An Australian company that operates primarily in the local economic environment has a functional
currency of A$. If the company transacts in foreign currencies, the resulting accounting balances must
be translated into A$ for inclusion into the company’s financial statements. This includes the translation
of foreign currency amounts for assets, liabilities, equities, revenues, expenses and cash flows. Examples
of foreign currency transactions include the sale or purchase of inventories, the acquisition of non-current
assets such as plant or land, and borrowings or loans made.
Exchange rates are the means of translating foreign currency amounts. An exchange rate is the ratio of
exchange for two currencies. A spot exchange rate is the rate at a point in time. An average exchange rate
can be calculated by averaging spot exchange rates over a period of time. The closing exchange rate is
the rate at the end of the reporting period. A forward exchange rate is a rate specified for a future date.
Exchanges rates for the A$ are expressed in direct form for one unit of foreign currency or in indirect
form for one unit of A$. In order to translate a foreign currency amount into A$ using an exchange rate
expressed in direct form, the process of translation is multiplication. In order to translate a foreign currency
amount into A$ using an exchange rate expressed in indirect form the process of translation is division.
AASB 121/IAS 21 is the accounting standard applicable to the translation of foreign currency transac-
tions. The accounting approach of AASB 121/IAS 21 relies on the distinction between monetary items and
non-monetary items. A monetary item is effectively defined as cash or a claim to cash; for example, cash,
receivables, payables, borrowings and loans. Foreign currency transactions that involve monetary items
are translated in three steps:
1. the date of the transaction: initial recognition and measurement of financial statement items using the
spot exchange rate
2. end of the reporting period: subsequent measurement of outstanding monetary item using the closing
exchange rate and resulting exchange difference recognised to profit or loss
3. cash settlement date: subsequent measurement of outstanding monetary item using the spot exchange
rate and resulting exchange differences recognised to profit or loss together with cash settlement
recorded using the spot exchange rate.
Non-monetary items such as inventories or plant that are measured at cost must be translated at the
historical exchange rate at the date of the transaction. Non-monetary items that are remeasured to fair
value, recoverable amount or net realisable value are remeasured using the spot exchange rate at the date
of remeasurement. The resulting exchange difference is included as part of the gain or loss arising from
the asset’s remeasurement.
Foreign exchange risk arises from foreign currency transactions because fluctuations in exchange rates
can affect the financial position, financial performance or cash flows of an entity. Foreign exchange risk
may relate to recognised assets and liabilities (e.g. accounts payable) or unrecognised firm commitments
(e.g. a contract to purchase plant) or a forecast transaction in the future (e.g. a planned purchase of
inventories). Forward exchange contracts may be used to hedge against foreign exchange risk. These
contracts involve an agreement to exchange a specified quantity of one currency for another on a future
date based on a specified forward exchange rate. A forward contract to buy foreign currency hedges an
underlying position where a cash outflow or monetary liability arises; for example, settlement of an account
payable. A forward contract that sells foreign currency hedges an underlying position where a cash inflow
or monetary asset arises; for example, settlement of an account receivable.
A forward contract is a derivative pursuant to AASB 9/IFRS 9 Financial Instruments. A forward contract
is initially measured at $nil and subsequently at fair value. The fair value of a forward contract is calculated
by reference to the gain or loss that would arise if the contract was closed out by taking the reverse position.
The gain or loss should be discounted for the time value of money. The gain or loss from the subsequent
measurement of a forward contract that is not designated as a hedging instrument is immediately recognised
in the profit or loss.
A forward contract designated as a hedging instrument for a hedged item that is a recognised asset or
liability is referred to as a fair value hedge. The gain or loss on a forward contract in a fair value hedge
is immediately recognised to the profit or loss. A forward contract designated as a hedging instrument for
a hedged item that is a highly probable forecast transaction is referred to as a cash flow hedge. The gain
or loss on a forward contract that is a cash flow hedge is recognised in other comprehensive income and a
cash flow hedge reserve. When the forecast transaction occurs, the gain or loss in the cash flow reserve is
removed and included in the amount of a recognised asset or liability or reclassified in other comprehensive
Pdf_Folio:824

income and recognised to the profit or loss. A forward contract designated as a hedging instrument for a
firm commitment may be recognised as fair value hedge or a cash flow hedge. The gain or loss on the
unrecognised firm commitment is recognised consistently with the gain or loss on the forward contract;
that is, in the profit or loss or in other comprehensive income.
KEY TERMS
cash flow hedge A hedge of the exposure to the variability in cash flows that is attributable to a
particular risk that is associated with all, or some component of, a recognised asset or liability or a
highly probably forecast transaction and could affect profit or loss.
closing rate The spot exchange rate at the end of the reporting period.
exchange rate The ratio of exchange between two currencies.
fair value hedge A hedge of the exposure to changes in the fair value of a recognised asset or liability or
an unrecognised firm commitment or some component thereof that is attributable to a particular risk
and could affect profit or loss.
forecast transaction An uncommitted but anticipated future transaction.
foreign currency transaction A transaction that is denominated or requires settlement in a
foreign currency.
foreign exchange difference The difference resulting from translating a given number of units of one
currency into another currency at different exchange rates.
foreign exchange risk The risk that an entity’s financial position, financial performance or cash flows
will be affected by fluctuations in exchange rates.
forward exchange contract An agreement between two parties to exchange a specified quantity of one
currency for another at a specified exchange rate on a specified future date.
forward rate The exchange rate specified in a forward exchange contract.
functional currency The currency of the primary economic environment in which the
company operates.
hedged item A recognised asset or liability, unrecognised firm commitment or highly probable forecast
transaction in a hedging relationship.
hedging instrument A financial instrument used in a hedging relationship.
hedging relationships Combinations of one or more hedged items.
hedging transactions Arrangements designed to mitigate foreign exchange risk.
monetary items Units of currency held and assets and liabilities to be received or paid in a fixed or
determinable amount of currency.
non-monetary item An asset or liability that is not receivable or payable in foreign currency.
qualifying asset An asset that necessarily takes a substantial period of time to get ready for its
intended use.
settlement date The day on which cash is received or paid.
spot exchange rate The exchange rate at a point of time for immediate delivery of the currency in
an exchange.
transaction date When control of the future economic benefits embodied in an asset are obtained from
or transferred to another entity.
unrecognised firm commitment A firm commitment that the entity is yet to recognise for
accounting purposes.
DEMONSTRATION PROBLEMS
23.1 Accounts payable repaid in instalments
Paradise Ltd is an Australian company that makes and sells curtains. On 1 March 2023, Paradise Ltd
ordered fabric from a French company at an invoice cost of €500 000 on terms FOB destination.
On 30 April 2023, the goods were delivered into stores. The agreed payment arrangements are that
10% of the total amount owing would be paid on delivery, 50% 2 months after delivery, and the
remaining 40% 4 months after delivery. The end of the reporting period for Paradise Ltd is 30 June.
Paradise Ltd prepares its financial statements in accordance with applicable accounting standards
including AASB 121/IAS 21. The following exchange rates are applicable.
Pdf_Folio:825

1 March 2023 A$1 = €0.50
30 April 2023 A$1 = €0.60
30 June 2023 A$1 = €0.70
31 August 2023 A$1 = €0.80
Required
Prepare the journal entries of Paradise Ltd necessary to record the above transactions in its
accounting records.
SOLUTION
2023
April 30 Inventories Dr 833 333
(To record credit purchase of inventories at the transaction
date using the spot rate, €500 000/€0.60 = $833 333)
April 30 Accounts payable Dr 83 333
(To record first payment of 10% of invoice,
€50 000/€0.60 = $83 333. The remaining balance is
€450 000/€0.60 = $750 000)
(Remeasurement of the balance remaining in accounts
payable using the closing rate, €450 000/€0.70 less
€450 000/€0.60 = $107 143)
(To record second payment of 50% of invoice,
€250 000/€0.70 = $357 143. The remaining balance is
€200 000/€0.70 = $285 714)
Aug. 31 Accounts payable Dr 35 714
(Remeasurement of the balance remaining in accounts
payable using the spot rate, €200 000/€0.80 less
€200 000/€0.70 = 35 714)
Aug. 31 Accounts payable Dr 250 000
(To record third and final payment of 40% of invoice,
€200 000/€0.80 = $250 000)
23.2 Cash flow hedge of forecast transaction then fair value hedge of recognised item
On 1 November 2022 Crying Sun Ltd ordered inventories to the value of US$500 000 on FOB
destination terms. On 31 January 2023, the inventories were delivered. On 1 November 2022,
Crying Sun Ltd also entered into a forward exchange contract to buy US$500 000 with a settlement
date of 28 February 2023 (the date when the invoice for the inventories is due to be paid) to hedge
against the foreign exchange risk attached to the purchase of and payment for the inventories. There
is a cash flow hedge to the date of the purchase transaction and then a fair value hedge to the date
the invoice is paid. Crying Sun Ltd has a financial year ending 31 December.

1 November 2022 A$1 = US$1.00 A$1 = US$0.95
31 December 2022 A$1 = US$0.90 A$1 = US$0.89
31 January 2023 A$1 = US$0.85 A$1 = US$0.84
28 February 2023 A$1 = US$0.75 A$1 = US$0.75
Required
Prepare the journal entries of Crying Sun Ltd necessary to record the above transactions in its
accounting records. Assume a discount rate of 0% when calculating the fair value of the forward
contract.
Pdf_Folio:826

SOLUTION
2022
(To record gain on forward contract for a cash flow hedge,
US$500 000/0.89 less US$500 000/0.95 = $35 482)
2023
Jan. 31 Forward contract Dr 33 440
(To record gain on forward contract for a cash flow hedge,
US$500 000/0.84 less US$500 000/0.89 = $33 440)
Jan. 31 Inventories Dr 519 313
Transfer from cash flow hedge reserve Dr 68 922
(To record the accounts payable, US$500 000/0.85 = $588 235,
and the cost of inventories after removing the amount in the
cash flow hedge reserve)
Feb. 28 Foreign exchange loss Dr 78 432
(To record foreign exchange loss on accounts payable to date of
settlement, US$500 000/0.75 less US$500 000/0.85 = $78 432)
Feb. 28 Accounts payable Dr 666 667
(To record settlement of accounts payable, US$500 000/0.75)
Feb. 28 Forward contract Dr 71 429
(To record gain on forward contract for a fair value hedge to
date of settlement, US$500 000/0.75 less US$500 000/0.84 =
$71 429)
Feb. 28 Cash at bank Dr 140 351
(To record settlement of forward contract and the realised cash
gain, US$500 000/0.75 less US$500 000/0.95)
It is worth noting that the settlement of the accounts payable and forward contract results in a net outlay
of $526 316 (i.e. $666 667 less $140 351). This is the net outlay guaranteed by the hedging relationship,
being US$500 000 at the forward rate of A$1.00 = US$0.95.
COMPREHENSION QUESTIONS
1 Explain the financial reporting issue that arises when a company enters into foreign currency
transactions. Provide examples of various foreign currency transactions and indicate whether each
transaction involves the initial recognition of a monetary item or non-monetary item or both.
2 Explain what is meant by the term ‘functional currency’.
3 Describe the indicators used in determining the functional currency of an entity.
4 Explain what is meant by a spot exchange rate, closing exchange rate and forward exchange rate.
5 Illustrate the direct and indirect methods of quoting exchange rates.
6 Explain how the items that arise from foreign currency transactions are translated into the functional
currency when initially recognised in the accounting records.
7 Describe how the transaction date is determined for the purpose of initially recognising items arising
from foreign currency transactions.
8 Explain the distinction between monetary and non-monetary items.
9 Explain what is meant by the term ‘exchange difference’. Distinguish between an unrealised exchange
loss and a realised exchange loss. Provide an overview of the accounting requirements of AASB 121/
IAS 21 in relation to foreign currency transactions and exchange differences.
10 Describe how monetary items designated in a foreign currency are subsequently remeasured under
AASB 121/IAS 21. At what dates does the remeasurement occur?
Pdf_Folio:827

11 Describe the conditions under which non-monetary items designated in a foreign currency are
subsequently remeasured under AASB 121/IAS 21.
12 Explain what is meant by the term ‘qualifying asset’. Describe the accounting treatment for exchange
differences that relate to qualifying assets.
13 If land or inventories are designated in foreign currency, how should the recoverable amount of the land
or realisable value of the inventories be measured?
14 What is meant by foreign exchange risk? How can forward exchange contracts be used to manage
foreign exchange risk?
15 Explain how the fair value of a forward contract is measured at inception date, at the end of the reporting
period and at settlement date.
16 Distinguish between a fair value hedge and a cash flow hedge that uses a forward exchange contract as
the hedging instrument. Describe the accounting treatment of any gains or losses on a forward contract
that qualifies for hedge accounting.
CASE STUDY 23.1

RECOGNITION OF LIABILITIES
You are the technical accounting consultant of a Big 4 accounting firm. One of your clients is an
Australian travel company that arranges package tours to overseas destinations. The client states: ‘When
we arrange accommodation in foreign hotels we recognise a liability at the spot rate. Then when we pay
for the accommodation any exchange gain or loss is included in the profit or loss. We believe that we are
complying with AASB 121/IAS 21’.
Required
Do you agree with the client’s position? Explain why.
CASE STUDY 23.2

RECOGNITION METHODS
AASB 121/IAS 21 mandates the immediate recognition method where exchange differences on monetary
items are recognised in the profit or loss in the period of exchange rate movement. Other methods such as
‘defer and amortise’ or ‘recognition on realisation’ are not permitted.
Required
Do you agree that the correct decision has been made from the point of view of the Conceptual Framework?
Are there other reasons to prefer the immediate recognition method?
APPLICATION AND ANALYSIS EXERCISES

⋆ BASIC | ⋆ ⋆ MODERATE | ⋆ ⋆ ⋆ DIFFICULT
23.1 Translation of various foreign currency transactions and balances ⋆ LO3, 6
On 1 June 2023, Laurie Ltd, an Australian company with a functional currency of A$, entered into a
number of transactions in NZ$ when the exchange rate was A$1.00 = NZ$1.30. Any assets arising
from the NZ$ transactions are still on hand and any liabilities remain unsettled. On 30 June 2023,
the exchange rate is A$1.00 = NZ$1.20.
Required
Translate each of the following items for initial and subsequent measurement as appropriate.
1. Sales revenue and accounts receivable of NZ$20 000
2. Inventories and accounts payable of NZ$32 000
3. Plant NZ$72 000
4. Interest-free borrowings of NZ$125 000
23.2 Translation of various foreign currency transactions and balances ⋆ LO6, 7
Know Your Product Ltd is an Australian company with a functional currency of A$. The company
entered into a number of transactions denominated in US$ during the year ended 30 June 2023.
The closing exchange rate is A$1.00 = US$0.77.
Pdf_Folio:828

Required
Determine the translated amount that will be included in the financial statements for each of the
following transactions or events.
1. Land at cost of US$600 0000 acquired on 1 February 2023 when the exchange rate is A$1.00 =
US$0.67.
2. Land revalued to US$900 000 on 30 June 2023 that had cost US$600 000 on 1 February 2023
when the exchange rate was A$1.00 = US$0.67.
3. Credit sale of US$240 000 on 12 March 2023 when the exchange rate is A$1.00 = US$0.68.
Received cash from debtor of US$120 000 on 30 June 2023.
4. Credit purchase of inventories of US$320 000 on 15 June 2023 when the exchange rate is
A$1.00 = US$0.62. The creditor remains unpaid at 30 June 2023.
5. A loan payable of US$500 000 arranged on 1 January 2023 when the exchange rate is
A$1.00 = US$0.60. On 30 June 2023, the outstanding interest on the loan is US$50 000.
6. A 6-month forward contract to buy US$2 000 000 entered into on 1 April 2023 at the forward
rate of A$1.00 = US$0.75. On 30 June 2023, the forward rate for a 3-month forward to
buy US$2 000 000 is A$1.00 = US$0.70. Assume a 3-month discount rate of 2% applies at
30 June 2023.
23.3 Translation of consulting service expense ⋆ LO3, 6, 7
Koala Ltd is an Australian company that receives management consulting services from Spin
Incorporated. On 15 June 2023, Koala Ltd received an invoice from Spin Incorporated amounting
to US$5 million for services provided over the period 1 January 2023 to 31 May 2023. On 15 July
2023, Koala Ltd paid the invoice. The functional currency of Koala Ltd is A$ and its financial year
ends on 30 June. Applicable exchange rates are as follows.
1 Jan. 2023 A$1 = US$0.70

31 May 2023 A$1 = US$0.64
Average 1 Jan. 2023 to 31 May 2023 A$1 = US$0.65
15 June 2023 A$1 = US$0.62
30 June 2023 A$1 = US$0.60
15 July 2023 A$1 = US$0.58
Required
Prepare the entries of Koala Ltd to record the effects of the management fee transaction in
accordance with AASB 121/IAS 21.
23.4 Translation of purchase of inventories on credit terms ⋆ LO3, 6, 7
Stranded Ltd is an Australian company that purchases inventories from Hammers plc, which is an
English company. The following information is relevant to a recent acquisition of inventories for
£200 000 pursuant to a contract with terms including FOB shipping point.
Date Event Exchange rate

11 May 2023 Inventories shipped A$1 = £0.41
22 June 2023 Inventories delivered A$1 = £0.42
30 June 2023 End of reporting period A$1 = £0.43
31 July 2023 Cash payment of £300 000 to Hammers plc A$1 = £0.39
Required
Prepare the journal entries of Stranded Ltd that relate to the foreign currency purchase of inventories
in accordance with AASB 121/IAS 21. How would your answer change if the inventories acquired
had a net realisable value of £170 000 at 30 June 2023?
23.5 Translation of sale of inventories on credit terms ⋆ LO3, 6, 7
Tropic Ltd is an Australian company that makes and sells small electronic goods. On 1 February
2023, a customer from the United States ordered some goods from Tropic Ltd at an invoice cost
of US$400 000 on terms FOB destination. On 30 April 2023, the goods were delivered to the
customer. The agreed payment arrangements are that 30% of the total amount owing would be
paid on delivery, 20% 3 months after delivery, and the remaining 50% 4 months after delivery. The
end of the reporting period for Tropic Ltd is 30 June. The following exchange rates are applicable.
Pdf_Folio:829

1 February 2023 A$1 = US$0.75
30 April 2023 A$1 = US$0.73
30 June 2023 A$1 = US$0.68
31 July 2023 A$1 = US$0.72
31 August 2023 A$1 = US$0.76
Required
Prepare the journal entries of Tropic Ltd necessary to record the above transactions in its
accounting records.
23.6 Translation of foreign currency borrowings and interest costs ⋆ LO3, 6
On 1 October 2022, the Australian company Run Down Ltd enters a loan agreement with the Bank
of Scotland to borrow £2 000 000 for a period of 5 years. The interest on the borrowings is payable
half-yearly in arrears at the fixed interest rate of 10% p.a. with interest payments of £100 000
(i.e. £2 000 000 × 10% × ½ year) due on 31 March and 30 September each year. The functional
currency of Run Down Ltd is A$. It has reporting periods ending on 31 December and 30 June.
Applicable exchange rates during the financial period ending 30 June 2023 are as follows.
1 Oct. 2022 A$1 = £0.42

31 Dec. 2022 A$1 = £0.40
31 Mar. 2023 A$1 = £0.38
30 June 2023 A$1 = £0.36
Required
In accordance with AASB 121/IAS 21, prepare the entries of Run Down Ltd to record the borrowing
transaction, the borrowing costs expense, the borrowings costs paid and the remeasurement of the
borrowings at the end of the reporting period.
23.7 Translation of purchase of plant, sale of inventories and interest free loan ⋆ ⋆ LO3, 6, 7
Apples Ltd is an Australian company. The functional currency of Apples Ltd is A$. It has reporting
periods ending on 31 December and 30 June. During the year ended 30 June 2023, Apples Ltd
entered into various foreign currency transactions in euros (€) as follows.
(a) On 15 November 2022, Apples Ltd ordered plant costing €400 000 from an Italian company
under an FOB destination contract. On 30 November 2022, the plant was delivered. On
25 January 2023, the invoice for the plant purchase was paid.
(b) On 30 November 2022, Apples Ltd sold inventories to a German customer for the agreed price
of €250 000. The inventories had a cost of $175 000. On 31 January 2023, the sales invoice was
paid by the customer.
(c) On 1 July 2022, Apples Ltd made an interest-free loan to a related French company, Attitude
Cavaliere, for €500 000. The term of the loan is set at 5 years, at which time Attitude Cavaliere
will be required to arrange its debt finances independently.
Applicable exchange rates are as follows.
1 July 2022 €1 = A$1.27

15 Nov. 2022 €1 = A$1.20
30 Nov. 2022 €1 = A$1.30
31 Dec. 2022 €1 = A$1.25
25 Jan. 2023 €1 = A$1.23

31 Jan. 2023 €1 = A$1.21
30 June 2023 €1 = A$1.35
Required
In accordance with AASB 121/IAS 21, prepare the entries of Apples Ltd for the half year to
31 December 2022 and the full year to 30 June 2022.
23.8 Translation of purchases of inventories on credit terms ⋆ ⋆ LO3, 7
You are the financial controller of Delight Ltd, an Australian company listed on the ASX that
distributes imported food products in the local market. The functional currency of Delight Ltd is
A$. Delight Ltd’s purchases of inventories in foreign currency during the year ended 30 June 2023
are set out below. Exchange rates at delivery date, shipment date, the end of the reporting period
Pdf_Folio:830
and payment date are expressed to A$1.

Madras Curry Thai Satay Russian Turkish German
Supplier Monster Saucy Caviary Delightful Sausagez
Foreign currency Indian rupee (IR) Thai baht (THB) Russian rouble Turkish lire (TL) Euros (€)
(RR)
Invoice amount 3 000 000 900 000 40 000 000 80 000 000 500 000
Contract basis FOB shipping FOB destination FOB shipping FOB shipping FOB destination
Shipment date 20 Jul. 2022 31 Jul. 2022 1 Nov. 2022 31 Mar. 2023 30 Apr. 2023
Delivery date 31 Jul. 2022 30 Aug. 2022 31 Dec. 2022 30 Apr. 2023 30 Jun. 2023
Payment date 30 Sept. 2022 31 Oct. 2022 31 Jan. 2023 31 Jul. 2023 31 Aug. 2023
Rate on delivery IR 10 THB 2 RR 1 000 TL 10 000 €0.80
Rate on shipping IR 12 THB 3 RR 2 000 TL 10 500 €0.78
Rate at the end
of the reporting
period IR 18 THB 10 RR 1 800 TL 10 750 €0.70
Rate on payment IR 15 THB 4 RR 500 TL 11 000 €0.75
Required
In accordance with AASB 121/IAS 21, prepare the necessary entries in relation to the inventories
purchase transactions up until and including 31 August 2023.
23.9 Translation of sales of inventories on credit terms ⋆ ⋆ LO3, 6, 7
You are the financial controller of Valley Vines Ltd, an Australian company listed on the ASX that
sells premium Australian wines into overseas markets. Valley Vines’ sales of inventories in foreign
currency during the year ended 30 June 2023 are set out below. Exchange rates at delivery date,
shipment date, the end of the reporting period and payment date are expressed to A$1.
Customer Israel #3 Dubai #6 Turkey #4 Egypt #8 United States #9

Foreign currency Israeli shekel Dubai dirham Turkish lire (TL)
Egyptian dinar US dollar (US$)
(NIS) (AED) (ED)
Invoice amount 4 500 000 30 000 000 20 000 000 000 750 000 000 4 000 000
Contract basis FOB shipping FOB shipping FOB destination FOB destination FOB shipping
Delivery date 30 Aug. 2022 31 Oct. 2022 31 Jan. 2023 31 Mar. 2023 30 Apr. 2023
Shipment date 31 Jul. 2022 30 Sept. 2022 30 Nov. 2022 28 Feb. 2023 15 Apr. 2023
Cash receipt date 31 Oct. 2022 5 Feb. 2023 31 Mar. 2023 31 Jul. 2023 31 Aug. 2023
Rate on delivery NIS 1.6 AED 3.5 TL 9 500 ED 5 000 US$0.75
Rate on shipment NIS 1.4 AED 4.0 TL 9 000 ED 5 500 US$0.80
Rate at the end
of the reporting
period NIS 1.2 AED 3.8 TL 10 750 ED 5 750 US$0.88
Rate on cash receipt NIS 1.3 AED 4.2 TL 10 500 ED 6 000 US$0.86
Required
In accordance with AASB 121/IAS 21, prepare the necessary entries in relation to the sale
transactions up until and including 31 August 2023.
23.10 Qualifying assets ⋆ ⋆ LO3, 6, 7
On 1 July 2022, Remote Ltd, an Australian company that has A$ as its functional currency, enters
a loan agreement with a lender in Hong Kong to borrow HK$800 000 and uses the funds to acquire
components for construction of a warehouse. By 31 December 2022, when the warehouse is
ready to use, further costs of A$100 000 have been paid to finish its construction. The interest
on the borrowings is payable half-yearly in arrears at the fixed interest rate of 10% p.a. with
interest payments of HK$40 000 (HK$800 000 × 10% × ½ year) due on 31 December and 30
June each year. Remote Ltd prepares half-yearly reports and its reporting periods end 30 June and
31 December each year. The following exchange rates are applicable for the annual financial period
to 30 June 2023.
1 July 2022 A$1 = HK$5.60

Average July–Dec. 2022 A$1 = HK$5.65
31 Dec. 2022 A$1 = HK$5.70
Average Jan.–June 2023 A$1 = HK$5.72
30 June 2023 A$1 = HK$5.75
Pdf_Folio:831

Required
In accordance with AASB 121/IAS 21, prepare the necessary entries in relation to the transactions
up until and including 30 June 2023.
23.11 Revalued assets and inventory write-downs ⋆ ⋆ LO3, 6, 7
On 15 July 2022, Adelaide Ltd, an Australian company that has A$ as its functional currency,
acquires land in Paris, France, for a cash consideration of €500 000. On 1 January 2023,
Adelaide Ltd acquires inventories on credit for €75 000. Subsequently at 30 June 2023,
Adelaide Ltd revalues the land to its fair value of €700 000. The inventories are still on hand
at 30 June 2023 and have a net realisable value of €70 000. On 1 August 2023, Adelaide Ltd
pays in full the inventories purchased. Relevant exchange rates are as follows.
15 July 2022 A$1 = €0.85

1 Jan. 2023 A$1 = €0.80
30 June 2023 A$1 = €0.82
1 Aug. 2023 A$1 = €0.83
Required
In accordance with AASB 121/IAS 21, prepare the necessary entries for Adelaide Ltd up until and
including 1 August 2023.
23.12 Forward contract with no hedging ⋆ ⋆ LO3, 6, 10
On 1 February 2023, Rosewood Ltd, an Australian company that has A$ as its functional currency,
enters a forward exchange contract to buy £200 000 in 6 months’ time at 31 July 2023. The contract
is entered into for speculative purposes as the management of Rosewood Ltd believe that future
economic conditions will lead to an appreciation in the £ relative to the A$. Relevant exchange
Forward rate
Spot rate (for 31/7/2023)
1 Feb. 2023 — date of contract inception £1 = A$1.68 £1 = A$1.80
30 June 2023 — end of reporting period £1 = A$1.72 £1 = A$1.82
31 July 2023 — date of contract settlement £1 = A$1.65 £1 = A$1.65
Assume a discount rate of 0% for fair value calculations.

Required
1. Prepare the necessary entries for Rosewood Ltd up until and including 31 July 2023 in
accordance with AASB 121/IAS 21.
2. Assuming that the forward contract entered is to sell £200 000, prepare the necessary entries
for Rosewood Ltd up until and including 31 July 2023. The other features of the contract stay
the same.
23.13 Forward contract with fair value hedging ⋆ ⋆ LO10
On 1 May 2024, Edmund Ltd, an Australian company that has A$ as its functional currency,
purchases inventories for US$200 000 with the invoice to be paid on 30 October 2024. On the
same date as the inventories purchase, Edmund Ltd enters into a forward exchange contract to
buy US$200 000 on 30 October 2024. Assume a discount rate of 0% for fair value calculations.
Forward rate
1 May 2024 US$1 = A$1.53 US$1 = A$1.57
30 June 2024 US$1 = A$1.56 US$1 = A$1.60
30 October 2024 US$1 = A$1.48 US$1 = A$1.48
Required
Prepare the necessary entries for Edmund Ltd up until and including 30 October 2024 in accordance
with AASB 121/IAS 21.
Pdf_Folio:832

23.14 Forward contract with fair value hedging ⋆ ⋆ LO10
On 1 March 2024, Frank Ltd, an Australian company that has A$ as its functional cur-
rency, enters into a firm commitment with a foreign supplier to buy an equipment for
US$500 000. The ownership of the equipment and the consideration for the purchase are
transferred on 31 August 2024. On the same day as entering the firm commitment, Frank Ltd
enters into a forward exchange contract to buy US$500 000 on 31 August 2024. Assume a discount
rate of 0% for fair value calculations. Relevant exchange rates are as follows.
Forward rate
1 March 2024 US$1 = A$1.36 US$1 = A$1.39
30 June 2024 US$1 = A$1.37 US$1 = A$1.41
31 August 2024 US$1 = A$1.38 US$1 = A$1.38
Required
Prepare the necessary entries for Frank Ltd up until and including 31 August 2024 in accordance
23.15 Forward contract with cash flow hedging ⋆ ⋆ LO10
On 1 January 2023, Toby Ltd, an Australian company that has A$ as its functional currency,
enters into a forward exchange contract to sell €300 000 on 31 August 2023. The forward contract
is designated as a hedge for a sales transaction of €300 000 that Toby Ltd expects to have with
a German customer on 31 August 2023. The sales transaction is highly probable based on past
experience. Assume a discount rate of 0% for fair value calculations. Relevant exchange rates are
as follows.
Forward rate
1 January 2023 €1 = A$1.27 €1 = A$1.32
30 June 2023 €1 = A$1.30 €1 = A$1.35
31 August 2023 €1 = A$1.36 €1 = A$1.36
Required
Prepare the necessary entries for Toby Ltd up until and including 31 August 2023 in accordance
23.16 Purchase of inventories paid in instalments; borrowing hedged by
forward contract ⋆ ⋆ LO3, 6, 10
You are the finance director of the Australian listed company Fire Ltd, which has a functional
currency in A$. Fire Ltd purchases goods from Hong Kong and has borrowings from a US bank.
The company’s financial year ends on 30 June 2023. Fire Ltd entered the following transactions
during the year.
(a) Fire Ltd purchased inventories from a Hong Kong supplier for HK$2 700 000 on 15 April 2023.
The purchase contract is settled in three equal instalments of HK$900 000. The following
exchange rates apply.
15 Apr. 2023 Date of purchase HK$2 700 000 A$1 = HK$5.99

31 May 2023 1st payment of HK$900 000 A$1 = HK$6.01
30 June 2023 End of the reporting period A$1 = HK$6.21

31 Aug. 2023 2nd payment of HK$900 000 A$1 = HK$6.18
30 Sept. 2023 3rd payment of HK$900 000 A$1 = HK$6.24
(b) On 1 January 2023, Fire Ltd borrowed US$3 000 000 from an investment bank in the United
States for a 12-month period. The borrowing has a fixed rate of interest at 10% p.a. payable
at 6-month intervals. On 1 April 2023, Fire Ltd entered a 9-month forward contract to buy
US$2 500 000 in order to hedge against the foreign exchange risk on the US$ loan principal.
The following exchange rates apply.
Pdf_Folio:833

Forward rate
Date Spot rate (for 31/12/2023)
1 Jan. 2023 A$1 = US$0.89 A$1 = US$0.84
1 Apr. 2023 A$1 = US$0.86 A$1 = US$0.82
30 June 2023 A$1 = US$0.85 A$1 = US$0.79
31 Dec. 2023 A$1 = US$0.80 A$1 = US$0.80
Assume a 0% discount rate for fair value calculations.

Required
Prepare the entries of Fire Ltd to account for its foreign currency transactions in accordance with
AASB 121/IAS 21.
23.17 Purchase of inventories paid in instalments; borrowing with hedged interest commitment;
purchase of inventories with hedged liability to supplier ⋆ ⋆ ⋆ LO3, 7, 10
You are the finance director of Gripweed Ltd, an Australian company listed on the ASX. The
company is an importer of goods from overseas markets. The company’s financial year ends
on 30 June 2023. The company entered the following transactions during the year.
(a) Gripweed Ltd purchased inventories from a Hong Kong supplier for HK$300 000. The title to
the goods passes to the company on delivery. The payment for the inventories is due in equal
instalments. The following exchange rates are applicable.
22 Apr. 2023 Date of order for inventories A$1 = HK$8.40

30 Apr. 2023 Date of delivery for inventories A$1 = HK$8.90
31 May 2023 1st payment of HK$100 000 A$1 = HK$8.96
30 June 2023 2nd payment of HK$100 000 A$1 = HK$8.99
31 July 2023 3rd payment of HK$100 000 A$1 = HK$9.44
(b) Gripweed Ltd purchased land in Japan on 1 July 2022 for ¥60 000 000. The land is subsequently
revalued on 30 June 2023 to its fair value of ¥90 000 000. The following exchange rates are
applicable.
1 July 2022 Date of acquisition of land A$1 = ¥180

30 June 2023 Date of revaluation of land A$1 = ¥265
(c) Gripweed Ltd arranged interest-only borrowings on 1 January 2023 for US$20 000 000. The
borrowings have a 10-year term and interest is paid half-yearly at the rate of 7.6% p.a.
Gripweed Ltd took out a 6-month forward exchange contract on 1 January 2023 as a hedge
against the initial interest payment due. The following exchange rates are applicable.
Forward rate
1 Jan. 2023 A$1 = US$0.80 A$1 = US$0.75
30 June 2023 A$1 = US$0.65 A$1 = US$0.65
(d) Gripweed Ltd purchases inventories on 1 May 2023 from an English supplier for £450 000. On
the same date, Gripweed enters a 3-month forward exchange contract to buy £450 000 to hedge
its liability to the supplier. On 31 July 2023, the supplier is paid and the forward contract is
settled. The following exchange rates are applicable.
Forward rate
1 May 2023 A$1 = £0.64 A$1 = £0.62
30 June 2023 A$1 = £0.52 A$1 = £0.47
31 July 2023 A$1 = £0.37 A$1 = £0.37
(e) Assume the same facts as part (d) except that the date of the purchase of inventories is
31 July 2023 and at 1 May 2023 it is a highly probable forecast transaction.
Pdf_Folio:834

Required
Prepare the entries of Gripweed Ltd to account for its foreign currency transactions in accordance
with AASB 121/IAS 21. Assume a 0% discount rate for fair value calculations. Explain the
techniques applied in respect of each transaction.
23.18 Sale of inventories with no hedge, fair value hedge and cash flow hedge ⋆ ⋆ ⋆ LO3, 7, 10
Cool Ltd is an Australian mining company listed on the ASX. The company is an exporter of iron
ore to overseas steel mills. The company’s functional currency is A$ and its financial year ends on
30 June 2023. The company entered various sale transactions during the year. Relevant exchange
Forward rate
1 Apr. 2023 A$1 = US$0.78 A$1 = US$0.75
1 June 2023 A$1 = US$0.76 A$1 = US$0.72
30 June 2023 A$1 = US$0.78 A$1 = US$0.74
31 July 2023 A$1 = US$0.80 A$1 = US$0.80
(a) On 1 April 2023, Cool Ltd sold iron ore to a Japanese customer for US$2 500 000. On 31 July
2023, the customer paid for the iron ore.
(b) On 1 June 2023, Cool Ltd sold iron ore to a Chinese customer for US$4 250 000. On 31 July
2023, the customer paid for the iron ore. On 1 June 2023, the company entered into a forward
exchange contract to sell US$4 250 000, which it designated as a hedge of the customer account.
(c) On 1 April 2023, in anticipation of a highly probable transaction with its Korean customer,
Cool Ltd entered into a forward exchange contract to sell US$1 500 000 as a hedging instrument.
The forward contract has a settlement date of 31 July 2023. On 1 June 2023, Cool Ltd sold iron
ore to a Korean customer for US$1 500 000. On 31 July 2023, the customer paid for the iron ore.
Required
Prepare the entries of Cool Ltd to account for its foreign currency transactions in accordance with
AASB 121/IAS 21. Assume a 0% discount rate for fair value calculations.
23.19 Hedged firm commitment; hedged highly probable forecast transaction; hedged recognised
liability; and borrowings and interest attributable to a qualifying asset ⋆ ⋆ ⋆ LO3, 7, 10
Aloha Ltd is an Australian company that purchases inventories and specialised equipment from
US suppliers. The company’s functional currency is A$ and its financial year ends on 30 June 2023.
The company entered various transactions denominated in US$ during the year. Assume a discount
rate of 0% for fair value calculations. Relevant exchange rates are as follows.
Forward rate
1 Jan. 2023 A$1 = US$0.85 A$1 = US$0.83
1 Mar. 2023 A$1 = US$0.79 A$1 = US$0.76
1 May 2023 A$1 = US$0.75 A$1 = US$0.73
30 June 2023 A$1 = US$0.70 A$1 = US$0.67
31 Aug. 2023 A$1 = US$0.77 A$1 = US$0.77
(a) On 1 March 2023, Aloha Ltd entered into a firm commitment with a US company to build a
new equipment item for US$1 800 000. On 31 August 2023, the item of equipment is delivered
and installed and recognised as an asset in Aloha Ltd’s accounting records. On 1 March
2023, Aloha Ltd entered a 6-month forward contract to buy US$1 800 000 for settlement on
31 August 2023. The forward contract is designated as a hedging instrument for an unrecognised
firm commitment.
(b) On 31 August 2023, Aloha Ltd acquired inventories, as normal around this time of year,
from a US supplier for US$5 000 000. On 1 January 2023, Aloha Ltd entered an 8-month
forward contract to buy US$5 000 000 for settlement on 31 August 2023. The forward
contract is designated as a hedging instrument for a highly probable forecast inventories
purchase transaction.
(c) On 1 May 2023, Aloha Ltd acquired inventories from a US supplier for US$500 000. The
invoice is paid in full on 31 August 2023. On 1 May 2023, Aloha Ltd entered a 4-month forward
exchange contract to buy US$500 000 for settlement on 31 August 2023. The forward contract
Pdf_Folio:835
is designated as a hedging instrument for a recognised liability.

(d) On 1 January 2023, Aloha Ltd commenced the construction of an item of specialised plant. The
estimated construction period for the plant is 18 months. On 1 January 2023, Aloha Ltd bor-
rowed US$18 000 000 to finance the construction of the plant. The interest on the borrowings is
10% p.a. paid at the end of each year. The average exchange rate for the period 1 January 2023 to
30 June 2023 is A$1.00 = US$0.825.
Required
Prepare the entries of Aloha Ltd to account for its foreign currency transactions in accordance with
AASB 121/IAS 21. Assume a 0% discount rate for fair value calculations.
ACKNOWLEDGEMENTS
Photo: © Dmitry Kalinovsky / Shutterstock.com
Photo: © Syda Productions / Shutterstock.com
Pdf_Folio:836


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CHAPTER 23

After studying this chapter, you should be able to:

CONCEPT FOR REVIEW

23.1.1 Functional currency

of its goods and services

792 Financial reporting

23.1.2 Types of foreign currency transactions

23.2 Exchange rates

CHAPTER 23 Foreign currency transactions and forward exchange contracts 793

Translation of foreign currency payable

794 Financial reporting

23.3 Initial measurement at the transaction date

CHAPTER 23 Foreign currency transactions and forward exchange contracts 795

23.4 Monetary and non-monetary items

796 Financial reporting

23.5 Foreign exchange differences for monetary items

23.5.1 Realised and unrealised gains or losses from

CHAPTER 23 Foreign currency transactions and forward exchange contracts 797

Beginning of period Date of transaction Date of settlement End of period

Accounts receivable Cash receipt

FIGURE 23.2 Realised exchange gain across two reporting periods

Date of transaction End of period Date of settlement End of period

Accounts receivable Accounts receivable Cash receipt

Realised foreign exchange gain A$30

23.5.2 The relationship between exchange rates and

798 Financial reporting

Foreign currency monetary item

23.6 Subsequent measurement of foreign currency

CHAPTER 23 Foreign currency transactions and forward exchange contracts 799

Stage 1 Stage 2 Stage 3

Record transaction at Remeasure monetary item Remeasure monetary item

23.6.1 Measurement of foreign currency monetary items at the

800 Financial reporting

23.6.2 Measurement of foreign currency monetary items

CHAPTER 23 Foreign currency transactions and forward exchange contracts 801

23.6.3 Illustrative examples

ILLUSTRATIVE EXAMPLE 23.1

Exporting goods on credit terms

13 May 2023 — transaction date A$1 = US$0.74

Date Accounts receivable in A$ Increase/(decrease)

802 Financial reporting

Journals for the year ending 30 June 2024

Brief observations concerning this example are as follows.

ILLUSTRATIVE EXAMPLE 23.2

Importing goods on credit terms

exchange rates are as follows.

15 July 2023 — transaction date NZ$1 = A$0.88

CHAPTER 23 Foreign currency transactions and forward exchange contracts 803

Date Accounts payable in A$ Increase/(decrease)

Brief observations concerning this example are as follows.

ILLUSTRATIVE EXAMPLE 23.3

Consulting revenue and foreign currency bank account

30 April 2023 — date of cash receipt A$1 = €0.78

Average for April 2023 — transaction period A$1 = €0.77

Date Cash at bank in A$ Increase/(decrease)

804 Financial reporting

Journals for the year ending 30 June 2023

Brief observations concerning this example are as follows.

ILLUSTRATIVE EXAMPLE 23.4

Foreign currency borrowings

1 July 2022 — date of transaction A$1 = £0.60

Date Bank borrowings in A$ Increase/(decrease)

CHAPTER 23 Foreign currency transactions and forward exchange contracts 805