Foreign currency transactions in books of accounts – how is the financial data translated and presented?

This article answers the following questions:

• How to record foreign currency transactions?
• Which exchange rate should be applied to a foreign currency transaction?
• How to account for down payments for assets under construction?

Multinational enterprises often transact in foreign currencies, which is perfectly standard. However, it may cause some problems as Polish regulations require that all such events be posted in the domestic currency. How to translate and measure such transactions and appropriately present them in the books? The answers to these questions are based on the International Accounting Standard 21 (IAS 21) and the Polish Accounting Act (the Act).

How are foreign currency transactions regulated in the Accounting Act?

The fundamental rule laid down in the Accounting Act is that the books of accounts of entities operating in Poland must be kept in the Polish currency – PLN (Article 9 of the Act).

With respect to the measurement of foreign currency transactions, the right method depends on the date at which the transaction is recorded:

• Historical measurement – in this case, the exchange rate used for the measurement of the transaction is stipulated in Article 30(2) of the Act:
  • the exchange rate actually used on that date, arising out of the nature of the transaction (in the case of sale or purchase of currencies or payment of amounts receivable or payable);
    or
  • the average exchange rate for a particular currency published by the National Bank of Poland on the day preceding the date of the transaction (in the case of payment of amounts receivable or payable if the application of the exchange rate referred to above is not reasonable and in the case of other transactions).
• Balance sheet measurement – the exchange rate used for the measurement of the transaction is stipulated in Article 30(1) of the Act:
  • the average exchange rate for a particular currency published by the National Bank of Poland and effective on that date.

There are exceptions to the general balance sheet measurement rule, for example applying to:

• Entities dealing in the purchase and sale of foreign currencies – in this case, the transactions are measured at the exchange rate of the purchase, however not higher than the average exchange rate for the particular currency at the date of the measurement, published by the National Bank of Poland.
• Entities that have adopted the mechanisms provided for in the National Accounting Standard No. 11 (NAS 11) – as stated in section 6.18 of NAS 11, advance payments and prepayments on account of acquiring a fixed asset denominated in foreign currencies should be translated to the Polish currency at the date the fixed asset is handed over. In that case, the transactions are not revalued but measured at the historical date. 

Mechanisms concerning the presentation of data in foreign currencies provided for in the International Accounting Standard 21 (IAS 21)

Entities which have adopted IAS 21 are free to choose a currency to present their financial data (the presentation currency) provided that the currency is analysed as appropriate and that the considerations concerning the currency are documented in the accounting policy.

A situation may occur where an entity chooses to present its data in EUR, while the majority of its business transactions are denominated in PLN. In that case, the entity must make proper translations, as follows:

• Assets and liabilities are translated at the closing rate effective at the date of the statement of financial position (balance sheet).
• Income and expenses are presented in the statement of comprehensive income, being translated at the exchange rates at the date of the transaction (with the average exchange rate being commonly used in that case). 

All resulting exchange rate differences from the above translations are recognised as a separate item in other comprehensive income.

Note that IAS 21 does not apply to:

• derivative transactions and balances that are within the scope of International Financial Reporting Standard 9 "Financial Instruments",
• hedge accounting for foreign currency items.

Measurement of foreign currency transactions according to IAS 21

Methods of recognising foreign currency transactions in the books kept in accordance with IAS 21 are divided – as in the case of bookkeeping under the Accounting Act – according to the following criteria:

• Historical measurement – the spot exchange rate of the functional currency to a foreign currency, effective at the date of the transaction, is applied.

Functional currency is the currency of the primary economic environment in which the entity operates, typically the currency of the state in which the entity conducts its business activity (although there might be exceptions). Foreign currency is any currency other than the functional currency.

• Balance sheet measurement – depending on what is measured:
  • Monetary items – the entity's cash in hand and at bank as well as amounts receivable and payable in a determined or determinable amount in a foreign currency – are measured at the closing rate.
  • Non-monetary items – whose primary feature is the inability to receive (or the lack of obligation to pay) a determined or determinable amount of currency units – are measured:
    • at the exchange rate at the date when their fair value was measured (if measured at fair value)
    • at the exchange rate at the date of the transaction (for remaining non-monetary items).

Closing rate is the spot exchange rate at the end of the reporting period. 

Exchange rate is the ratio of exchange for two currencies. 

Spot exchange rate is the exchange rate for immediate delivery.

Depending on the measured asset, the spot exchange rate may correspond to the purchase or sale price, as referred to in Polish accounting regulations.

International Accounting Standard 21 provides for a simplification consisting in using an average exchange rate applicable in a given week or month for a particular foreign currency – with the proviso that this solution is inappropriate if exchange rates fluctuate significantly.

How to approach down payments for assets under construction in a foreign currency?

Some entities make deposits or prepayments and advance payments on account of acquisition of fixed assets and are not certain if they are classified as monetary or non-monetary items. 

Monetary units which are refunded to the entity (return of the deposit) are considered as monetary items, otherwise – in the event of prepayments or advance payments – the payments are classified as non-monetary items and presented in the financial statements in the amount translated at the exchange rate at the date of the transaction.

Foreign currency transactions need proper procedures

To sum up, to adequately record foreign currency transactions, it is necessary to apply correct exchange rates, as stipulated in the Polish Accounting Act or International Accounting Standard 21. Regardless of whether historical or balance sheet measurement is adopted, it is essential to differentiate between monetary and non-monetary items and take into consideration notable exceptions, such as down payments on account of fixed assets.

In the face of complex rules and the obligation of compliance with Polish and international regulations, it is worth consulting an experienced audit firm specialised in auditing financial statements and internal bookkeeping procedures. You are thus welcome to contact us and find out how our support in developing an accounting policy which aligns with the specific nature of your business and a comprehensive internal audit can provide security of your financial operations.