What closing rate to apply when more rates are available?
Let me answer one of your questions in this article. This is the question asked by Dipanjan from Botswana:
What to do if dual rates exist? Which closing rate to choose?
Hi Silvia, greetings from Botswana. Which closing exchange rate to use for translation at the year-end: buy rate, mid rate, sell rate?
We have lots of assets and liabilities denominated in foreign currencies and we need to translate all monetary items with the closing rate at the end of the reporting period.
The question is – what closing rate shall we use? There is more than one closing exchange rate stated in our country: mid rate, buy rate, sell rate. The differences would be quite material.
This is a great question because that’s the very practical issue that many accountants face so let me answer that.
Answer: Make a choice, but be consistent
In some cases the differences in exchange rates are small and the total impact of using different rates would not be significant for your financial statements. You can use the mid rate in this case.
It’s the spot rate. In my own country, we use EUR and for the translating the year-end balances of monetary assets and liabilities, we use the closing spot rate of EUR to foreign currency as declared by the European Central Bank.
However, in other circumstances, when there’s more than one rate, the differences can affect your financial statements a lot.
In this case IAS 21 prescribes that when several exchange rates are available, the rate used is that at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date – that’s stated in the paragraph 26 of IAS 21.
Therefore, you always have to ask: if the foreign currency receivable is paid now at the reporting date, at what rate will it be converted on our bank account?
And, the answer is:
Your receivables and other monetary assets would be settled at the buy rate and your payables and other monetary liabilities and the sell rate.
Buy rate is the rate at which the bank buys the foreign currency from you and therefore, when you have the receivable in foreign currency, you will get the foreign currency and you will sell it to the bank – and the bank will buy it from you at the buy rate. That’s why you translate the assets at the buy rate.
On the other hand, the sell rate is the rate at which the bank sells the foreign currency to you. So, if you have payable in foreign currency, you need to buy that foreign currency from the bank first in order to pay that payable and the bank will SELL it to you at the sell rate.
If this is too hard to remember, just remember the simple help or mnemonic – it is always beneficial for the bank, not for you.
Example: buy and sell rate
So, if you have 1 000 USD and you need EUR, the buy rate is 1.2 and the sell rate is 1.1 USD/EUR – which rate is OK to apply?
At the buy rate of 1.2, 1 000 USD is – let me calculate – 833 EUR, and at the sell rate of 1.1, 1 000 USD is 909 EUR – what amount would you get if you bring your 1 000 USD to the bank? The lower amount, of course – so you translate your asset of 1 000 USD with the buy rate of 1.2 at 833 EUR.
On the other hand, If you have to pay 1 000 USD to someone, but you have just EUR, how much you need to pay to the bank to get USD? The higher amount, 909 EUR – so you translate your liability of 1 000 USD with the sell rate of 1.1 at 909 EUR.
Let me warn you that here you should apply these rates consistently; i.e. always mid rate, or always buy-sell rates. You can’t just apply the mid rate once and then the buy-sell rate… you have to be consistent from period to period. Period.
Bonus question: How about unofficial exchange rates?
What if in your country, there’s some official exchange rate and an unofficial exchange rate? And, what if you’re using unofficial rate and that rate is widely and legally used?
In this case you can apply the unofficial rate for your translation, but only if you can strongly prove that the transactions can be, will be or were settled at that rate.
So, thanks to Dipanjan for this great question.
I put this answer into a video and you can watch it here on YouTube:
Any questions or comments related to dual rates? Please write below, thank you!
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Hi Silvia. Need your clarification and explanation in the context of IFRS.
XYZ, a hypothetical, listed company whose functional currency is BDT/ Taka (Bangladeshi currency) and borrowed Euro 1,000 from a foreign lender and pay off the loan to other foreign and local lenders amounting to USD 600 and EURO 400. At the time of borrowing Euro 1000, translation exchange rate is TK.100/Euro 1 and at the time of settlement of liability at foreign currency, translation exchange rate TK105/ USD 1 and TK.107/ Euro 1. In addition, Exchange rate from Euro to USD is USD 0.95 / EURO 1.
From the scenario as stated above, please let me explain the following questions.
1. Can we use cross functional exchange rate i.e. Euro to USD i.e. USD 0.95 / Euro 1 instead of using the exchange rate at the time borrowing i.e. Tk.100/ Euro 1 and exchange rate at the of settlement TK105/ USD 1 and TK.107/ Euro 1? if so, how?
2. Does IFRS permit to comply cross exchange rate? if so, any reference?
Hi Silvia, I have a question. I have a client operating in trading commodity. We have physical forwards transactions that happen in 2 January 2018, but the client record them using the rate of 31 January 2018. May I know what correct rate to be used the spot rate which is 2 January or 31 January the closing month end rate? and Where can I check in the standards, the theory related to this?
you should use the rate at the date of the transaction since this is the date when you first recognized the asset or liability resulting form settled forwards. I would say IAS 21 is a good standard to look at, more specifically at translating the foreign currency transactions to the functional currency.
Would like to ask, my country does not have closing rates. What I have provided by the bank is the merchant rates which have sell rate and buy rate. May I request for your explanation on what is mid rate and where can I get the mid rate as I’m not familiar with it.
Is there any alternative rates should I use since my country does not have closing rates? Also what does it mean by the unofficial exchange rate?
Hi Alex, please go through that article and video again, it tells you what to do.
Thank you Silvia! I have gone through the video and it is easy to understand from there. Does choosing the closing rate here applies similar treatment for translation to a presentation currency in the financial statements?
I would say yes 🙂
Great explanation Silvia. Always rewarding when you simply these stuff with soild proofs from the standards.
Hi Silvia, Great info..you have nicely explained about the usage of rates when more than one rate available for translation purpose.
Thank you Silvia
Thanks a lot for your time and help.
I have a question too. We have a leasing contract between mother company (the lessor) and the daughter companies (the lessees). The leasing is accounted for as according to local accounting standards in mother company as operational and in daughter companies as financial. After the year end mother company has to consolidated the individual financial statements of the subsidiaries ( approved by the auditors). How do we take away the intercompany operation given we have fixed assets and lease liability , depreciation and interest in subsidiaries and we have only rent incomes in mother company and nothing in the balance sheet. Is it that all the amounts relating to the fixed assets and liabilities etc taken away and the income from the mother company? , so that we have no trace of this operation in the consolidated report? and maybe describe it in the notes. As far as I remember the first step is to translate the subsidiaries financial statement to mother companies accounting policies and then take away the intercompany operations? Thanks in advance for your enthusiasm which inspires
Dear Oxana, thank you for your kind words!
As for the new questions, please send them via e-mail or via Contact form, as I would like to keep the discussion below the podcast relevant to the topic. Thank you! S.
Pls answer for this deferred tax issue
say my tax exemption period is 10 years from now, I have a PPE asset with accounting depreciation for 8 years and for tax purpose depreciate for 6 years. In this case there is no differed tax impact.
But , say if accounting depreciation for 12 years and for tax depreciation for 8 years, what will be the impact on deferred tax? can we eliminate those assets from my deferred tax calculation considering it as permanent difference ?
Also, should I take gratuity provision for my differed tax computation?
Appreciate very much if you could answer for these things.
Thanks & Regards,
Suneth ( Sri Lanka)
this question is off topic and does not relate to the closing rates. Please keep your questions relevant to the topic solved. You can try reading this article, it will answer your question. There’s short illustration of your issue. S.
Thanks Silvia for giving ur time and help
Thanks for your great idea.
Why we have to use historical rate for conversion of share capital. How and from where this is supported by the IFRSs as I am not clear as to how to categorise share capital and equity as Non-monetary item. Share capital, in essence, is a long term loan that conceptually is an obligation of a business concern to the shareholders.
Looking forward to your help in obtaining clarity on this area.
Oh yes, share capital and other equity items – this is not quite clear in the standards. Please read this article for more insights. S.
I come from Bosnia and Herzegovina. The Central Bank of Bosnia and Herzegovina publishes the Daily Exchange Rates List every working day with regard to buy, sell and mid-rate for different currencies. I did not understand should we also apply buy/sell rates at the initial recognition of the transaction (for example when we issue an invoice to our customer in USA or when we receive the money in US dollars)?
Well, you should be consistent – thus either apply mid rate both for closing and initial recognition, or apply buy/sell for both situations.
I have a question regarding restating the financial statements of reversing a provision that was created in the the last two years . I am wondering whether reversing the provision from the Retained earning of the comparative figures only is ok in both ( Financial position and changes in equity statements) or I should restate the income statement of the comparative year with the amount charged expense in that year and also the opening balance of the comparative years of Retained earning in the changes in equity statement
Hi Amr, this is off topic. Thank you for keeping the comments relevant to this question. Have a great day!
When translating monetary items with closing rate , exchange gain or loss is recognized on OCI?
Profit and loss?
Thank you for this new opportunity of learning by listening in anywhere we are. Desde Colombia gracias.