How Banks Treat FX In Multi-Currency Accounting

By Pat Low

What is multi-currency accounting? Why do banks use this instead of the legacy single currency system?

Traditional way of recognising foreign currency transactions in a base currency of account cannot support the needs of entities operating in an environment of fast moving and massive turnover transactions in multiple currencies. These entities are primarily in the financial services industry. Banks, for example, handle huge volumes of foreign exchange deals in multiple currencies and in wholesale-sized transactions daily. The front office monitors currency risk exposures by the seconds. The middle office keeps daily vigil on realised exchange gains or losses, and valuations on their massive FX carry trades and open cash positions.
 

The impact of changing exchange rates is a much discussed topic in the accounting profession. It has taken years for IAS21 to be finalised. Throughout all these dialogues over the years, multi-currency accounting has been the elephant in the room. Find out how banks employ multi-currency accounting systems to handle this matter in an entirely different manner.

 

"How Banks Treat FX In Multi-Currency Accounting" explains the detailed debits and credits with easy-to-understand illustrations. It may surprise many that there is no such thing as foreign currencies in multi-currency accounting. This is a topic where there is a dearth of literature.

This is a book written from the trenches for those who appreciate practical experience.

• Language: English
• Publisher: Patpub
• Release date: May 19, 2023
• ISBN: 9798223580263

Pat Low

Pat Low clerked with Ernst & Young, Singapore, for 3 years before moving on to the banking industry where he stayed for the next three decades. He has worked in commercial banking, merchant banking and wholesale banking environments in the Singapore offices of international banks. He has managed middle and back offices with responsibilities for operations, compliance, systems, accounting, loan administration, and taxation. Pat has been involved with two start up operations and helped with systems implementation from ground up. In a dynamic industry during a growth phase, systems are challenged by the need to innovate and upgrade to support new products, regulatory and risk management demands. Pat has had hands-on experience in several in-house application developments that enhanced operational capabilities.

Book preview

1.  Introduction

Transacting in various currencies and the need to record in a particular currency presents bookkeeping issues because of exchange rate fluctuations. Traditionally, the home or domestic currency is used as the unit of account, often called the base currency. All other currencies are foreign currencies and any transactions denominated in them need to be converted to the base currency to be captured in the accounts. Over time, historical cost and fair value concepts have evolved and accounting standards have been established on how to treat foreign currency transactions.

This may surprise some. For banks, there is no foreign currency in the accounting sense. It sounds oxymoronic but walk through the explanatory debits and credits in 1he book, it becomes apparent.

For banks, dealing in a particular currency in and of itself, does not present any exchange risk given exchange rate fluctuations. For example, extending a YEN loan, accepting CHF deposits, investing in AUD corporate bonds, etc., such transactions present no exchange risks per se. Banks view spot risks as the mismatch between a  currency’s assets and liabilities. These are currency positions created by foreign exchange transactions, i.e., banks' buying and selling of currencies. Banks’ forward currency risks are associated with their portfolio of foreign exchange carry trades. The values of these spot cash positions and carry trades are subject to exchange rate volatility.

Bank accounting efforts are directed towards providing fair value for spot currency positions, mark-to-market of carry trades, and realisation values of delivered trades. This book shows how this is done in a multi-currency accounting system. In addition, it also shows technicalities of multi-currency systems is an elephant in the room not addressed by international accounting standards.

This is a primer on the bookkeeping aspects of foreign exchange transactions in a multi-currency system. It is written for middle office personnel in banks, central bank inspectors, bank internal auditors, public accountants handling a banking portfolio, or accounting professionals and students who want to learn a subject matter hardly covered in text books or reference materials, and the general public who want some heady stuff demystified for them.

Note for viewing with ereader: Reflowable ebooks do not handle tables well. A book on accounting invariably contains a trove of tables, some with multitude of columns. To go around this problem, tables have been converted to jpeg images which impinge on quality somewhat. Some ereader settings may display the more compact tables too small for a proper view. For tables baring the binoculars icon, click on the image for a clearer picture if required. Linked images are available for as long as the online storage remains in service.

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2.  Accounting Standards for foreign currency transactions

Companies maintain a set of accounts to record all transactions. The recording is done in a single currency called ‘base’ currency. The term ‘base’ is not to be confused as that used by FX traders which is an identifier in a currency pair (explained in chap.7). To be clear, let's call this the book currency. The book currency in a single currency accounting system is usually the home (domestic) currency. A company may choose to use a different currency to record transactions if their major economic activity is in that currency. That is known as the functional currency. In other words, a book currency can be either the domestic currency or the functional currency. All other currencies are then considered ‘foreign’ currencies.  Should a company in Singapore use USD as its functional currency, then the domestic SGD is treated as a foreign currency.

Accounting standards are established on how to record foreign currency transactions at inception, on their impact on profit and loss during their life, and on disposal.

Basically, in single currency systems, all foreign currency transactions are recognised and recorded in the books in the base currency using temporal or historical method, i.e., based on rates at the date of transactions.

Various foreign currency monetary and non- assets and liabilities are revalued for year end reporting and exchange gains and losses recognised by translating at rates on year end dates. Finally, on settlement or disposal they are valued on rates at maturity or disposal date and gains or losses on exchange recognised.

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Illustration:

A company whose book currency is SGD, exported some products invoiced on 1 Oct 2021 for USD100,000. The customer eventually paid up on 15 February 2022. Exchange rates on relevant dates were :

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1 Oct 2021  1.3580

31 Oct 2021  1.3500

31 Dec 2021  1.3487

15 Feb 2022  1.3465

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The relevant accounting entries:

(1) USD100,000x1.3580 = SGD135,800 based on rate on date of transaction.

(2) To record loss in value of trade debt : USD100,000x1.3487 = SGD134,870. SGD135,800-SGD134,870 = SGD930.

(3) To record loss in value on settlement : USD100,000x1.3465 = SGD134,650. Realised loss is : SGD135,800-SGD134,650=SGD1,150.

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The financial reporting as at 31 Dec 2021 :

Sales USD100,000 x 1.3500  =  SGD135,000

Debtors USD100,000 x 1.3487  =  SGD134,870

Provision for loss  =  SGD  930

This serves the purpose for most businesses.

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Entities consolidating foreign operations:

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Some companies may have overseas branches, joint-ventures, subsidiaries etc. These overseas operations submit financial returns in a different presentation currency. To consolidate the accounts, the parent company translates by:

Assets and Liabilities at year end rates.

Revenue and Expenses at rate on date of transaction. If this is not possible, average rates are used.

Take an example a US company working on its Australian branch financials.