Let us see the recognition and measurement of foreign currency transactions in the books of accounts.
First we need to understand what is meant by a foreign currency transaction.
Foreign currency transaction is a transaction in a currency other than the functional currency of the entity.
A foreign currency transaction is the one that is denominated in foreign currency that requires settlement in such foreign currency.
Let us look at the requirements for recognising a foreign currency transaction initially.
First, the foreign currency transaction is entered in separate books of accounts.
Then, the same is revalued by applying the spot rate to get the value in the functional currency of the entity.
In certain situations, average exchange rate may also be allowed, provided certain conditions are fulfilled.
Let us look at the requirements for subsequent measurement of such foreign currency transactions. Foreign currency transaction should be translated into functional currency.
For translating into functional currency, the rate at which the account balances should be converted into foreign currency is determined based on whether the item is a monetary item or a non-monetary item.
Monetary items are translated to the functional currency using the closing rate as on the reporting date.
For non-monetary items, the exchange rate to be used will depend upon the basis of measurement of such item.
If the basis is historical cost, then the account balance should be translated at the rate as on the date of transaction. However, if the basis of measurement is fair value, then the account balance should be translated into the functional currency at the rate as on the date on which the fair value is determined.