Currency Management

Overview

An enterprise may have transactions in foreign currencies or it may have foreign branches. Foreign Currency transactions should be expressed in enterprise’s reporting currency and the financial statement of foreign branches should be translated into enterprise’s reporting currency in order to include them in the financial statement of the enterprise.

The principle issues in accounting for foreign currency transactions and foreign branches are to decide which exchange rate to use and how to recognize the effect of exchange rates in the financial statements.

Effects of changes in Foreign Exchange Rates

In India, Financial statements are prepared in Rupee, which is the reporting currency. All the transactions are done in rupee and, therefore, recorded in rupee. However, if enterprise has the transactions in another currency, say, in US,  dollars, because the enterprise is making export sales or importing material, plant or taking loan from abroad, in these cases, transactions shall be in foreign currency but recording and reporting has to be done in rupee, then the question of translation of foreign currency transaction in INR arises.

Further, there may be a case that an enterprise domiciled in India has the foreign operation in the form of –

a)   Branch in foreign currency: The transactions of foreign branch have to be incorporated in Head Office books as the financial statements are presented for whole enterprise including branches, domestic as well as foreign. The transactions of foreign branches are dominated /measured in the currency of the country in which the branch is situated, for example, if an Indian company X Ltd. Has a branch in New York. The branch must be transacting in US dollars where as X Ltd. Reports in rupee, therefore, an accounting standard is needed which will prescribe the method of translation of foreign currency in to reporting currency ( in this case , rupee).

b)   Subsidiary in foreign currency: If an enterprise domiciled in India has a subsidiary in foreign countries, and if as per applicable laws, Indian holding enterprises has to consolidate the account of foreign subsidiary, the need of accounting standard arises which will prescribe the procedure and principles for translation of subsidiary’s financial statement which are in foreign currency in to Indian Currency, as the reporting currency as the holding enterprise is Indian rupee.

c)   Associated or Joint Venture in foreign currency: The need of  Accounting standard will be felt when proportionate consolidation method under AS-27 [Financial Reporting of Interest in Joint Venture] is applied for jointly controlled entities and equity method of accounting is done in case of investment in associate in consolidated financial statements as per AS-23.

Accounting Standard -11 [AS-11]

AS-11 (revised 2003) shall be applicable in respect of accounting periods commencing on or after 01.04.2004 and is mandatory in nature. The revised 2003 AS supersedes AS-11 (1994). However, accounting for transactions in foreign currencies entered in to by the reporting enterprise itself or though its branches before 01.04.2004 will continue to be done as per AS-11(1994).

Applicability of AS-11

The accounting standard applies to –

1. a)   In accounting for transaction in foreign currencies
2. b)   In translating the financial statements of foreign operations – integral as well as non-integral.
3. c)   The accounting standard also prescribes the accounting for Forward Exchange Contract.

Non - Applicability of AS-11

The accounting standard is not applicable to –

1. a)   Re-statement of an enterprise’s financial statements from its reporting currency in to another currency for the convenience of users accustomed to that currency.
2. b)   The presentation in cash flow statement of Cash Flow arising from transactions in a foreign currency and the transactions of cash flow of foreign operations.
3. c)   Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest cost (refer AS-16)

Currencies

Currencies are legal means of payment in a country.

For each monetary amount that we enter in the SAP system, we must specify a currency. Currencies are entered as per ISO standards, for example, USD for US dollar, INR for Indian Rupee.

Few common terminologies associated with Currencies are as follows:

a)   Reporting currency– is the currency used in presentation of the financial statements.

b)   Foreign currency - is the currency other than the enterprise currency.

c)   Group Currency - A group currency is used in the consolidated financial statements. Before the consolidation process can be completed, all values in the  individual financial statements must be translated from the local or transaction currency into group currency

d)   Company currency: A currency used for internal trading partner

e)   Hard Currency: A country specific second currency used in countries with high rate of inflation.

f)    Index currency: A country specific theoretical currency used in some countries with high inflation as a comparison currency for purpose of statutory reporting.

In SAP, we define various currencies used by our company/company codes

Define Currency Codes (T code OY03)

SPRO-> SAP NetWeaver -> General Settings -> Currencies -> Check currency code

Other Terminologies:

g)   Exchange rate– is the ratio for exchange of two currencies as applicable to the realization of certain assets or the payment of specific liability and even recording of specific transactions or group of transactions.

h)   Average rate – is the mean of exchange rates in force during a period.

i)     Forward rate – is the exchange rate established by the terms of an agreement for exchange of two currencies at a specified future date.

j)    Closing rate – is the exchange rate at the balance sheet date.

k)   Monetary items - are money held and assets & liabilities to be received and paid in fixed or determinable amounts of money e.g. cash receivables and payables.

l)     Non monetary items – are assets and liabilities other than monetary items e.g. fixed assets, inventories, investment in equity shares.

m) Settlement date – is the date at which receivable is due to be collected or payable is due to be paid.

n)   Recoverable amount– is the amount which the enterprise expects to recover from the use of asset including its residual value on disposal.

What are foreign currency transactions?

Transactions denominated in a foreign currency or require settlement in a foreign currency are called foreign currency transactions.

Example of foreign currency transactions are –

1. Buying or selling of goods or services priced in foreign currency.
2. Acquisition or disposal of fixed assets denominated in foreign currency.
3. Incurs and settles liabilities denominated in foreign currencies.
4. Lending or borrowings when the amounts are denominated in foreign currency.
5. Unperformed forward exchange contract.

Exchange Rate(s) 

In SAP, we have to specify for each of the company codes, in which currency, the ledgers should be managed. This currency is the national currency/ local currency /company code currency/ operative currency of the ledger. From a company code view, all other currencies are then foreign currencies. In addition to the local currency, we can manage the ledger in two parallel currencies, for eg: group currency or hard currency.

In order for the system to translate amount in various currencies, we must define exchange rates. For each currency pair, we can define different exchange rates and then differentiate between them by using exchange rate types.

In Financial Accounting, currencies and currency translations are relevant in the following circumstances-

(a)  Account Master Data - Defining account currencies

(b)  Posting - Posting documents in foreign currency

(c)  Clearing - Clearing open items in foreign currency

(d) Foreign Currency Valuation

As we already defined in the previous section, Relationship between two currencies in known as Exchange Rate.

In other words, exchange rates are used to translate an amount in to another currency.

We define exchange rates in the system for the following purposes:

• Posting and Clearing

To translate amounts posted or cleared in foreign currency, or to check a manually entered exchange rate during posting or clearing.

• Exchange Rate Differences

     In order to determine gains or losses from exchange rate differences.

• Foreign Currency Valuation

To valuate open items in foreign currency and foreign currency balance sheet accounts as part of the closing operations.

Note: Exchange rates are defined at client level and therefore apply for all company codes.

To Maintain Exchange Rates (T Code OB08)

SPRO-> SAP NetWeaver -> General Settings -> Currencies -> Enter Exchange Rates

If you maintain the exchange rates on a daily basis, you should delete the exchange rates that you no longer required, so that there are not too many entries in the system.

We do not have to enter all exchange rates. There are many tools that can be utilized to automatically determine other exchange rates from existing ones.

Following tools are available-

a)   Inversion

b)   Reference Currency

c)   Exchange rate Spread

Exchange Rate Types (T Code OB07)

SPRO-> SAP NetWeaver -> General Settings -> Currencies -> Check Exchange Rate Types

Exchange rates for different purposes for the same date are defined in the system as exchange rate types.

If we need to carry out currency translations between a numbers of different currencies, we can simplify exchange rate maintenance by entering a base currency for the exchange rate type. Instead of entering translation rates between every single currency, we only need to specify the translation rate between each currency and the base currency. All currency translations then take place in two steps - into the base currency and from the base currency into the target currency.

Example

The base currency is INR. You want to translate GBP to USD. To do this, the following entries must be made in the table for maintaining currency translation rates:

• Ratio for GBP -> INR
• Ratio for USD -> INR

Translation from GBP to USD is then carried out automatically. The translation is done as though this exchange rate (GBP-> USD) was actually entered in the conversion table. 

The following exchange rate types exist:

• Buying rate
• Bank Selling rate
• Average rate
• Historical exchange rate
• Key date exchange rate

Define Translations ratio for currency translation (T Code OBBS)

The Currency Translation Ratio identifies the relationship of the units of one currency to the units of another. It is not possible to maintain exchange rate in the system without maintaining the translation ratio for the currency pair. It is essential to maintain these ratios for each exchange rate type & currency pair.

Configuration of Foreign Currency Revaluation in SAP

In this section, we define the specifications required for the valuation of foreign currency balances e.g. Bank accounts holding foreign exchange and Open Items in foreign currency – Customers and Vendors

Define Valuation methods

IMG à Financial Accounting à General ledger Accounting à Business Transactions à Periodic Processing  à Valuate à  Define Valuation methods

SAP uses exchange rate type M to value all foreign currency items. M is the average rate for any foreign currency.

In this step, you define your valuation methods for the open items. With the valuation method, you group specifications together which you need for the balance and individual valuation. Before every valuation run, you specify the required valuation method.

SAP provides various Valuation methods. We can also create our own key starting with Z.

SAP provides the following valuation methods:

BSK                  CZ/SK valuation method

EVR                  Always Valuate

KTO                  FC bal. per account, Lowest cost principle

Double click on BSK to display the configuration parameters

Val Method BSK is used for foreign currency account balances valuation for e.g. Bank account held in foreign currencies.

In the valuation procedure, various configuration options are available:

Lowest Value Principle – The Valuation is only displayed if the valuation difference between the local currency amount and the valued amount is negative that is an exchange loss is taken place. The valuation is carried out per item total.

Strict Lowest Value Principle – The valuation is only displayed if, as a consequence, the new valuation class has a greater devaluation and/or a greater revaluation at credit entries than the previous valuation. The valuation is calculated per item total.

Always Valuate – If you select this procedure, revaluations are also taken into consideration.

Revalue only – if you select this procedure, system only does a revaluation if applicable but does not do devaluation where there is exchange loss.

Reset- if you select this parameter, then the open items is valuated at the acquisition price. This way the valuation difference is set to zero. The old valuation method is reset. The account determination is reversed. The revenue that arises is posted to the expense account.

Exchange rates are types that are attached to the valuation methods.

Determine rate type from account balance- If you select this field, the account balance/group balance in the relevant foreign currency is used to determine the exchange rate type. This is relevant for account balance revaluation.

A document type SA is attached to Valuation method.

Configuration details – EVR (always valuate)

Configuration details – KTO

Assign GL accounts for Foreign Currency valuation (T code OBA1)

IMG >Financial Accounting > General Ledger Accounting >Business Transactions > Periodic Processing > Valuate > Foreign Currency Revaluation > Prepare Automatic postings for Foreign Currency valuation.

Double click on KDB line Item

Exchange Rate difference in foreign currency balances e.g. bank accounts held in foreign currency.

Exchange Rate Difference key: Can be kept blank or you can enter a key with 4 digits e.g. 0001. In case you create this exchange rate key then the same has to be updated in the GL code of the foreign currency account i.e. the control data tab which has the field exchange rate difference key. Only when it is attached, the system will re-valuate the foreign currency account.

Expense account: We need to enter the expense GL code for unrealized foreign exchange loss. The loss on revaluation is unrealized and will be automatically reversed in the next month e.g. 2345678  unrealized exchange gain/loss trade.

E/R gains: You need to enter the revenue GL coded for unrealized foreign exchange gain. The loss on revaluation is unrealized and will be automatically reversed in the next month.

Double Click on KDF

Here we will enter the GL codes for AR and AP (the reconciliation account).

We can enter different GL codes for currency and currency type or we can keep it blank.

12000092   Sundry Creditors for Expenses

84000001   Exchange Gain / loss others – Realized

84565882   Exchange Gain / loss others – Revaluation

12000023 Creditors Revaluation

Account Determination (OBYC)

There can be exchange rate difference on account of document posted through MM process, in such cases we need to maintain the exchange gain/loss account for KDM (Materials management exch.rate diffs) key using Transaction code – OBYC.

Exchange rate differences in the case of open items (KDM)

In the case of open items, Exchange rate differences arise when an invoice relating to a PO is posted with a different exchange rate to that of the goods receipt and the material cannot be debited or credited due to standard price control or stock under coverage/shortage.

Double click on KDM to display the configuration parameters:

Now system will post the arising Gain/loss automatically to the assigned GL account, for this purpose default cost centers are required to be maintained for the gain/loss accounts to which the posting will be done using transaction code – OKB9