exchange rate

Application of exchange rate

According to Croatian financial reporting standards, all accounts and reports are obliged to be reported using official Croatian currency (Kuna – HRK). If a company is conducting business using foreign currency, the foreign currency needs to be converted to national currency using the corresponding exchange rate. The exchange rate that must be applied is the medium exchange rate that is listed by the National Bank of Croatia.

International accounting standard which determines the accounting treatment of transactions in foreign currency is IAS 21 – The effects of changes in foreign exchange rates. To correctly apply the exchange rate, some accounting terms need to be defined for the exchange rate to be accepted according to law:

  • Foreign activities – including foreign business management and foreign currency transaction
  • Domestic and foreign currency – the entrepreneur has domestic currency for accounting business and currency that is not domestic for a company in Croatia
  • Positive and negative exchange rate differences – increase or decrease of foreign exchange rate comparing to Croatian Kuna
  • Monetary and non-monetary items.

During the initial recording of transaction denominated in foreign currency, it is necessary to convert foreign currency in Kuna (domestic currency) on the day when the company received goods or services. Afterward, it’s no longer required to record it in foreign currency. One of the examples is a transaction where a machine is purchased from a foreign country. After converting it, the value of a machine no longer needs to be denominated in foreign currency, therefore it’s not obliged to record it in both currencies.

However, there is a different example with monetary items and some non-monetary items for which according to Croatian financial reporting standards it is required to adjust the value in case of a change between exchange rates. If that kind of transactions weren’t presented in both currencies, eventually it wouldn’t come to any value adjustment.  Therefore, to correctly record the exchange rate differences, it must be taken into account whether the exchange rate differences occur with monetary or non-monetary items.

From an accounting perspective, the spot exchange rate is important because it represents the current exchange rate now when some transaction is executed. As a consequence, positive and negative exchange rate differences appear, and it has to be considered revenue or expense. These revenues or expenses are not subject to value-added tax

What needs to be emphasized in exchange rate fluctuations is a currency clause. Currency clause is a kind of a protection instrument for a business entity. Using them companies can hedge risk from the reduction of value of a domestic currency by depositing money in foreign currency.  The Law of mandatory relations determines that treatment.

When it comes to recording costs of exchange rates, the general directive about expenditure should be applied, since exchange rate fluctuations are not specifically explained in the Profit tax law. Therefore, according to the above-mentioned directive, outlays of a tax period that doesn’t correspond with activities of taxpayers are not considered as real outlays. (Profit tax law, at.5. pt.6.)

Finally, when a company identifies the exchange rate fluctuations, it has to be reported in profit and loss account.

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