Definition
An exchange rate in accounting is the ratio used to convert an amount in a foreign currency into the base currency on a given date. IAS 21 requires the spot rate at the transaction date for initial recording, the closing rate for monetary balances at each reporting date, and allows an average rate when it approximates actual rates.
How it works
Three rates matter. The spot rate on the transaction date records the invoice, receipt or payment. The closing rate at the end of the period retranslates monetary items such as foreign-currency bank balances, receivables, payables and loans. An average rate for a month or quarter can be used for many small transactions or for translating a foreign subsidiary's income statement, if rates did not swing widely.
Non-monetary items carried at historical cost, such as inventory, prepaid expenses or equipment bought abroad, stay at the rate on the date they were acquired. Retranslating them is a common error.
Decide on one rate source, for example the central bank's published rate, and apply it consistently. Ledgeriano stores the rate on each entry, so a report rerun next year still uses the rate that applied when the entry was posted.
Formula
Base amount = Foreign amount × Rate (base per 1 foreign unit)
Base amount = Foreign amount ÷ Rate (foreign per 1 base unit)
Example: recording and retranslating a receivable
A GBP-based company invoices a customer 10,000 EUR on 15 November when 1 EUR = 0.86 GBP, so it records a receivable of 8,600 GBP.
At 31 December the invoice is still unpaid and the closing rate is 0.88 GBP. The receivable is retranslated to 8,800 GBP and the 200 GBP difference is recognised as a foreign exchange gain.