In this article we follow up on our previous report on foreign currency advances during the accounting period. We provide further insight into how accounting and subsequent reporting can help you transition to the new regime for recording advances made or received in foreign currency and how, once the new approach to foreign currency advances is in place, you can also achieve a higher level of compliance with International Financial Reporting Standards (IFRS) in your reporting.
The new approach to foreign currency advances is based on the division of receivables and debts into those whose settlement will require future cash flow (e.g. a deposit) and those whose settlement will be made in kind (e.g. by delivery of products, goods or services). For the former group of receivables and payables (with cash settlement), the obligation to translate such receivables and payables at the current exchange rate as of the balance sheet date continues to apply. The second group of receivables and payables (i.e. without future monetary settlement) are "exempted" from this obligation to translate at the current exchange rate and, therefore, these non-monetary items are not "translated" and are fixed at the exchange rate prevailing when they are settled. Such a procedure is in line with IFRS, and therefore its introduction into Czech accounting will bring an advantage to entities that either report themselves under IFRS or that prepare reporting packages for group reporting by foreign parent companies.
For practical application, it is generally recommended that advances received that will be settled in kind (i.e. by delivery of goods, merchandise or services) should be reported under the balance sheet item "Deferred income". Similarly, we recommend recognising advances paid as follows:
- to recognise the advance paid for inventories as part of the item advances made for inventories;
- to record advances paid for fixed assets (intangible and tangible) under advances made for tangible or intangible fixed assets; and
- to recognise the prepayments for services as part of the balance sheet item "Accrued expenses".
This method of reporting can be extremely helpful in implementing the new approach to foreign currency advances, particularly in view of the setup of most accounting software, which typically automatically translates balances in Group 31 and 32 accounts at the balance sheet rate, whereas balances in Group 38 accounts do not. Similarly, it is not common to automatically translate balances in account classes 0 and 1. Before making any changes to the accounting methodology, we recommend that you conduct a thorough analysis of the appropriateness of the changes and the impact of the changes on your company. We will be happy to help you with this analysis.
For the sake of completeness, we add that if completion of the agreed and backed-up delivery is unlikely (e.g. the supplier announces that it is unable to fulfil the order), then the statements should respond appropriately:
- recognise the advance received from the supplier as a liability and translate the item as of the balance sheet date at the balance sheet rate;
- recognise the advance payment made to the customer as a receivable and translate the item as of the balance sheet date at the balance sheet rate.
The reason for this recognition is the nature of such advances as monetary items that carry foreign exchange risk because they are expected to be settled in cash.
Illustration of settlement of an advance paid in a foreign currency
On 28 October 2021, our accounting entity ordered the manufacture of specific production tools from a foreign supplier for a total agreed price of EUR 10,000. The supplier requested a deposit of 20%, for which it issued an advance invoice on 28 October 2021. The tools were delivered to us on 14 February 2022 together with a proper invoice, which was paid on 4 March 2022. We use fixed monthly exchange rates in our accounting, which were set as follows: October 2021: CZK 25.495 / EUR; November 2021: CZK 25.695 / EUR; balance sheet rate 2021: CZK 24.860 / EUR; February 2021: CZK 24.365 / EUR, March 2021: CZK 24.995 / EUR.
|
Date |
Accounting operation |
Amount in EUR |
Exchange rate |
Amount in CZK |
MD |
DAL |
|
28.10 |
Advance invoice received |
2,000 |
25.495 |
50,990 |
xxx |
xxx |
|
5.11 |
Payment of advance invoice |
2,000 |
25.695 |
51,390 |
052 |
221 |
|
31.12 |
Closing operations |
2,000 |
24.860 |
49,720 |
xxx |
xxx |
|
14.2 |
Proper invoice received |
8,000 |
24.365 |
194,920 |
042 |
321 |
|
14.2 |
Acceptance of instruments and entry into service |
xxx |
xxx |
51,390 |
042 |
052 |
|
xxx |
xxx |
246,310 |
022 |
042 |
||
|
4.3 |
Payment of proper invoice with calculation of exchange rate difference |
8,000 |
24.995 |
199,960 |
321 |
221 |
|
|
|
5,040 |
563 |
321 |
This is the preferred solution, which results in the correct valuation of the acquired transaction in the accounts and the recognition of only the exchange differences that actually exist. In practice, however, situations arise where the supplier delivers a proper invoice with the full amount (EUR 10,000) less the advance payment (EUR 2,000). When processing such an invoice with the customer, some accounting software then takes this invoice in exactly this structure into its own records. In these cases, internal processes need to be set up in such a way as to achieve the above-mentioned result of correct valuation of the purchased asset (goods or service cost). For the sake of completeness, it should be noted that the procedure whereby the full amount is re-entered on the regular invoice / tax receipt for VAT purposes and the advance paid is deducted from it also complicates the correct determination of the VAT base.
Illustration of settlement of an advance received in a foreign currency
We will use an identical assignment but approach it from the perspective of a supplier of production tools. Also, for the supplier, this procedure leads to the correct determination of the amount of revenue and exchange gain or loss.
|
Date |
Accounting operation |
Amount in EUR |
Exchange rate |
Amount in CZK |
MD |
DAL |
|
28.10 |
Advance invoice issued |
2,000 |
25.495 |
50,990 |
xxx |
xxx |
|
5.11 |
Advance payment received |
2,000 |
25.695 |
51,390 |
221 |
384 |
|
31.12 |
Closing operations |
2,000 |
24.860 |
49,720 |
xxx |
xxx |
|
14.2 |
Proper invoice issued |
8,000 |
24.365 |
194,920 |
311 |
601 |
|
Recognition of deferred income |
xxx |
xxx |
51,390 |
384 |
601 |
|
|
Handover of products to the customer |
--- |
--- |
--- |
583 |
123 |
|
|
4.3 |
Payment of proper invoice with calculation of exchange rate difference |
8,000 |
24.995 |
199,960 |
221 |
311 |
|
|
|
5,040 |
311 |
663 |