Exchange differences on foreign currency advances

An advance in a foreign currency, in most cases, represents a sum of money paid to suppliers or money received from customers. The issuance of the proforma invoice – as a request for its payment – should not be accounted for until it is paid. It is accounted for only after the money has been either credited or debited from the bank account or after a movement at the cash register.

The fact that the foreign currency advance will most likely not be refunded is very important while deciding whether or not to perform an exchange rate conversion whereas a proper performance from both parties is expected. There is no cash flow expected from provided advances – the advance payment from the bank account or the cash register has been made and the return is usually not expected, therefore the exchange rate risk is not taken into account in this situation. On the other hand, a receivable as an expectation of payment and future cash flows in a foreign currency, is converted. In case the advance becomes receivable, the cash income is expected, and a foreign currency receivable is also associated with exchange rate risk. Therefore, its balance should be recalculated according to the current exchange rate.

The ambition of the Czech National Accounting Council is to eliminate partial inconsistencies in the law as well as regulations related to the law by issuing its own interpretations. Interpretation I-43 was issued in October 2020 and aims to establish a sufficient accounting treatment for the showing of advances provided in a foreign currency in the financial statements.

The interpretation distinguishes whether the provided advance is part of the total acquisition price of the property (service) or if it is receivable.

Provided advance is part of the total acquisition price of the property or service

If delivery of the subjected item of the contract is expected, in accounting, the advance provided is the result of payment of the acquisition price of the property or service before their actual delivery. It basically represents a separate part of the total acquisition price of the purchased property or service and is accounted for as follows:

• The balance of the provided advance is converted into CZK as of the date of provision of funds, at the balance sheet date it is no longer converted, and therefore no exchange rate difference arises.
• The advance provided is reported in the balance sheet according to the nature of the acquired assets within fixed assets or inventories. When acquiring the service it is reported as deferred costs.
• At the time of delivery of the property or service, the amount of the advance provided is not converted according to the current exchange rate.
• In case more than one advance payment is made before the asset or service is delivered, each advance payment is converted with the historical exchange rate (at the date the cash is provided).

For those advances provided which are not expected to be recovered and at which the exchange differences from the conversion is reported, according to the rationale of the Interpretation, “this can be considered as a procedure that is in conflict with reflecting a true and fair view of the financial position of the entity in the financial statements”. 

Provided advance is a foreign currency receivable

If there is a probability that property or service will not be delivered and therefore a refund is expected, the advance provided is a foreign currency receivable and the procedure is as follows:

• The balance of the advance provided is converted with the exchange rate at the balance sheet date and the exchange rate difference is accounted for to the financial costs and revenues.
• The advance provided is reported in the balance sheet as part of receivables.

In conclusion, it can be stated that the perception of provided advances in the context of the future income and the associated showing and converting of those advances lead us to true and fair views of the company’s financial situation when preparing financial statements.  

If necessary, do not hesitate to contact us, we will be happy to help you regarding this matter.