International Accounting Standard (IAS) 21, which is titled “The Effects of Changes in Foreign Exchange Rates,” prescribes rules for foreign currency valuation and foreign currency translation. It was issued by the International Accounting Standards Board (IASB). Foreign currency valuation is the recording of foreign currency transactions in functional currency. Foreign currency translation is the translation of a foreign operation into presentation currency. The SAP General Ledger functionality of SAP ERP Central Component (SAP ECC) 6.0 provides the capability to comply with the rules of IAS 21 with respect to foreign currency valuation and foreign currency translation in an organization following a dual reporting format.

A multinational organization may have to deal with foreign currencies in two different situations. One of the situations arises when that organization has to record transactions in a foreign currency. For example, A US-based, multinational company having US dollars as its functional currency also has to record transactions in a foreign currency, such as the Japanese yen. IAS 21 prescribes rules for recording such foreign currency transactions in the functional currency (i.e., foreign currency valuation).

The second situation arises when an organization has a subsidiary in a different country. That subsidiary has to translate and present its financial statements into a different presentation currency at the end of the financial year to include them in group financial statements. For example, a European subsidiary of a US-based, multinational company having the euro as its functional currency also has to present its financial statements in US dollars at the end of the financial year. IAS 21 also prescribes rules for translation of a foreign operation to a presentation currency.

For entities that have SAP ERP Central Component (SAP ECC) 6.0 as a system of record, its SAP General Ledger functionality provides the capability to comply with rules and provisions of IAS 21, prescribed for foreign currency valuation and foreign currency translation.

I explain the provisions of IAS 21 and show how to put them into effect in SAP ECC when an organization also follows a format of dual reporting with reports for both IFRS and US Generally Accepted Accounting Principles (GAAP).

Foreign Currency Valuation

As per IAS 21, all foreign currency transactions need to be recognized in the books by translating them in the functional currency. You apply the spot exchange rate between functional currency and the foreign currency on the date of the transaction.

At the end of each reporting period, you need to complete two steps:

1. Translate all monetary items using the exchange rate on the closing day of the reporting period.
2. Ensure that all nonmonetary items recorded at the historical costs in foreign currency are not revalued on the last day of the reporting period (they are retained at historical cost).

Exchange differences arise on the translation of monetary items at the end of each reporting period when the exchange rates used for revaluation are different from the rates used for translating them at the time of initial recognition. These exchange differences should be recognized in the statement of comprehensive income in the period during which such revaluation occurs.

Foreign Currency Translation

IAS 21 prescribes that when the functional currency of an entity is different from the presentation currency of the group, then at the end of each reporting period the entity is required to translate its financial statements (results and financial position) from the functional currency to the presentation currency. In other words, when a corporate group is composed of various individual entities with different functional currencies, then the financial statements of each of those entities must be translated into the common presentation currency to present the consolidated financial statements of the group as a whole. IAS 21 specifies that this translation into presentation currency should happen as follows:

1. Assets and liabilities must be translated using the exchange rate on the last day of the reporting period.
2. Income and expenditures must be translated using the exchange rate at the date of transaction.
3. All exchange differences must be disclosed in the financial statements as part of equity.

Key Settings in SAP ECC

Now I discuss some key settings that are required in SAP ECC 6.0 to execute both foreign currency valuation and foreign currency translation at the end of each reporting period.

Validate Local Currency and Group Currency Settings in a Legal Entity

Before proceeding with making the required settings specific to foreign currency valuation and foreign currency translation in the sections below, you must validate the settings for the local currency and the group currency in the legal entity in order to post valuation and translation as they should be.

Follow IMG menu path Financial Accounting (New) > Financial Accounting Global Settings (New) > Ledgers > Ledger > Define Currencies of Leading Ledger. Click the Position button. In the dialog box that appears select your company code from the list of options (Figure 1). Press Enter.

Figure 1

The list of company codes for which currencies are defined

In the next screen (Figure 2), you see the settings applicable for 1st local currency (company code currency) and 2nd local currency (defined as Group currency here by selecting currency type [Crcy type] 30).

Figure 2

Define settings for company code and group currencies for your company code

For 1st local currency, source currency (Srce curr.) is always selected as Transaction Currency by default. This default selection ensures posting of foreign exchange differences in company code or functional currency during Foreign Currency Valuation. However, for 2nd local currency, you need to select 2, making 1st local currency or functional currency the source for translation into group or presentation currency. This setting ensures posting of foreign exchange differences in group currency during Foreign Currency Translation.

Define Valuation Methods

First, define a valuation method to determine the method by which a foreign currency valuation is to be performed for an open item. You need to define a valuation method for foreign currency valuation, as well as for foreign currency translation. Follow IMG menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodical Processing > Valuate > Define Valuation Methods. Click the New Entries button (Figure 3).

Figure 3

The overview screen of valuation methods defined

In the Details screen (Figure 4), you define the key properties of a valuation  method(e.g., Valuation Procedure, Document Type, and Exchange Rate Determination). When you create valuation methods for foreign currency valuation and foreign currency translation, I suggest that you select the Always evaluate button in the valuation procedure. This enables the system to always revalue an open item, regardless of whether revaluation is positive or negative. In the case of both positive and negative valuation, exchange rate type M is normally used. Exchange rate type M indicates an exchange rate on the closing day of the period.

Figure 4

The Details screen of a valuation method

I also advise you to use different document types for foreign currency valuation and foreign currency translation methods, so you can track postings for each separately.

Define Valuation Areas

Valuation areas are used to perform different valuations independently and determine GL Accounts that will be posted for each type of valuation. To create valuation areas, follow IMG menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodical Processing > Valuate > Define Valuation Areas (Figure 5). For the purpose of complying with IAS 21, create a valuation area for each foreign currency valuation and foreign currency translation. Assign these valuations areas to the corresponding valuation methods created for foreign currency valuation and translation that I describe in the section titled “Define Valuation Methods.”

Figure 5

Define valuation areas and their properties

Assign company code currency in the currency type field for the valuation area created for foreign currency valuation, because this valuation area is to be used for valuating foreign currency transactions into functional currency (company code currency). You also assign Group currency in the Crcy type field to the valuation areas for foreign currency translation, because this valuation area is to be used for translating functional currency into presentation currency (group currency).

Check Assignment of Accounting Principles to Ledger Group

Next, you perform a validation step in which you confirm if each accounting principle has already been assigned to a ledger group for parallel or dual reporting in the SAP General Ledger. Follow IMG menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodical Processing > Valuate > Check assignment of Accounting Principle to Ledger Group (Figure 6). Validate if the accounting principles (IFRS and local GAAP) are assigned to appropriate ledgers as part of SAP General Ledger customization. (SAP General Ledger customization is outside the scope of this article.)

Figure 6

Assign accounting principles to ledger groups

Assign Valuation Areas and Accounting Principles

In this step, you assign both the valuation areas, created earlier for foreign currency valuation, and foreign currency translation to the same accounting principle created for IFRS reporting. This step is necessary because both the valuation areas are required to post valuation or translation as per the IFRS principle. Follow IMG menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodical Processing > Valuate > Assign Valuation Areas and Accounting Principles (Figure 7).

Figure 7

Assign an accounting principle to the valuation areas

In this step, you assign the IFRS principle to both the valuation areas created for posting foreign currency valuation and translation. This step is necessary because you intend to post valuation and translation, as per IFRS, in these two valuation areas to the parallel ledger created for IFRS reporting. In the previous step, you already assigned the IFRS principle to a parallel ledger.

Settings for Automatic Postings for Foreign Currency Valuation

The SAP system provides multiple procedures to recognize valuation differences based on various criteria. To go to these procedures provided by SAP, follow IMG menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodical Processing > Valuate > Foreign Currency Valuation > Prepare automatic postings for foreign currency valuation (Figure 8).

Figure 8

List of procedures to recognize exchange difference

The two procedures shown in the list in Figure 8 that are relevant for setting up automatic account determination for foreign currency valuation in an SAP system, as per the rules prescribed by IAS21, are:

• Exch. Rate Diff. using Exch. Rate Key – KDB (transaction key)
• Exchange Rate Dif.: Open Items/GL Acct – KDF (transaction key)

I discuss these two procedures while explaining account determination for monetary items not managed on an open item basis and managed on open item basis. As I mentioned earlier, at the end of each reporting period, only monetary items are valuated using the exchange rate on the closing day of the period. Now, these monetary items are classified in the SAP system as:

• Monetary items that are non-open-item managed (e.g., foreign currency bank accounts)
• Monetary items that are open-item managed (e.g., accounts receivable and accounts payable reconciliation, accounts that undergo clearing process periodically)

For monetary items that are non-open-item managed, use the procedure Exch. Rate Diff. using Exch. Rate Key. After you double-click the name of this procedure (Figure 8), a dialog box asks you to enter the Chart of Accounts (Figure 9). Enter the chart of accounts and click the green arrow.

Figure 9

Enter the chart of accounts

In the next screen that appears, define the exchange rate difference key (up to four alphanumeric characters). Assign to this key the expense and gain accounts to post foreign currency loss and gain, respectively, which occur during foreign currency valuation (Figure 10).

Figure 10

Define the exchange rate difference key and assign the exchange difference expense or gain accounts

After completing the settings, enter the exchange rate difference key, defined above, in the GL masters of the non-open-item managed accounts to which foreign currency transactions are posted and that you want to valuate. To update the GL master record follow the SAP Easy Access path Accounting > Financial Accounting > General Ledger > Master Records > GL Accounts > Individual Processing > Centrally > Enter the GL Account Number and the Company Code. In the next screen, enter this key in the field named “Exchange rate difference key” under the Control Data tab (Figure 11).

Figure 11

Assign the exchange rate difference key in the GL master

For monetary items that are open-item managed, use the procedure Exchange Rate Dif.: Open Items/GL Acct. After you double-click the name of this procedure (Figure 8), you are asked to enter the Chart of Accounts. Enter the Chart of Accounts and click the green arrow. On the next screen, click the New Entries button (Figure 12).

Figure 12

A list of open-item-managed accounts for which exchange difference account determination is maintained

At the header level on the next screen (Figure 13), enter the GL Account that needs to be valuated, the currency in which the account is maintained, and the currency type (e.g., 10 for company code currency). Assign the exchange difference expense and gain accounts.

Figure 13

Maintain the exchange difference account determination for an open-item managed account

Settings for Automatic Postings for Foreign Currency Translation

In this setting, the SAP General Ledger allows you to set up automatic account determination for the posting of exchange differences that arise when financial statements in functional currency are translated into a presentation currency or a group currency. It is important to note that for carrying out Foreign Currency Translation, the Financial Statement Version is used. This is because translation to presentation currency takes place at the level of financial statement items that are assigned to a Financial Statement Version. Each financial statement item within a financial statement version represents a group of GL accounts of similar nature. Hence, when translation happens at the level of a financial statement item, all GL accounts attached to it are translated in a similar fashion.

Follow IMG menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodical Processing > Valuate > Foreign Currency Valuation > Define Account Determination for Currency Translation. In the dialog box to determine the work area, enter the Chart of Accounts that contains the GL accounts for which balances are to be translated. The valuation area (e.g., V2) enables you to perform translation independently in accordance with IFRS. This valuation area also enables you to determine GL accounts that are posted for exchange differences for foreign currency translation. (I explained the definition of valuation areas earlier. Refer back to Figure 5.) The Financial Statement Version (e.g., INTC) also determines the financial statement items and its GL accounts for translation.

After entering the required information in the fields shown in Figure 14, click the green arrow.

Figure 14

The selection screen for foreign currency translation

In the next screen click the New Entries button. (I have not included this screen in the article.) Now the Overview of Added Entries screen appears (Figure 15). Click the items listed under the FS Item (financial statement item) column. In the dialog box that appears enter the financial statement items for the financial statement versions in the chart of accounts hierarchy. These items indicate group accounts to be revaluated in a similar manner (e.g., assets or liabilities).

Figure 15

Define account determination for currency translation

For each of the items under the financial statement version (i.e., a group of the same class of accounts, such as assets, liabilities, expenses, or incomes), you need to maintain the exchange rate type, balance sheet adjustment account, and exchange rate loss or gain accounts. The balance sheet adjustment account is a balance sheet account to which the revaluation amount in group currency is posted on translation. Similarly, the loss or gain in group currency on translation is posted to valuation loss or gain accounts that are profit and loss (P&L) accounts.

Note that for balance sheet accounts, the period close spot exchange rate is considered for translation (in this case, it’s represented by C for assets and liabilities accounts, as shown in Figure 15). However, for P&L accounts (i.e., expenses and incomes), the period average rate is used (represented by M for revenue and expenses, as shown in Figure 15).

Execution of Foreign Currency Valuation at the Period End

At the end of each reporting period, all monetary items need to be revaluated at the exchange rate, as on the last day of the reporting period. In the SAP General Ledger, the transaction for foreign currency valuation is FAGL_FC_VAL. Follow menu path Accounting > Financial Accounting > General Ledger > Periodic Processing > Closing > Valuate > Foreign Currency Valuation (New).

In the Foreign Currency Valuation screen, populate the fields for Company Code, Valuation Key Date (which, as per IAS 21, is the last day of the reporting period), and the Valuation Area. The valuation area is the area in which the revaluation is to be posted. (For foreign currency valuation, you had defined V1 as the valuation area to be posted). You also need to select, in each of the relevant tabs highlighted in Figure 16, customer/vendor accounts, Open Item Managed GL Accounts, and GL Accounts maintained in foreign currencies.

Figure 16

The selection screen for foreign currency valuation

Execute transaction FAGL_FC_VAL. The next screen (Figure 17) displays the GL Accounts considered for valuation, along with the calculated amount of revaluation in local or functional currency in the last column named New difference.

Figure 17

The results of foreign currency valuation

If you click the Postings button on the menu bar on top of the screen, you see what postings have taken place, including the reversal entry to be posted on the first day of the next period (Figure 18).

Figure 18

Postings generated for foreign currency valuation

An Example of Foreign Currency Valuation

Here is an example to see how the valuation takes place and, also, the calculations behind it. Let’s assume the 1st local currency of a legal entity (company code) is USD (US dollar). The 2nd local currency of that legal entity is defined as a group currency and is EUR (euro).

As part of account determination configuration, the following is maintained to record exchange difference or valuation:

• Unrealized forex gain/loss account (P&L)
• Valuation adjustment account (B/S)

On Jan 1, the legal entity posts a customer invoice in GBP (British pound sterling) (foreign currency) using transaction FB70. Here are the exchange rates at the time of the invoice posting: 

1 GBP = 1.6 USD

1 USD = 1.25 EUR

Post the invoice as follows:

Receivable……Dr…….50 GBP (FC)…..80 USD (1st LC, i.e., functional currency)….100 EUR (2nd LC, i.e., Group Currency)

Sales…………Cr…….50- GBP (FC)…..80- USD (1^st LC, i.e., functional currency)….100- EUR (2nd LC, i.e., Group Currency)

On Jan 31 (i.e., the period end), foreign currency valuation is executed. Here are the exchange rates at the period close:

1 GBP = 1.8 USD

1 USD = 1.3 EUR

At this time, when currency valuation is run, only the foreign currency (GBP) is revaluated into local/functional currency (USD). So, the revised amount in USD will be 90 USD (50 GBP * 1.8). Hence, the difference 10 USD will be posted to the B/S adjustment account, and the gain of 10 USD is booked into the P&L account.

Post the valuation entry as follows:

Valuation Adjustment Account (B/S)……Dr…….0 GBP (FC)…..10 USD (1^st LC)….13 EUR (2nd LC, i.e., Group Currency)

Unrealized Forex Gain/Loss Account (P&L)…………Cr…….0- GBP (FC)…..10- USD (1st LC)….13- EUR (2nd LC, i.e., Group Currency)

Execution of Foreign Currency Translation at the Period End

At the end of each reporting period and after you execute the foreign currency valuation, you need to convert all balances in functional currency into the presentation or group currency. In the SAP General Ledger, the transaction for foreign currency valuation is FAGL_FC_TRANS.

Follow SAP menu path Accounting > Financial Accounting > General Ledger > Periodic Processing > Closing > Valuate > Currency Translation of Balances.

In the selection screen for Currency Translation (Figure 19), enter the company code for which translation needs to be carried out. If you need to translate specific GL accounts, specify those in the GL account field; otherwise, leave this field blank to include all GL accounts. Also, SAP recommends selecting Val. Period balance only, so that only the balances for the period under consideration for translation are selected and not the cumulative balances. Enter the key date for translation, which is normally the period end date. The valuation area defined for posting translation adjustments needs to be selected here. (In this case, V2 was defined as a valuation area for posting translation, as shown in Figure 5.)

Figure 19

Selection screen for Foreign Currency Translation

You also need to check the check boxes Generate Postings and Reverse Postings, so that adjustments are posted in the IFRS ledger on the last day of the period and then are reversed on the first day of the next period. In the settings described earlier (Figures 6 and 7), the IFRS ledger group was assigned to the valuation areas for Revaluation and Translation through accounting principle IFRS.

Execute transaction FAGL_FC_TRANS. You see the results in the next screen (Figure 20).

Figure 20

Result of foreign currency translation

As shown in Figure 20, the GL accounts considered for translation (in this case, I selected one GL account as an example) are displayed. The calculated amount of translation in presentation or group currency is displayed in the New difference column.

If you click the Postings button on the menu bar on top of Figure 20, you see what postings have taken place, including the reversal entry to be posted on the first day of the next period (Figure 21).

Figure 21

Postings generated for foreign currency translation

Foreign Currency Translation: An Example

Continuing with the example in the last section on foreign currency valuation, it’s now time to execute the foreign currency translation on the same period end date (January 31), after the Foreign Currency Valuation is already run.

As part of translation on January 31, the total balance in local or functional currency is translated into the second local or group currency. That is, the 90 USD (80 + 10) is revaluated by applying the exchange rate of 1.3, amounting to 117 EUR (90 USD * 1.3).

Out of 117 EUR, 100 EUR was already posted in the receivable A/C on the transaction date (January 1). Refer to the example in the valuation section. Also, at the time of foreign currency valuation on January 31 and just before executing translation, 13 euros were posted on account of revaluation of 10 USD (revaluation amount in functional currency). Hence, the posting in group currency now takes place for the balance amount of 4 euros (i.e., 117 – 100 – 13).

Post the translation entry as follows:

Valuation Adjustment Account (B/S)……Dr…….0 GBP (FC)…..0 USD (1^st LC)….4 EUR (2^nd LC, i.e., Group Currency)

Unrealized Gain/Loss Account (P&L)…………Cr…….0- GBP (FC)…..0- USD (1^st LC)….4- EUR (2^nd LC, i.e., Group Currency).