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Exchange Rate Differences

In order to define the term ˝exchange rate differences˝, we first need to define the term ˝currency˝. Currency refers to a generally accepted medium of exchange of a certain country (kn, USD, EUR, GBP, CHF etc.). Value, i.e. value ratio of one currency in relation to another is calculated using the exchange rate. The exchange rate fluctuates, depending on supply and demand of foreign currency on the foreign exchange market, which results in daily exchange rate changes. Exchange rates are announced on exchange rate lists, which show the value of a foreign currency unit in relation to the national currency (eg. 100 EUR = 753 kn). By using exchange rate lists it’s possible to calculate relationships between certain foreign currencies (eg. 100 EUR = 82.66 GBP).

Exchange rate lists announce three kinds of exchange rates: buying rate, average rate and selling rate. In different financial transactions different exchange rates are used. Besides central national banks (in Croatia: Croatian National Bank), commercial banks announce their exchange rate lists as well. We’ll describe how banks use exchange rates in their operations in the following, very simple example: when selling foreign currency to their clients (foreign currency = receivables denominated in a currency other than the national currency), banks use the announced selling rate. So, if a client wants to buy 100 EUR from the bank, they’ll have to pay the counter value of 759 kn to the bank. Namely, this is how much the stated amount is, converted at the selling rate on the transaction date. If we assume that, just before the transaction described, another client sold the same 100.00 EUR to the bank, the bank paid him a counter value of 749.00 kn, which is how much 100.00 EUR is, converted at the bank’s buying rate (since the bank bought foreign currency from their client).

In summary, through these transactions the bank has collected (earned) 10.00 kuna based on the exchange rate difference.  

Exchange rate differences are also amounts that are a result of exchange rate changes (as the price of money) between two periods. For example, if we imported goods worth 1,000.00 EUR on a certain date, these goods (converted according to Croatian National Bank current average rate, which is most commonly used for recording foreign currency transactions in the books) were worth 7,590.00 Kn on the date of importation. Assuming that we sold the goods and collected money on the same day, we have ˝marketed˝ that exact amount. However, if a foreign supplier has approved the payment period of 20 days, and we have to ˝engage˝ 7,530.00 kn on the maturity date (which is how much 1,000.00 EUR on an import invoice on the maturity date is worth), we have earned 60.00 kn on a positive exchange rate difference. In the opposite case, when the invoice amount is worth more on the maturity date in kuna than the same amount in foreign currency on the day of importation, we have ˝lost˝ a certain amount in kuna, by achieving a negative exchange rate difference.

In other words, positive exchange rate differences represent company’s income, and negative exchange rate differences its expenditure.

Foreign Exchange Act prescribes that all receivables and payables toward abroad (or on commercial banks’ loans approved with the use of foreign currency clause) have to be converted to their counter value in kuna, according to Croatian National Bank’s average rate on the day balance is determined (eg. 31st December) and have to determine and enter positive or negative exchange rate differences according to all indicated items.

Published 13/01/2012

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