Exchange rates fixed by a contract

Where a company contracts to settle a transaction at a particular rate of exchange, the exchange rate fixed by the contract must be used to record the transaction.
For Example: In 2005, Selvakan Ltd buys a computer system from a US manufacturer for $800,000. The contract specifies an advance payment of $50,000, a further $400,000 to be paid on delivery and the balance when the system has been successfully installed. All payments are to be made at an exchange rate of $1.55/£. The company acquires the computer system on 1 March 2005.

The company will record the purchase of the computer system at the contracted rate of $1.55/£ (i.e. at a cost of £516,130), regardless of the spot rate at 1 March. It will translate the payment of each installment of the purchase price at the same rate. Thus no exchange differences will arise. Even if some of the price remains unpaid at 31 December 2005, the liability will be translated at the contracted rate.

This treatment reflects the economic reality – the company is going to have to pay precisely £516,130 for the computer system, irrespective of how exchange rates move.