for Accounting Professionals
IAS 21 The effects of changes in foreign exchange rates
2011
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Robin Joyce
Professor of the Chair of
International Banking and Finance
Financial University
under the Government of the Russian Federation
Visiting Professor of the Siberian Academy of Finance and Banking
Moscow, Russia
2011 Updated
IAS 21 The effects of changes in foreign
exchange rates
Contents
1. Consolidation Introduction
3
2. Definitions
4
3. IAS 21 for Banks
5
4. Foreign Currency Transactions in the Normal Course of
Business
6
5. Initial Recognition of a Transaction
7
6. Reporting at Balance Sheet Dates
8
7. Financial Statements of Foreign Operations
9
1. Consolidation Introduction
Aim
The aim of this workbook is to assist the individual in understanding
consolidation methodology for IFRS and the role of foreign currency
both in consolidated statements and single-undertaking financial
statements. It also covers foreign currency transactions arising from
trade.
Consolidation Approach
Before commencing a consolidation, the accountant should have the
full financial statements of the parent and subsidiaries produced as
of the same date, and having used the same accounting policies.
Where possible, all subsidiary year-ends must be the same as the
parent undertaking. Under IAS 27, the maximum permitted
difference is 3 months.
8. Disposal of a Foreign Operation
16
9. Disclosure Requirements
18
Adjustment should be made for any significant differences created
by any subsidiary having a different accounting date.
10. Annex – Examples -Foreign operations with noncoterminous year ends
18
The length of reporting periods and any difference in the reporting
dates should be consistent from period to period.
11. Multiple Choice Questions
20
12. Exercise Questions
23
13. Solutions
26
14. IFRS Framework
28
Transactions between group undertakings should be listed, and
balances between group undertakings should be agreed and listed.
Where an undertaking has been purchased, the financial statements
at the time of acquisition should be on hand. Similarly, where an
Note: Material from the following PricewaterhouseCoopers publications has been
used in this workbook:
Applying IFRS , IFRS News, Accounting Solutions
undertaking has been sold, the financial statements on the date of
sale should be available.
Spreadsheets are ideal for producing consolidated balance sheets
and income statements, although bespoke consolidated software is
Group, or business combination
Two or more companies where one company controls the other(s).
available.
Dissimilar business activities must be consolidated, if they controlled
by the parent undertaking.
OTHER COMPREHENSIVE INCOME
Control
Control is the power to govern the financial and operating policies of
an undertaking to obtain benefits.
IAS 1 introduced Other Comprehensive Income as a financial
statement.
All movements into and out of revaluation reserves and foreign
currency translations (both in Equity) are recorded here.
Indications of control are:

If a gain, or loss, is reported in profit and loss, any related
exchange gain, or loss, will also be reported in profit and loss.
If a gain, or loss, is reported in Other Comprehensive Income,
any related exchange gain, or loss, will also be reported in
Other Comprehensive Income.
2. Definitions
Undertaking
An undertaking is any business, either incorporated or
unincorporated.
Parent
A parent is an undertaking that controls another undertaking.
Subsidiary
A subsidiary is an undertaking that is controlled by another.

Ownership of more than 50% of the voting rights.
Effective control over more than 50% of the voting rights. For
example, a husband owns 30% and a wife owns 40%.
As they are connected parties, they can exercise control over
the subsidiary.
Controlling the composition of the board of directors
Fair value
Fair value is the price that would be received to sell an
asset, or paid to transfer a liability, in an orderly
transaction between market participants at the
measurement date. (IFRS 13)
Monetary items
Monetary items are money held, assets receivable, and liabilities
payable, in cash.
Associate
An undertaking in which the parent has significant influence, but is
neither its subsidiary, nor part of a joint venture of the parent.
Indications of significant influence are:

Ownership of 20-50% of the voting shares

Representation on the Board of Directors
Joint Venture
A joint venture is an undertaking subject to the joint control of two or
more enterprises. The joint control is governed by a contract
between the parties.
Foreign Operation
A foreign operation is a branch, associate, joint venture or
subsidiary, where the activities are conducted in a different country
to that of the parent undertaking.
Presentation Currency
The presentation currency is that used in the parent’s and in the
consolidated financial statements.
FUNCTIONAL CURRENCY
The functional currency is the currency of the primary economic
environment in which the undertaking operates.
Foreign Currency
Foreign currency is any currency other than the functional currency.
Exchange Difference
Exchange difference is the difference calculated from reporting the
same number of units of a foreign currency at different exchange
rates.
Closing Rate
The closing rate is the spot exchange rate at the balance sheet date.
Net Investment in a Foreign Undertaking
The net investment in a foreign operation is the parent’s share of the
net assets of the undertaking.
Spot exchange rate
The Spot exchange rate is the exchange rate for immediate delivery.
3. IAS 21 for Banks
The majority of bank transactions in foreign currency relate to
financial instruments. These are revalued daily in most countries,
using the rates provided by the Central Bank, with revaluation
differences going to the income statement.
This treatment is the same under IFRS (with the exception of
available-for-sale financial instruments, where the revaluation
difference will go to equity until they are sold).
Dealing in foreign currencies involves another layer of risk for Banks
(Barings Bank in the UK was bankrupted by speculating on the
Japanese Yen), but also for bank clients, who often are unable (or
unwilling) to fully manage their foreign currency risk.
IFRS 7 requires banks to detail exposure and the management of
their foreign exchange risk in financial statements.
IFRS 9 applies to many foreign currency derivatives and,
accordingly, these are excluded from the scope of IAS 21.
However, those foreign currency derivatives that are not within
the scope of IFRS 9 (for example) some foreign currency
derivatives that are embedded in other contracts) are within the
scope of IAS 21.
In addition, IAS 21 applies when an entity translates amounts
relating to derivatives from its functional currency to its
presentation currency.
4. Foreign Currency Transactions in the Normal Course of
Business
Transactions and Investments in Foreign Currencies
Transactions and investments in foreign currencies increase
business risk due to the currency fluctuations against the national
currency.
Holding any assets, or liabilities, denominated in foreign currency
entails a currency risk. There is a risk that you will make a profit or
loss, if the exchange rate changes when settlement is made.
Techniques such as hedging, forward contracts and options may be
employed to reduce risk.
International business necessitates many firms trading in foreign
currencies. The time between quoting a price fixed in a foreign
currency, and finally receiving the funds should be minimised to limit
risk.
Example:
You quote a price of $1000 for an item. Based on today’s exchange
rate, you will make a profit of 25%. However, the Rouble strengthens
against the $ by 10% per month, eliminating your profit before you
receive the cash in month 5:
Roubles
Exchange Roubles Roubles Profit
Month
Action
$
Rate Revenue Cost
/Loss
1 Quote
1000 30,00
30000 22500 7500
2 Receive Order 1000 27,00
27000 22500 4500
3 Production
1000 24,30
24300 22500 1800
4
Delivery
1000
21,87
21870
22500
5
Payment
1000
19,68
19680
22500
-630
-2820
While this illustration is extreme, the risk is always present.
Investments, such as a foreign branch or subsidiary, increase the
time that the parent is at risk to currency fluctuations.
The foreign operation may trade profitably, but the investment may
be adversely hit by a fall in the foreign currency against that of the
parent.
Commission costs, incurred in buying or selling foreign currencies,
reduce profits. Exchange controls may inhibit the parent from
repatriating funds to reduce risk.
A firm needs to know its foreign exchange exposure, from
transactions and investments. It needs to develop and refine a
strategy to handle fluctuations in each currency to which it is
exposed.
When a gain, or loss, on exchange is realised by settling a foreign
currency item, nothing more can be done, except to update the
books of account.
On 1st January, you sell $100 of services to a foreign customer on
credit. The exchange rate is $1=30 Roubles.
In the Russian books of account, you:
Only a review of the unrealised gains and losses provides
opportunities for performance improvement.
5. Initial Recognition of a Transaction
If a company transacts business, or holds assets or liabilities in a
foreign currency, the transaction should be accounted for at the
exchange rate on the day of the transaction. The rate that should be
used is the mid-market rate ‘spot’ rate on the day the transaction
takes place.
An average rate may be used for a week, or a month, for all
transactions in each foreign currency, if there is no material
fluctuation in the exchange rates.
The date of the transaction is the date when the transaction is
contracted, or recognised, rather than the date of receiving (or
paying) cash. If the receipt of cash is earlier, a payment in advance
is registered. If later, an account receivable, or payable, would be
recognised at the spot rate.
Example:
Debit Accounts Receivable
3000
Credit Sales
3000
The cash is received in $ on February 1st when the exchange rate is
$1 = 25 Roubles. The Rouble is stronger and the dollar weaker
compared to the rate on January 1st.
In the Russian books of account, you:
Debit Cash
2500
Debit Exchange Loss
Credit Accounts Receivable
500
3000
In this case, less Roubles (500) are received than would have been
the case had the $100 been received on 1st January.
If the dollar had strengthened against the Rouble, by February 1st,
more Roubles would have been received in exchange for the $100.
For example if the rate had been $1=40 Roubles, this would have
created an exchange gain of 1000 Roubles.
Gain or Loss?
If you keep your books in Roubles, but trade is denominated in $,
movements in the $ against the Rouble will have the following
results from your $ denominated assets and liabilities:
$ Assets
$ Liabilities
$ Rises $ Falls
Gain
Loss
Loss
Gain
6. Reporting at Balance Sheet Dates
Monetary items (money held, assets receivable, and liabilities
payable, in cash or cash equivalents) will be reported at the closing
rate (mid-market rate on the balance sheet date).
Non-monetary items (such as property, plant and equipment)
should be reported at the exchange rate of the transaction.
This will either be the exchange rate of historic cost, or the valuation
date, where fair values are used.
Example:
Equipment was bought from abroad on Jan 1st, but had not been
paid for by March 31st, when the period ended.
The exchange rates were:
January 1st
March 31st
$1=30 Roubles.
$1=24 Roubles.
The cost of the equipment was $2000, and depreciation for the
period was 5% of cost.
In the Russian books of account, the following balances would
appear:
Equipment cost
Depreciation
Net book value
Accounts payable
Exchange gain
Notes:
Cost = 2000*30= 60000
Depreciation= 5% (60000)= 3000
Accounts Payable= 2000*24= 48000
Exchange Gain= 2000* (30-24)= 12000
The $ fall against the Rouble gives a benefit when settling the
accounts payable. Had the $ risen, the $2000 would have cost more
Roubles, generating an exchange loss in the period.
Accounting Treatment of Exchange Differences
Exchange differences on monetary items should be recognised in
the period’s income statement, even if the difference has not been
realised (by settlement) by the balance sheet date. If it has not been
settled, then further exchange differences may occur in later periods.
An exception to this is where a monetary item forms part of the
parent’s net investment in a foreign operation (such as an inter
company loan) the exchange difference should be recorded in
equity, until the disposal of the net investment. Upon disposal, it will
be recorded as a gain, or loss, in the income statement.
Example:
A holding company sets up a subsidiary abroad with net assets of $1
million.
You structure this subsidiary with $1000 of share capital and
$999.000 of inter company
60000 loan.
3000
The inter company57000
loan should be considered as part of the net
investment in the subsidiary
48000
(referred to as quasi-capital) and any
exchange differences relating to it will be recorded in changes to the
value of equity.
12000 (re accounts payable)
7. Financial Statements of Foreign Operations
If the exchange rate when the company was set up was $1=30
Roubles and at the balance sheet date was $1=32 the value of the
loan has altered by
[999,000 x (32-30)=19,980].
The 19,980 exchange gain should be added to the equity of the
holding company.
The undertaking that has a monetary item receivable from or
payable to a foreign operation may be any subsidiary of the group.
For example, an undertaking has two subsidiaries, A and B.
Subsidiary B is a foreign operation.
Subsidiary A grants a loan to Subsidiary B. Subsidiary A's loan
receivable from Subsidiary B would be part of the undertaking's net
investment in Subsidiary B if settlement of the loan is neither
planned, nor likely to occur in the foreseeable future. This would also
be true if Subsidiary A were itself a foreign operation.
Non-monetary items that are measured at fair value
Non-monetary items that are measured at fair value in a foreign
currency shall be translated using the exchange rates at the date
when the fair value was determined.
This group is rare for most undertakings. If a property has been
revalued in US$ and the functional currency of the undertaking is
Roubles, the valuation is translated at the spot rate of the date on
which it was valued.
When it is revalued again in US$, then the revaluation is translated
at the spot rate of the new valuation.
Presentation Currency
The presentation currency of a group is the currency of the IFRS
statements, and may be dictated by the nation in which the firm is
located, or the financial market in which its securities are sold.
Consolidation of foreign operations uses the rules of presentation
currency.
IFRS statements may be produced under more than one
presentation currency to meet demands of readers. For banks,
providing statements in different currencies may be of interest to
(international) correspondent banks.
Functional Currency
Underlying the presentation currency is the functional currency.
There is only one functional currency for each company.
This reflects the currency of the operations, rather than that of the
users of the accounts.
The functional currency is central to reporting under IFRS. The
results of all operations will be translated into the functional
currency.
The results will then be translated into the presentation currency.
Whilst the parent firm’s national currency will be the appropriate
reporting choice in most cases, many firms operate in a commercial
world dominated by other currencies.
Most companies in Russia will have Russian Roubles as their
functional currency, as most of their transactions are made in
Roubles.
The functional currency reflects the underlying transactions, events
and conditions that are relevant to it.
Accordingly, once determined, the functional currency is not
changed unless there is a change in those underlying transactions,
events and conditions.
Those firms in the oil industry, regardless of the country in which
they operate, are dominated by transactions in US$. To prepare
accounts in currencies other than US$ would lead to major changes
in results due to exchange movements between the US$ and their
home currencies.
Determining The Functional Currency
The primary economic environment in which an undertaking
operates is normally the one in which it generates cash.
The functional currency is that which mainly influences sales prices
for goods and services, and of the country which influences costs of
labour and materials.
The following additional factors are considered in determining the
functional currency of a foreign operation, and whether its functional
currency is the same as that of the reporting undertaking (the
reporting undertaking, being the owner of the foreign operation as its
subsidiary, branch, associate or joint venture):
 whether the activities of the foreign operation are carried out
as an extension of the reporting undertaking, rather than
being carried out with a significant degree of autonomy.
 whether transactions with the reporting undertaking are a
high, or low, proportion of the foreign operation’s activities.
 whether cash flows from the activities of the foreign operation
directly affect the cash flows of the reporting undertaking, and
are readily available for remittance to it.
 whether cash flows from the activities of the foreign operation
are sufficient to service debt obligations, without funds being
made available by the reporting undertaking.
When the above indicators are mixed and the functional currency is
not obvious, management uses its judgment to determine the
functional currency that most faithfully represents the economic
effects of the underlying transactions, events and conditions.
Each firm determines its functional currency for itself. The same
functional currency will apply to all group members on consolidation.
Other factors that may influence the determination of the functional
All foreign currency items will be translated into the functional
currency are:
currency.


The currency in which funds from financing activities are
generated (debt and equity instruments).
The currency in which receipts from operating activities are
usually kept.
Example: Functional currency determination
Undertaking C operates an information distribution website dealing
in current affairs, weather and other news. The website is written in
Mandarin, and it is estimated that 95% of users who access the
website reside in China. The undertaking generates revenue through
the placement of advertisement ‘banners’on the website’.
The customers who place banners on the website are all
multinational companies.
The servers are located in Jersey for tax purposes.
The costs of maintaining the website are paid to employees in China
in dollars. The customers are invoiced in dollars.
The undertaking’s funding is held in various currencies, including
euros, dollars and sterling. Revenues and costs are denominated in
dollars, as it is a more stable and liquid currency than the Chinese
yuan.
What is the functional currency of the undertaking?
The functional currency of the undertaking is the Chinese yuan.
An undertaking’s functional currency is the currency of the primary
economic environment in which the undertaking operates.
An undertaking’s functional currency will therefore be driven
primarily by the environment that determines the selling price of its
services and the costs that it needs to incur to provide those
services.
The customers that utilise the website reside mainly in China, so the
price at which the undertaking can sell its advertising services will be
driven by the Chinese, not the US, economy.
Although the undertaking pays its costs in dollars, the remuneration
that employees will demand will be driven by the Chinese, and not
the US, economy. The fact that items are denominated in dollars is
not relevant in this case.
An undertaking's functional currency reflects the underlying
transactions, events and conditions that are relevant to it.
Accordingly, once determined, the functional currency is not
changed unless there is a change in those underlying transactions,
events and conditions.
Example: Change of functional currency
Undertaking C is a UK company which is applying IAS 21 for the first
time in its financial statements for the year ending 31 December
20X6.
Undertaking C previously prepared its undertaking financial
statements in US dollars.
However, on applying the criteria in IAS 21, the functional currency
is considered to be pound sterling. There are no other changes in
circumstances that would lead to a change in functional currency.
Can C account for the change in functional currency prospectively
from the date of change?
No, this is allowed if there is a change in functional currency due to a
change in the underlying transactions, events and conditions.
In this case there has not been a change in circumstance, so the
above rules are not applicable.
Instead, IAS 21 must be applied retrospectively in full as a change in
accounting policy.
In order to calculate what the IAS 21 prior period adjustment should
be in the undertaking financial statements, it will be necessary to:
(a) retranslate the previously presented local currency (US$)
financial statements into sterling; and
(b) restate those sterling numbers as if IAS 21 had been applied
retrospectively in full, that is as if sterling had always been the
functional currency.
Assets and liabilities
The closing rate of the presentation currency, on the balance sheet
date, should be used for assets and liabilities of a foreign
undertaking. This includes goodwill and fair value adjustments.
Income and expenses
Translation of local currency to functional currency
Each transaction is translated to the functional currency at the
following exchange rate:
Monetary items (money held, assets receivable, and liabilities
payable, in cash) will be reported at the rate ruling on the balance
sheet date (mid market closing rate).
Non-monetary items (such as property, plant and equipment) will
be reported at the exchange rate of the transaction.
This will either be the exchange rate of historic cost, or the valuation
date, where fair values are used.
Examples of these transactions are in the previous section.
Income and expenses should be translated at the rate of the day of
transactions.
The net exchange differences resulting should be classified as
equity.
This will be seen when the change in the net assets, expressed in
the presentation currency, differs from the net profit, expressed in
the presentation currency.
The net profit will be expressed in a compound rate, reflecting
transactions throughout the period.
Often, individual monthly accounts are aggregated when producing
quarterly or annual accounts, each translated at their own exchange
rate, to calculate the net profit, expressed in the presentation
currency.
Translation of functional currency to presentation currency
Example:
A foreign venture is started on January 1st with $1 million of
inventory provided by third parties.
The inventory is sold for $1.1 million in various transactions during
the month.
$1 million is paid to settle the accounts payable, leaving $100000 in
cash on 31st January.
Exchange differences are transferred to equity.
Example:
The exchange rates were:
January1st
January31st
Average rate
$1=30 Roubles.
$1=22 Roubles.
$1=26 Roubles
Translations to Roubles are as follows:
Cash balance
(period-end rate)
Net profit
rate)
Exchange loss
Where the foreign operation was owned in a previous period, as
opposed to being purchased, or inaugurated, in the period, the
opening net investment of the period needs to be restated at the
closing exchange rate.
=$100.000*22=
=$100.000*26=
=
2,2 million Roubles
2,6 million Roubles (average
0,4 million Roubles
(difference classified as equity)
The cash balance determines the overall result, as this is the
increase in the value of the investment.
A foreign venture is started on January 1st with $1 million of
inventory provided by third parties.
The inventory is sold for $1.1 million in various transactions during
the month.
$1 million is paid to settle the accounts payable, leaving $100000 in
cash on 31st January.
This trading pattern is repeated in February.
The exchange rates were:
January 1st
$1=30 Roubles.
January 31st
$1=22Roubles.
Average rate
$1=26Roubles
The net profit does not fully reflect the month-end balance sheet,
and the exchange loss is needed to balance the accounts.
February 1st
February 28th
Average rate
Only when the cash is repatriated to the parent will the exchange
loss (or gain) be realised.
Translations to Roubles are as follows:
However the (unrealised) gain, or loss will be calculated each month,
and transferred to equity.
$1=25Roubles
$1=37Roubles
$1=31Roubles
January
Cash balance =$100000*22=2,2million Roubles (period-end rate)
Net profit
=$100000*26 =2,6million Roubles(average rate)
Exchange loss
(classified as equity)
=0,4million Roubles(difference)
Exchange differences arising from changes to equity, such as capital
increases or dividends, should also be transferred to equity.
February
Restate opening cash balance @ closing rate:
$100000 * (37-22) = 1,5million Roubles = exchange gain (classified
as equity)
Cash balance
=$200000 * 37
=7,4million
Roubles (period-end rate)
Net profit
= $100000 * 31
=3,1million Roubles
(average rate)
Exchange gain on net profit $100000* (37-31) = 0,6 million Roubles
(classified as equity)
Minority Interests (Non-controlling interests)
Often an undertaking owns 100% of a subsidiary operation. When it
does not, the shares that it does not own, and are not owned by
other members of the undertaking’s group, are referred to as
Minority Interests.
Minority interests are third-party partners in a subsidiary.
Where there are minority interests relating to foreign undertakings,
Reconciliation:
Cash balance =$200000 * 37
=7,4 million Roubles
their share of exchange gains (and losses) should be added to the
Net Profit January
Net Profit February
Exchange loss January
Exchange gain on cash
Exchange gain February
=2,6 million
=3,1 million
=-0,4 million
=1,5 million
=0,6 million
Minority Interests (Non-controlling interests) in the consolidated
Total
=7,4 million Roubles
balance sheet.
For example, if minority interests own 20% of a foreign undertaking,
20% of exchange differences relating to that undertaking should be
transferred to Minority Interests in each period. As this is only a book
entry, no money is transferred as a result.
Example:
Net assets (held as an investment) of an 80% owned foreign
subsidiary are $10 million. No trading takes place in the period.
The exchange rates were:
January 1st $1=30 Roubles.
January 31st $1=35 Roubles.
The exchange gain is:
$10 million * (35-30) =5 million Roubles.
As the parent owns only 80%, 4 million Roubles of gain are recorded
as equity, and the remaining 1 million Roubles are added to minority
interests in the balance sheet.
Inter company balances should be agreed by each party prior to
finalising the financial statements submitted for consolidation.
In the example below, the exchange rates are given for
January 1st, assuming no movement on the accounts during the
month.
Example:
Your foreign operation is financed by a $1 million inter company
loan.
It also has an account receivable of 800,000 Euros from another
group company.
The exchange rates were:
January 1st
$1=30 Roubles
January31st
$1=22 Roubles.
1Euro=35 Roubles
1Euro=28 Roubles
The $ exchange gain = $1million * (30-22) = 8 million Roubles
(It is a gain as fewer Roubles are owed.)
The Euro loss = 800.000 Euros * (35-28) = 5,6 million Roubles.
(It is a loss as fewer Roubles will be received.)
Exchange differences frequently occur.
It is vital to record the foreign currency amount, as well as the
Rouble amount, of each transaction. Each transaction will have its
own exchange rate, and the total amount in foreign currency will not
be easy to calculate without this information.
Exchange differences should be written off to the Income Statement,
unless the balance forms part of the parent’s net investment in a
foreign operation (such as an inter company loan).
The $ gain will go to equity, as it is part of the net investment
financing the undertaking.
The Euro loss will be recorded in the income statement, as it is a
trading item.
Where possible, all subsidiary year-ends must be at the same time
as that of the parent undertaking.
Under IFRS 10, the maximum permitted difference is 3 months.
In such a case, the exchange difference should be recorded in
equity, until the disposal of the net investment. Upon disposal, it will
be recorded as a gain, or loss, in the income statement.
Where there is a difference, the assets and liabilities of the foreign
operation are translated at its balance sheet date.
Adjustment should be made for any significant differences created
by any foreign operation having a different accounting date (see
Annex for examples).
Example: Gains or losses from translation of a foreign
subsidiary’s financial statements
Issue
Management should classify exchange differences arising on the
translation of a foreign undertaking’s financial statements as equity,
until the disposal of the net investment.
How should management recognise translation losses in respect of
a foreign subsidiary’s financial statements where those losses result
from a severe devaluation of the subsidiary’s measurement
currency?
Background
A is a French parent undertaking with a subsidiary, B, in Africa.
During the year the African country’s currency suffered a severe
devaluation and undertaking A incurred material losses on the
translation of B’s financial statements.
Undertaking D has operations in four business segments. The
foreign exchange gains and losses arising from the revaluation of
foreign currency receivable balances are recorded within
administrative expenses and therefore within operating profit.
D presents segment information in accordance with IFRS 8,
Operating Segments, including segment result.
Should segment result include the foreign exchange gains and
losses arising from the revaluation of foreign currency receivables
from that segment?
Yes. The foreign exchange gains and losses arise directly from the
revaluation of the foreign currency receivables from each segment
and should be included in segment result which is the difference
between segment revenue and expense.
Segment expense is the directly attributable costs of each segment.
The foreign exchange gains and losses are directly attributable to
the segments from which they arise.
8. Disposal of a Foreign Operation
Solution
Management should recognise the loss on the translation of B’s
financial statements in equity. The severity of the devaluation does
not affect the treatment.
The exchange differences are not recognised as income or expense
for the period because the changes in exchange rates have little, or
no, direct effect on the present and future cash flows from operations
of either the subsidiary or the parent.
Example: Exchange gains and losses segments
On disposal of a foreign undertaking, all exchange differences
deferred into equity crystallise and should be added to the gain, or
loss, on disposal in the Income Statement.
Example:
A foreign subsidiary was sold for $500,000.
Its share capital was $75,000, its retained earnings $350,000 and
exchange losses in equity were $80,000.
(Note: the total of these 3 figures will equal the net assets, assuming
there is no other component of equity.)
The gain on disposal: $500,000 – ($75,000+$350,000-$80,000) =
$155,000.
The gain will be translated into functional currency at the spot rate
on the transaction day.
(i) the loss of control of a subsidiary that includes a foreign
operation;
(ii) the loss of significant influence over an associate that includes a
foreign operation; and
(iii) the loss of joint control over a jointly-controlled undertaking that
includes a foreign operation.
In the case of a partial disposal, only the proportionate share of the
net cumulative exchange difference should be included in the
Income Statement.
Example:
20% of a foreign subsidiary was sold for $250,000.
Its share capital was $100,000, its retained earnings $1,500,000 and
exchange gains in equity were $50,000.
The gain on disposal: $250,000 –
20%($100,000+$1,500,000+50,000) = $60,000
The gain will be translated into functional currency at the spot rate
on the transaction day and included in the Income Statement
Disposal or partial disposal of a foreign operation
In addition to the disposal of an undertaking’s entire interest in a
foreign operation, the following are accounted for as disposals even
if the undertaking retains an interest in the former subsidiary,
associate or jointly controlled undertaking:
On disposal of a subsidiary that includes a foreign operation, the
cumulative amount of the exchange differences relating to that
foreign operation that have been attributed to the non-controlling
interests (minority interests) shall be derecognised, but shall not be
reclassified to profit or loss.
On the partial disposal of a subsidiary that includes a foreign
operation, the undertaking shall re-attribute the proportionate
share of the cumulative amount of the exchange differences
recognised in other comprehensive income to the noncontrolling interests in that foreign operation.
As the undertaking’s share decreases, the share of the noncontrolling (minority) interests increases, so an extra share of
exchange differences is allocated to them.
In any other partial disposal of a foreign operation (not a
subsidiary), the undertaking shall reclassify to profit or loss
only the proportionate share of the cumulative amount of the
exchange differences recognised in other comprehensive
income.
A partial disposal of an undertaking’s interest in a foreign operation
is any reduction in an undertaking’s ownership interest in a foreign
operation, except those reductions that are accounted for as
disposals.


An undertaking may dispose, or partially dispose, of its interest in a
foreign operation through sale, liquidation, repayment of share
capital or abandonment of all, or part of, that undertaking.
The payment of a dividend is part of a disposal only when it
constitutes a return of the investment, for example when the
dividend is paid out of pre-acquisition profits.
the total net exchange differences included in the net profit for
the period.
net exchange differences classified as equity as a separate
component of equity, and its opening and closing balances .
Where the presentation currency differs from the functional currency
of the firm, the reason for this should be disclosed.
Any change in presentation currency, or functional currency, should
be disclosed.
In the case of a partial disposal, only the proportionate share of the
related accumulated exchange difference is included in the gain or
loss.
The method selected to translate goodwill and fair value adjustments
A write-down of the carrying amount of a foreign operation, either
because of its own losses or because of an impairment recognised
by the investor, does not constitute a partial disposal.
Material impacts of changes in foreign currency rates, after the
balance sheet date, should be detailed, if financial statement users
would otherwise be misled in making their evaluations and
decisions.
Accordingly, no part of the deferred foreign exchange gain or loss is
recognised in other comprehensive income is reclassified to profit or
loss at the time of a write-down.
arising on acquisition should be disclosed.
Disclosure of an undertaking’s foreign currency risk management
policy is encouraged.
Hyperinflation Economies and Hedge Accounting
IAS 29 covers the accounting treatment of foreign undertakings
located in hyperinflation economies. IAS 39 covers hedge
accounting, including the hedging of foreign currencies. They are
beyond the scope of this workbook, but are covered in the IAS 29
and IAS 39 workbooks.
9. Disclosure Requirements
An undertaking’s financial statements should disclose:
10. Annex – Examples -Foreign operations with noncoterminous year ends
Undertaking F prepares its annual financial statements at 30
September. However, local regulations require one of its
subsidiaries, undertaking G, to prepare its financial statements at 31
August.
Undertaking F uses G’s results for the 12 months to 31 August for
consolidation purposes, rather than have a second set of results
audited to 30 September.
As the change in exchange rates between 31 August 2006 and 30
September 2006 is significant, undertaking F should use the
exchange rate of 30 September 2006 for consolidation purposes.
The exchange rate between the pound (used for group reporting)
and undertaking G’s local currency was £1:
Joint venture with a noncoterminous year-end
LC15, 000 at 31 August 2006 and £1: LC18,000 at 30 September
2006. There were no significant transactions or other events at G
during September 2006.
Investor F has an overseas joint venture (JV). F prepares financial
statements to the year ending 30 April and the JV prepares financial
statements to the year ending 31 December.
Undertaking G’s net assets at 31 August 2006 were LC234m.
Can investor F use the JV.s December financial statements in
preparing its own financial statements in April?
What exchange rate should management use to translate the results
of undertaking G?
IAS 28 requires the use of financial statements drawn up to the
same date as the investor unless it is impractical to do so.
Where a foreign operation has a different reporting date than the
reporting undertaking, IFRS 10, allows the use of a different
reporting date provided that the difference is no more than three
months.
In particular IAS 28 prohibits a difference of more than three months
between the year-end of the investor and of the associate.
Also, adjustments must be made for the effects of any significant
transactions, or other events that occur between the different dates.
The assets and liabilities of the foreign operation should be
translated at the exchange rate at the balance sheet date of the
foreign operation, but adjustments should be made for significant
changes in exchange rates up to the balance sheet date of the
reporting undertaking.
Translating undertaking G’s balance sheet as at 31 August using the
31 August 2006 exchange rate results in net assets of undertaking G
of £15,600. However, translating the balance sheet using the 30
September 2006 exchange rate results in the consolidation of a
balance sheet with net assets of £13,600.
Therefore, investor F should request the JV to prepare specialpurpose financial statements drawn up to the year ending 30 April.
5. Exchange Difference is:
11.
Multiple Choice Questions
1. Monetary assets are:
1) Cash only.
2) Cash and Bank balances.
3) Money held, assets receivable, and liabilities payable, in cash
or cash equivalents.
2. A Foreign Operation is:
1) A foreign representative where the activities are not an
integral part of the parent.
2) A foreign operation is a branch, associate, joint venture or
subsidiary, where the activities are conducted in a different
country to that of the parent undertaking.
3) Neither of the above.
3. The functional currency is:
1) The currency of the primary economic environment in which
the undertaking operates.
2) The national currency of the country where an undertaking is
based.
3) Neither of the above.
4. The Presentation Currency is:
1) Used in the parent’s and in the consolidated financial
statements.
2) The local currency of a foreign operation in which it reports.
3) The currency with the largest exchange gains.
1) The difference between two different currencies.
2) The difference calculated from reporting the same number of
units of a foreign currency, in the presentation currency, at
different exchange rates.
3) The average difference between the exchange rate at the
beginning and end of a period.
6. The Closing Rate is:
1) The average rate used in the year a firm closes down.
2) The spot exchange rate at the balance sheet date.
3) The exchange rate at which all assets and liabilities are
stated.
7. The net investment in a foreign operation is:
1) The parent’s share of the net assets of the undertaking.
2) The minority interest’s share of the net assets of the
undertaking.
3) The amount invested in the undertaking stated at cost.
8. Transactions and investments in foreign currencies:
1) Decrease business risk.
2) Increase business risk.
3) Neither of the above.
9. Techniques such as hedging, forward contracts and options
can:
1) Reduce risk.
2) Increase risk.
3) Are purely for speculation.
10. The foreign operation may trade profitably, but the
investment may be adversely hit by:
1) Rise in the foreign currency against that of the parent.
2) Fall in the foreign currency against that of the parent.
3) Exchange rates remaining the same.
11. Opportunities for performance improvement will more likely
come from:
1) A review of the realised gains and losses.
2) A review of the unrealised gains and losses.
3) Neither of the above.
12. The exchange rate on the day of the transaction is called:
1)
2)
3)
4)
The ‘spot’ rate.
The closing rate.
The average rate.
A rate sometime in the future.
2) More Roubles would be received from an account receivable
in $.
3) Less Roubles would be paid to settle an account payable in $.
15. If the $ falls in value against the Rouble, and you have net $
liabilities:
1) An exchange loss will result.
2) An exchange gain will result.
3) Neither gain nor loss will result.
16. If the $ rises in value against the Rouble, and you have net
$ assets:
1) An exchange loss will result.
2) An exchange gain will result.
3) Neither gain nor loss will result.
17. If the $ falls in value against the Rouble, and you have net $
assets:
1) An exchange loss will result.
2) An exchange gain will result.
3) Neither gain nor loss will result.
13. The date of the transaction is:
1) The date cash is transferred.
2) The date when the transaction is contracted, or recognised.
3) When the transaction is entered into the books of account.
14. If the $ strengthens:
1) Less Roubles would be received from an account receivable
in $.
18. If the $ rises in value against the Rouble, and you have net
$ liabilities:
1) An exchange loss will result.
2) An exchange gain will result.
3) Neither gain nor loss will result.
19. Monetary items will be reported:
1) At the closing rate on the balance sheet date.
2) At the exchange rate of the transaction.
3) At the average rate for the year.
20. Non-monetary items should be reported:
1) At the closing rate.
2) At the exchange rate of the transaction.
3) At the average rate for the year.
21. Exchange differences on monetary items should be:
1) Recorded in equity, until the disposal of the net investment.
2) Recognized in the period’s income statement.
3) Ignored.
22. Where a monetary item forms part of the parent’s net
investment in a foreign operation, the exchange difference
should be:
1) Recorded in equity, until the disposal of the net investment.
2) Recognized in the period’s income statement.
3) Ignored.
23. For a Dependent Foreign Operation, each transaction is
entered at:
1) The exchange rate that would have been used in the parent’s
books – the parent’s functional currency.
2) Closing rate.
3) Average rate.
24. For foreign operations, closing rate should be used for:
1) Income and expenses.
2) Assets and liabilities.
3) Each transaction.
25. For foreign operations, the rate of the day of transactions
should be used for:
1) Income and expenses.
2) Assets and liabilities.
3) Each transaction.
26. The opening net investment of the period needs to be
restated at the:
1)
2)
3)
4)
Closing exchange rate.
Average exchange rate.
Previous year’s opening rate.
Previous year’s closing rate.
27. Exchange differences arising from changes to equity, such
as capital increases or dividends, should:
1) Be recognized in the period’s income statement.
2) Be transferred to equity.
3) Ignored.
28. Where there are minority interests relating to foreign
undertakings, their share of exchange gains (and losses)
should be:
1) Ignored.
2) Included with the parent’s share of exchange gains.
3) Added to the minority interests in the consolidated balance
sheet.
You quote a price of $2000 for an item. Based on today’s exchange
29. Inter-company balances should be:
rate, you will make a profit of 30%. However, the Rouble strengthens
1) Ignored.
2) Agreed by each party.
3) Transferred to the Holding Company.
against the $ by 15% per month, eliminating your profit before you
receive the cash in month 5:
30. Exchange differences on most inter-company trading
transactions should be:
1) Ignored.
2) Written off to the income statement.
3) Recorded in equity.
31. On disposal of a foreign operations, all exchange should be:
1) Ignored.
2) Added to the gain, or loss, on disposal in the income
statement.
3) Recorded in equity.
32. In the case of a partial disposal, how much exchange
difference should be included in the Income Statement?
1) All.
2) None.
3) Proportionate share.
12.
Exercise Questions
1. Based on the following information please complete the
following table.
Roubles
Exchange Roubles Roubles Profit
Month
Action
$
Rate Revenue Cost
/Loss
1
Quote
2000
30,00
2 Receive Order 2000
3 Production
2000
4 Delivery
2000
5 Payment
2000
2. Based on the following information what would be your
entries in the Russian books of account.
On 1st January, you sell $100 of services to a foreign customer on
credit. The exchange rate is $1=30 Roubles.
In the Russian books of account, you:
Debit Accounts Receivable
Credit Sales
3000
3000
The cash is received in $ on February 1st. The exchange rate has
weakened to $1 = 40 Roubles.
In the Russian books of account, you:
Debit
……..
Debit
……..
Credit
……..
Credit
……..
3. Complete the following table.
Accounts payable
Exchange gain
If you keep your books in Roubles, but trade is denominated in $,
movements in the $ against the Rouble will have the following
results from your $ denominated assets and liabilities:
You set up a subsidiary abroad. It has net assets of $10 million
structured with $1000 of share capital and $9999000 of intercompany loan.
…….. (relating to acc
5. Based on the following information the inter-company loan
should be considered as part of what?
$ Falls $ Rises
$ Assets
$ Liabilities
6. Using the following information find:
4. Based on the following information what would be the
balances appearing in the Russian books of account.
Translations to Roubles, cash balance, net profit and the exchange
gain/loss.
Equipment was bought from abroad on Jan 1st, but had not been
paid for by March 31st, when the period ended.
The exchange rates were:
January 1st
March 31st$1=20 Roubles.
The cost of the machine was $10,000, and depreciation for the
period was 10% of cost.
In the Russian books of account, the following balances would
appear:
Equipment cost
Depreciation
Net book value
A foreign venture is started on January 1st with $1 million of
inventory provided by third parties.
$1=30 Roubles.
The inventory is sold for $1.2 million in various transactions during
the month.
$1 million is paid to settle the accounts payable, leaving $200000 in
cash on 31st January.
The exchange rates were:
January 1st
January 31st$1=36 Roubles.
Average rate$1=33 Roubles
……..
Translations to Roubles are as follows:
……..
Cash balance =
……..
Net profit =
Exchange gain/loss =
7. Given the following information complete the tables for the
Restate opening cash balance @ closing rate.
Cash balance =
Net profit =
Exchange loss on net profit =
months of January and February. Also, complete the
reconciliation table.
Reconciliation:
A foreign venture is started on January 1st with $1 million of
Cash balance =
Net Profit January =
Net Profit February =
Exchange gain January =
Exchange loss on cash =
Exchange loss February =
Total =
inventory provided by third parties. The inventory is sold for $1.2
million in various transactions during the month.
$1 million is paid to settle the accounts payable, leaving $200000 in
cash on 31st January.
This trading pattern is repeated in February.
The exchange rates were:
January 1st
January 31st $1=40 Roubles.
Average rate
$1=35 Roubles
st
February 1 $1=34 Roubles
February 28th
$1=20 Roubles
Average rate
$1=27 Roubles
8. Fill in the missing figures.
$1=30 Roubles
Net assets of an 75% owned foreign subsidiary are $100 million
(held as an investment). No trading takes place in the period.
The exchange rates were:
January 1st
$1= 30 Roubles
January 31st
$1= 22 Roubles.
Translations to Roubles are as follows:
January
Cash balance=
Net profit =
Exchange profit = (classified as equity)
February
The exchange loss is:
…….. million Roubles.
11. Find the gain/loss on disposal.
As the parent owns only……..%, ……………..million Roubles of
gain are recorded as equity, and the remaining ……..million
Roubles are added to ……..
30% of a foreign subsidiary was sold for $600000.
Its share capital was $100000, its retained earnings $1900000 and
exchange losses in equity were $260000.
The gain / loss on disposal is ……..
9. Find the Euro and the Dollar exchange gain/loss.
Your foreign operations financed by a 2 million Euro inter company
loan. It also has an account receivable of $400,000 from another
group company.
13.
Solutions
Answers to Multiple Choice Questions:
The exchange rates were:
January 1st $1=30 Roubles
January 31st $1=28 Roubles
1Euro = 35 Roubles
1Euro = 22 Roubles
The Euro exchange gain/loss = ……..million Roubles.
The $ gain/loss
=……..million Roubles.
10.Find the gain/loss on disposal
A foreign subsidiary was sold for $750000.
Its share capital was $60000, its retained earnings $500000 and
exchange profits in equity were $200000.
The gain / loss on disposal: $……..
1. 3)
11. 2)
21. 2)
31. 2)
2. 2)
3. 1)
4. 1)
5. 2)
6. 2)
7. 1)
8. 2)
9. 1)
10. 2)
12.
13.
14.
15.
16.
17.
18
19.
20.
22.
23.
24.
25.
26.
27.
28.
29.
30.
32. 3)
1)
2)
2)
2)
2)
1)
1)
1)
2)
1)
1)
2)
1)
1)
2)
3)
2)
2)
Answers to Exercise Questions:
1.
Month
Action
Roubles
Roubles
$ Exchange Revenue Roubles Profit
1
2
3
4
5
Quote
2000
Receive Order 2000
Production 2000
Delivery
2000
Payment 2000
Rate
30,00
25,50
21,68
18,42
15,66
60 000
51 000
43 360
36 840
31 320
Cost
42 000
42 000
42 000
42 000
42 000
/Loss
18 000
9 000
1 360
-5 160
-10 680
7.
2. In the Russian books of account, you:
January
Debit Cash
4000
Credit Exchange Gain
Credit Accounts Receivable
1000
3000
3.Gains / Losses are:
$ Assets
$ Liabilities
Cash balance
=$200000 * 36 = 7,2 million Roubles (period-end
rate)
Net profit
= $200000 * 33 = 6,6 million Roubles (average rate)
Exchange gain
= 0,6 million Roubles(difference) (classified as
equity)
$ Falls $ Rises
Loss
Gain
Gain
Loss
4. In the Russian books of account, the following balances
would appear:
Equipment cost
Depreciation
Net book value
Accounts payable
Cash balance
=$200000 * 40 = 8,0 million Roubles (period-end
rate)
Net profit
= $200000 * 35 = 7,0 million Roubles (average rate)
Exchange profit
= 1,0 million Roubles(difference) (classified as
equity)
February
Restate opening cash balance @ closing rate.
$200000 * (20-40) = 4,0 million Roubles = exchange loss(classified
as equity)
Cash balance
=$400000 * 20 =8,0million Roubles (period-end
300000
rate)
30000
Net profit
= $200000
270000* 27 =5,4million Roubles (average rate)
Exchange loss on net profit
$200000* (20-27)= 1,4 million Roubles
200000
(classified as equity)
Exchange gain relating to accounts payable100000
Reconciliation:
Cash balance =$400000 * 20
=8,0 million Roubles
5.The net investment in the subsidiary.
6.Translation to Roubles are:
Net Profit January
Net Profit February
Exchange gain January
=7,0 million
=5,4 million
Exchange loss on cash
Exchange loss February
Total
=-4,0 million
=-1,4 million
= 8,0 million Roubles
8. The exchange loss is:
$100 million * (22-30) = 8 million Roubles.
As the parent owns only 75%, 6 million Roubles of gain are recorded
as equity, and the remaining 2 million Roubles are added to minority
interests in the balance sheet.
14.
IFRS Framework
All international standards apply in full to consolidated accounts
(except where otherwise stated). The following are the more
important:
IASB Conceptual Framework
(Concepts that underlie the preparation and presentation of
financial statements for external users.)
IAS 1 Presentation of Financial Statements
9. The Euro exchange gain
IAS 7 Statements of Cash Flows
2 million Euro * (35-22) = 26 million Roubles.
(It is a gain as fewer Roubles are owed.)
The $ loss =
$400000 * (30-28) = 0,8 million Roubles.
(It is a loss as fewer Roubles will be received.)
IAS 21
The Effects of Changes in Exchange Rates
(especially Financial Statements of Foreign Operations)
IAS 28
Accounting for Investments in Associates
IAS 36
Impairment of Assets
The Euro gain will go to equity, as it is part of the net investment
financing the undertaking. The $ loss will be recorded in the income
statement, as it is a trading item.
IFRS 1
First-time Adoption of IFRS
IFRS 3
Business Combinations
10. The gain / loss on disposal:
$750000 – ($60000+$500000+$20000) = $10000 loss.
IFRS 5 ‘Disposal of Non-Current Assets and Presentation of
Discontinued Operations’
IFRS 9 Financial Instruments
11. The gain on disposal:
$600000 – 30%($100000+$1900000-260000) = $78000 gain.
IFRS 10 Consolidated Financial Statements
IFRS 11 Joint Arrangements