E-14 Advanced Accounting and
Financial Reporting
Lecture 11 & 12
IAS 21 Effect of Changes in Foreign Exchange Rates
Foreign Subsidiary Consolidation
Practice and Revision
Sajid Shafiq, ACA
IAS 21-Overview
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Objectives, Scope and Definitions
Functional Currency
Presentation Currency
Monetary and Non-monetary items
Transactions in Foreign Currency
– Initial recognition
– Reporting at subsequent reporting dates
– Recognition of exchange difference
• Transactions settled within the period
• Transaction balance outstanding at end of reporting period
– Net investment in a Foreign Operation
– Change in Functional Currency
• Translation into Presentation Currency (Foreign Subsidiary Consolidation)
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Procedures for translation into Presentation Currency
Hyperinflationary Economies
Goodwill
Disposal of a Foreign Operation
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Objectives, scope and Definitions
Objectives
• To prescribe how to include
foreign currency transactions
and foreign operations in the
FS of an entity, and how to
translate FS into a different
currency for presentation
purposes.
Scope
IAS 21 applies to:
• accounting for foreign currency transactions;
• translating the FS of foreign operations that are included in the FS of
another entity, for example, on consolidation of subsidiaries or the
inclusion of associates by the equity accounting method; and
• translating an entity's results and financial position into a different
currency for the presentation of its FS.
Definitions
Closing rate is the spot exchange rate at the end of the reporting period.
Exchange difference is the difference resulting from translating a given number of units of one currency into
another currency at different exchange rates.
Exchange rate is the ratio of exchange for two currencies.
Foreign currency(FCY) is a currency other than the functional currency of the entity.
Foreign operation(FO) is an entity that is a subsidiary, associate, JV or branch of a reporting entity, the
activities of which are based or conducted in a country or currency other than those of the reporting entity.
Functional currency is the currency of the primary economic environment in which the entity operates.
Monetary items are units of currency held and assets and liabilities to be received
or paid in a fixed or determinable number of units of currency.
Net investment in a foreign operation is the amount of the reporting entity’s interest in the net assets of that
operation.
Presentation currency (PC)is the currency in which the FS are presented.
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Practice Qs
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Functional Currency
Additional factors for FO
An Entity
•An entity cannot choose its functional currency; instead,
management needs to make an informed assessment of the facts.
Indicators to consider include (in order of priority)
•the currency that mainly influences the prices at which goods and
services are sold;
•the country whose competitive forces and regulations mainly
influence the pricing structure for the supply of goods and services;
•the currency in which financing is generated; and
•the currency in which cash generated from an entity’s operating
activities is usually retained.
A Group
•In a group, each entity, for example the parent, each subsidiary and
associate, needs to determine its own functional currency rather than
adopting a single one which is common across the whole group.
•Additional factors should be considered to determine whether the
functional currency of a FO is the same as that of the reporting entity (the
group). The overriding factor is whether the FO operates independently of
the reporting entity or is merely an extension of that entity.
For a group of entities, IAS 21 requires a two stage process:
1. Individual entity level: treatment of foreign exchange transactions
(functional currency); and
2. Consolidation level: translation of the FS of entities, for example
subsidiaries, associates and branches, into a common currency for
consolidated FS purposes (presentation currency).
•Whether the activities of the FO are
carried out as an extension of the
reporting entity, or are being carried out
with a significant degree of autonomy. An
example of the former is when the FO
only sells goods imported from the
reporting entity and remits the proceeds
to it. An example of the latter is when the
operation accumulates cash and other
monetary items, incurs expenses,
generates income and arranges
borrowings, all substantially in its local
currency.
•Whether transactions with the reporting
entity are a high or a low proportion of
the FO’s activities.
•Whether cash flows from the activities of
the foreign operation directly affect the
cash flows of the reporting entity and are
readily available for remittance to it.
•Whether cash flows from the activities of
the foreign operation are sufficient to
service existing and normally expected
debt obligations without funds being
made available by the reporting entity.
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Effect of Selection of Functional Currency
On 01 January 2011, A Co operating in US purchases inventory from an EU country
on credit of one month. The value of inventory in € is 100,000. The details of
exchange rates is as follows:
01- Jan $/€ = 1.5
31- Jan $/€ = 2.0
The effect of selection of $ or € as functional currency will be:
Date
$ as Functional Currency
01- Jan
Dr. Inventory
Cr. Payable
$150,000
$150,000
31-Jan
Dr. Payable
$150,000
Dr. Exchange Loss (ß) $ 50,000
Cr. Bank
$200,000
€ as Functional Currency
Dr. Inventory €100,000
Cr. Payable
€100,000
Dr. Payable
Cr. Bank
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
€100,000
€100,000
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Presentation Currency
• IAS 21 does not require to present financial
statements using functional currency. An
entity has a completely free choice of the
currency in which its financial statements are
presented.
• The approach that is required to translate the
financial statements of an entity, or a group of
entities, into a different presentation currency
is discussed later.
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Practice Qs
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Monetary and Non-monetary items
• The essential feature of a monetary item is a right to receive (or an
obligation to deliver) a fixed or determinable number of units of currency.
Examples include:
– pensions and other employee benefits to be paid in cash;
– provisions that are to be settled in cash; and
– cash dividends that are recognised as a liability.
• Conversely, the essential feature of a non-monetary item is the absence of
a right to receive (or an obligation to deliver) a fixed or determinable
number of units of currency. Examples include:
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amounts prepaid for goods and services (eg prepaid rent);
goodwill;
intangible assets;
inventories;
property, plant and equipment; and
provisions that are to be settled by the delivery of a non-monetary asset.
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Transactions in the Functional Currency
Initial recognition
• An entity should record FCY , for example the buying or selling of goods or services whose price is denominated in a FCY,
in a consistent manner.
• An entity does this by recognising each transaction at the spot exchange rate on the date that the transaction took
place.
• Thus, if an entity whose functional currency is CU buys a non-current asset for N$1 million when the spot exchange rate
is CU1:N$2, then the transaction will initially be recorded at CU500,000.
• Where there are high volumes of such transactions, for practical reasons an average exchange rate over the relevant
period may be used as an approximation. However, if exchange rates fluctuate significantly over short periods of time
it is not appropriate to use an average rate since it would not be a fair approximation for actual rates.
Reporting at the ends of subsequent reporting periods
At the end of each reporting period the following translations of foreign currency should be carried out.
Item
Exchange rate
Monetary items
Closing rate (i.e. the spot exchange rate at the end of the
reporting period)
Non-monetary items measured at historical Cost
Rate of exchange at the date of the original transaction
(i.e. the date of purchase of the non-current asset)
Non-monetary items measured at fair value
Exchange rate at the date when fair value was determined
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Recognition of exchange differences
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The difference that arises from translating the same amounts at different exchange rates is referred
to as an exchange difference.
Such amounts will generally arise in the preparation of a set of FS from the settlement of monetary
amounts payable or receivable in a foreign currency and the retranslation at the entity’s period
end.
Exchange differences should normally be recognised as part of the profit or loss for the period.
However, where gains and losses on a non-monetary item are recognised in OCI, for example a gain
on the revaluation of a property in accordance with IAS 16, any exchange difference resulting from
retranslation of the revalued asset is also reported as part of OCI.
Transactions settled within the period
When a FCY is settled within the same accounting period as that in which it was originally recorded, any
exchange differences arising are recognised in the profit or loss of that period.
Transaction balance is outstanding at the end of the reporting period
When a FCY is settled in a different accounting period to the one in which the transaction originated,
the exchange difference recognised in profit or loss for each period, up to the date of settlement, is
determined by the change in exchange rates during each period.
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Recognition of Exchange Differences
Illustration
Warrilow has a year end of 31 December 2007 and uses the CU as its functional currency.
On 29 November 2007, Warrilow received a loan from a foreign bank for N$1,520,000. The proceeds
were used to finance, in part, the purchase of a new office block. The loan remained unsettled at the
year end.
Exchange rates:
29 November 2007 CU1 = N$1.52
31 December 2007 CU1 = N$1.66
The following amounts should be recorded by Warrilow, ignoring interest payable on the loan.
29 November 2007
The cash advance from the bank is translated at the rate on the date that it was received (N$1,520,000 /
1.52 = CU1,000,000) and a liability recorded for the same amount.
31 December 2007
As the loan was still outstanding at the end of the period and it is a monetary item, it should be
retranslated at the exchange rate at the end of the reporting period (N$1,520,000 / 1.66 = CU915,663 ).
The exchange difference should be recognised as a gain in profit or loss for the period. (CU1,000,000
less CU915,663 = CU84,337).
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Recognition of Exchange Differences
Illustration
Aston has a year end of 31 Dec 2007 and uses the CU as its functional currency. On 25 Oct 2007 Aston buys goods
from an overseas supplier for N$286,000. The goods are still held by Aston as part of inventory at the year end.
Exchange rates:
25 October 2007 CU1 = N$11.16
16 November 2007 CU1 = N$10.87 31 December 2007 CU1 = N$11.25
(a) If, on 16 November 2007, Aston pays the overseas supplier in full the following entries should be recognised:
25 October 2007.
The initial transaction is recorded as a purchase and a liability at the exchange rate at the date that the transaction
took place (N$286,000 / 11.16 = CU25,627).
16 November 2007.
The actual cost of settling the liability on the date of settlement is calculated (N$286,000 / 10.87 = CU26,311). The
exchange difference between the originally recorded liability and the actual amount required to settle it (CU25,627
less CU26,311 = CU684) is recorded as an exchange loss in profit or loss for the period. Inventories at the year end are
nonmonetary items and will be carried at their original value i.e. CU25,627.
(b) If the supplier had remained unpaid at the year-end, the following transactions would have been recognised:
25 October 2007.
The initial transaction is recorded as above at CU25,627.
31 December 2007.
The year-end balance is retranslated at the year-end exchange rate as it is a monetary liability. (N$286,000 / 11.25 =
CU25,422) The difference should be reported as part of the profit or loss for the period. The exchange gain
recognised in profit or loss will be CU205 (CU25,627 less CU25,422 = CU205). The value of inventories at the year end
will be CU25,627 (as recorded above).
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Net Investment in a Foreign Operation
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An entity may have a monetary amount receivable from, or payable to, a foreign entity (for
example an overseas subsidiary) that is not intended to be settled in the foreseeable future.
For a receivable, this amount essentially forms part of the overall investment in the foreign
entity. At the period-end, monetary amounts such as this are retranslated and any
differences recognised in profit or loss of the appropriate entity. But IAS 21 operates on the
basis that as such differences are part of the overall investment in the foreign entity, they
should only be recognised in profit or loss when the foreign entity is disposed of.
In the preparation of the consolidated FS, any exchange difference arising from the net
investment in a foreign operation should be reported initially in OCI and not in the
consolidated profit or loss for the period. If the foreign entity is subsequently sold, any such
exchange differences will form part of the reported profit or loss on disposal by reclassifying
the amount from equity to profit or loss.
The loan could be made by a group entity other than the parent entity. For example, an
entity 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
entity’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.
It is only differences relating to the overall investment in the foreign entity which are
recognised in other comprehensive income; differences on intra-group trading balances
which will be settled in the short term remain in the profit or loss of the period.
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Change in Functional Currency
• If the underlying economic activities change in
such a way that there is a change in the
functional currency of an entity, the new
functional currency should be applied
prospectively from the date of the change in
circumstances.
• The entity should not restate amounts previously
recorded as these reflected the economic reality
at that time.
• All amounts should be retranslated into the new
functional currency at the date of the change.
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Translation into Presentation Currency
Procedures for translation into presentation currency
•The translation into a PC can be undertaken by an individual entity, if it decides to present its FS in a currency
different to its functional currency.
•Much more commonly, it is undertaken when entities within a group have functional currencies different from
the PC of the parent. For the preparation of the group’s CFS, such entities will need to retranslate their FS into
the PC being used.
•The steps to translate financial statements into a different presentation currency are:
•retranslate the assets and liabilities for each SFP presented (i.e. the current period end and the
comparative period) at the closing rate at the date of that statement of financial position;
•retranslate income and expenditure recorded in each SCI presented (i.e. the current period and the
comparative period) at the exchange rates at the dates of the transactions; for practical reasons an
average rate may be used for each period, assuming that the exchange rate does not fluctuate
significantly during the period; and
•recognise all resulting exchange differences in other comprehensive income.
•Where exchange differences relate to a FO that is not wholly owned, accumulated exchange differences
attributable to the NCI should be allocated to NCI in the consolidated SFP.
Hyperinflationary economies
•Where an entity has a functional currency that is the currency of a hyperinflationary economy, it is required to
restate its functional currency FS in accordance with IAS 29
•If, however, such an entity chooses to use a different PC, the requirements in IAS 21 for the retranslation of the
FS into the PC should be applied
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Goodwill
• In the CFS, any goodwill arising on the acquisition of a FO should be
treated as an asset of the FO.
• The GW should therefore be expressed in the functional currency of the
FO and translated at the closing rate at the date of each SFP.
• The same treatment is required of any fair value adjustments to the
carrying amounts of assets and liabilities arising on the acquisition of a FO.
• In both cases exchange differences are recognised in OCI, rather than as
part of the profit or loss for the period.
Illustration
• An entity acquires a foreign subsidiary on 15 August 2007. The goodwill
arising on the acquisition is R$400,000. At the date of acquisition the
exchange rate into the parent’s functional currency is R$4:CU1. At the
parent entity’s year end the exchange rate is R$5:CU1.
• The goodwill at the date of acquisition is CU100,000 (R$400,000/4). At the
year end it is retranslated to CU80,000 (R$400,000/5). The difference of
CU20,000 is recorded as an exchange loss and reported in other
comprehensive income.
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Disposal of a foreign operation
• Where a foreign entity is disposed of, any
exchange differences that have been
recognised in OCI and accumulated in a
separate component of equity are required to
form part of the profit or loss on disposal.
• Such amounts will therefore be reclassified
from equity to profit or loss as a
reclassification adjustment in the period in
which the disposal takes place.
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Practice Qs
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Disposal of foreign operation
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Practice Qs
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Disposal of foreign operation
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Practice Qs
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Practice Question- Foreign Operation
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Practice Qs
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IAS 21, Consolidation of Foreign Subsidiary Practice Qs
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Class Practice Question
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Class Practice Question
IAS 21, Consolidation of Foreign Subsidiary
Practice Qs
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Class Practice Question
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Practice Qs
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Practice and Revision Questions
Group Accounts area
Paper
Attempt
Foreign Subsidiary
E-14
Dec-10
Piecemeal Acquisition and Disposal
E-14
P-2
Dec-09, Dec-06
Dec-09
Jointly Controlled Entity
E-14
Jun-10, Jun-06
Consolidated Statement of Cash Flow
E-14
P-2
Dec-10
Dec-10
Consolidated SFP(including associate)
F-7
Jun-10
Consolidated SCI(including associate)
F-7
Dec-09
Combined Question on CSFP and CSCI
F-7
Dec-10
Complex Group, CSCI
P-2
Jun-10
Complex Group, CSFP
P-2
Dec-07
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Practice Qs
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