Presentation Currency - Chartered Accountants Ireland

CHAPTER 31

FOREIGN CURRENCY

TRANSACTIONS AND

TRANSLATION OF FOREIGN

OPERATIONS

Connolly – International Financial Accounting and Reporting – 4 th Edition

31.1 INTRODUCTION

•

Exchange rates effect competitiveness

•

A strong / weak currency impacts on exports and imports

•

There is arguably no one best position – it depends on the nature of your business

•

Businesses that deal in a foreign currency are exposed to risks

•

IAS 21 The Effects of Changes in Foreign Exchange Rates

•

IAS 29 Financial Reporting in Hyperinflationary Economies


IAS 21 The Effects of Changes in Foreign Exchange Rates

Objective and Scope

•

To set down the manner in which foreign currency transactions should be brought to account

•

To set down the manner in which the financial statements of foreign operations should be translated for inclusion in the enterprise’s financial statements by consolidation, proportionate consolidation or by the equity method


Key definitions

•

Functional Currency

The currency of the primary economic environment in which the enterprise operates.

•

Presentation Currency

The currency in which an enterprise presents its financial statements.

•

Closing Rate

This is the spot exchange rate at the reporting date.

•

Exchange Difference

This is the difference resulting from translating one currency into another currency at different exchange rates.

•

Monetary and Non Monetary Items

Monetary items are assets/liabilities held to be received/paid in fixed or determinable amounts. Examples include deferred tax, pensions and provisions. The feature of a non-monetary item is the absence of a right to receive a fixed or determinable amount of money (this includes prepayments, goodwill, intangible assets, inventory and property).


31.2 Foreign Currency Transactions

•

Initial Recognition



Each transaction should be translated using the ER on the date the transaction occurred, or if stable, an average rate



If certain transactions are to be settled at a specified rate, or are covered by a matching forward contract, then the use ‘contracted rate’

•

Reporting at Subsequent Reporting Dates



Monetary items at closing ER (e.g. trade receivables and payables)



Non-monetary items measured at HC are not re-translated at the reporting date (e.g. non-current assets and inventory)



Non-monetary items measured at foreign currency fair value are re-translated at each date of fair value measurement


Recognition of exchange differences

•

Those arising on settlement of monetary items should be expensed in the period they arise

•

Where a gain/loss on a non-monetary item is recognised directly in equity any exchange component of that gain/loss should be recognised directly in equity

•

Conversely when a gain/loss on a non-monetary item is recognised in profit or loss , any exchange component of that gain/loss should be recognised in profit or loss.

•

If a transaction is settled before the end of a reporting, then:

(i) record the foreign currency transaction in the functional currency at the spot exchange rate at the date of the transaction (an average rate for a period may be used if exchange rates do not fluctuate significantly);

(ii) record the settlement at the exchange rate at the date of settlement;

(iii) recognise the exchange difference (i.e. (i) minus (ii) in arriving at operating profit in the statement of comprehensive income).


Example 31.1: Transactions settled at the reporting date

Blue Limited, whose year end is 31 December, buys goods from a foreign company for 180,000 Ricos on 31 July 2013. The transaction is settled on 31 October 2013.

Exchange rates:

31 July 2013 €1 = 1.5 Ricos

31 October 2013 €1 = 1.6 Ricos

Requirement

Show the journal entries to record the above transaction.


Example 31.1: Transactions settled at the reporting date

Initial recognition:

Dr SPLOCI – P/L – purchases

Cr SFP – trade payables

€120,000

€120,000

Being initial recognition of goods purchased on credit (180,000

Ricos / 1.5)

At settlement:

Dr

Cr

Cr

SFP

SPLOCI

SFP

– trade Payables

– P/L – Fx Gain (e.g. CoS)

– Cash

€120,000

€7,500

€112,500

Being settlement and recognition of exchange difference


Transactions not settled at the reporting date

If a transaction is not settled before the end of a reporting, then:

(i) record the transaction (in the functional currency) at the spot exchange rate at the date of the transaction;

(ii) retranslate any monetary items;

(iii) recognise any exchange difference in arriving at profit or loss in SPLOCI.


Example 31.2: Transactions not settled at the reporting date

Top Limited buys goods from a foreign company for 500,000

Zicos on 31 October 2012. The transaction was not settled at

31 December 2012, the company’s year end.

Exchange rates:

31 October 2012 €1 = 1.6 Zicos

31 December 2012 €1 = 1.75 Zicos

Requirement

Show the journal entries to record the above transaction.


Example 31.2: Transactions not settled at the reporting date

Initial recognition:

Dr

Cr

SPLOCI

SFP

– P/L – purchases

– trade payables

€312,500

€312,500

Being initial recognition of goods purchased on credit (500,000

Zicos / 1.6)

At the reporting date:

Dr

Cr

SFP – trade payables

SPLOCI – P/L – Fx Gain

€26,786

€26,786

Being translation of payable at reporting date and recognition of exchange difference


Example 31.3: Purchase of a non-monetary item

A company purchased a property on 1 January 2013 for 20,000 DM (when

€1 = 4DM), with the account being settled on 1 March 2013 when the exchange rate was 20,000 DM = €5,500. If the company’s year end is after 1

March 2013, then this transaction should be recorded as follows:

At 1 January 2013:

Dr SFP – property €5,000

Cr SFP – payables €5,000

Being initial recognition of property

At 1 March 2013:

Dr

Dr

SPLOCI – P/L – Fx Loss €500

SFP – payables €5,000

Cr Bank €5,500

Being settlement of liability and recognition of exchange difference


Example 31.3: Purchase of a non-monetary item

However, if the company’s year end is 31 January 2013, and at 31 January 2013 20,000 DM = €4,900, then:

At 31 January 2013:

Dr SFP – payables

Cr SPLOCI – P/L – exchange gain

€100

€100

31 January 2013:

Dr SFP – payables €4,900

Dr SPLOCI – P/L - exchange loss €600

Cr SFP – bank €5,500


REVIEW QUESTION 31.1


1.

DR

DR

Review Question 1 – MANCO Limited

Cash

CR

CR

Loan Account

- Being US $1m loan received at $1.75/ €

Loan Account

SPLOCI – P/L – FX gain

- Being FX gain on YE retranslation of $1m at $1.80/ €

2.

DR

DR

DR

DR

CR

PPE

Payables – Frtz

- Being purchase of PPE DM55,000 at DM3.15/ €

SPLOCI – P/L – depreciation

CR

CR

Accumulated Depreciation

- Being 6 months depreciation at 20% pa

Payables – Frtz

SPLOCI – P/L – FX loss

Bank and cash

- Being payment for PPE DM55,000 at DM3/ €


€

571,429

15,873

17,460

1,746

17,460

873

€

571,429

15,873

17,460

1,746

18,333

3.

DR

DR

CR

CR

Purchases

Payables – Etien

- Being BFr600,000 purchases at BFr68/ €

Payables – Etien

SPLOCI – P/L – FX gain

- Being FX gain on YE retranslation of BFr600,000 at bfR69.5/ €

€

8,824

191

SPLOCI – Ye 31 March 2013

Included in arriving at PBT:

FX gains and (losses) ( €15,873 - €873 + €191)

Depreciation PPE

SFP as at 31 March 2013

Non Current Assets: PPE (NBV)

Current Assets: Bank and cash

Current Liabilities / Non Current Liabilities: Loan

Current Liabilities: Trade Payables


€

8,824

191

€

15,191

(1,746)

€

15,714 xxxxx

(555,556)

(8,633)

31.3 FOREIGN CURRENCY TRANSLATION

•

Should follow normal consolidation procedures ( See Chapters

26-28 ).

•

IAS 27 permits the use of different reporting dates as long as they are no more than three months apart and adjustments are made for the effects of any significant transactions between those dates. In such cases, the exchange rate to adopt is that at the reporting date of the foreign operation.

•

IAS 21 shows how to translate FS into a presentation currency

(i.e. the currency in which the FS are presented. This contrasts with the functional currency , which is the currency of the primary economic environment in which the (foreign) entity operates. Depending upon the relationship between the parent and the subsidiary companies, the presentation currency and the functional currency may or may not be the same .


Normal consolidation procedures

•

Eliminate IC balances

•

Need to translate I/C monetary balances

•

Goodwill treated as asset of foreign operation and translated at CR


Presentation currency = Functional currency

SAME FUNCTIONAL CURRENCY: i.e. Foreign trade conducted as a direct extension of investing company

Decision depends upon:

•

Extent to which foreign cash flows have a direct impact upon those of the investing company

•

Extent to which the functioning of the enterprise is dependent directly upon the investing company

•

Currency in which the majority of the trading transactions are denominated

•

Major currency to which the operation is exposed

Specific circumstances:

•

Acts as a selling agent

•

Merely a producer/manufacturer

•

Located overseas for tax or exchange control reasons


Presentation currency = Functional currency

The translation mechanics are:

•

Non-monetary assets (e.g. PPE and inventory) translated at historical rate (Cost or Revaluation)

•

Monetary assets and liabilities (e.g. receivables and payables) translated at CR

•

OSC and pre-acquisition reserves at historic rate (i.e.

‘acquisition rate’)

•

Post-acquisition reserves are a balancing figure

•

SPLOCI translated using ER ruling at the dates the amounts recorded in the financial statements were established (e.g.

Depreciation - Historic Rate)

All other items - Average Rate

•

If available, use rates specific to opening and closing inventory

•

Exchange difference included in PBT in the SPLOCI – P/L


Presentation currency ≠ Functional currency

Indicators are:

•

Investment based on net worth of foreign entity

•

May be partly financed by local currency loans

•

Day-to-day operations of foreign entity are not dependent on holding company’s currency

•

Net investment will remain until business is liquidated or disposed


Presentation currency ≠ Functional currency

The translation mechanics are:

•

Assets & liabilities translated at the year-end rate (i.e. CR)

•

OSC and pre-acquisition reserves at historic rate (i.e.

‘acquisition rate’)

•

Post-acquisition reserves are a balancing figure

•

Compare difference between closing reserves and opening reserves with translated retained earnings to obtain exchange difference

•

Exchange differences taken directly to reserves (separate component)

•

SPLOCI translated using AR

•

Exchange difference will arise from:



Retranslating the opening NA at CR



Translating SPLOCI at AR and SFP at CR


Foreign exchange differences

Presentation Currency = Functional Currency:

•

Exchange differences should be recognised in the SPLOCI – P/L.

Presentation Currency ≠ Functional Currency (Presentation Currency

Method):

•

All exchange differences should be recognised in equity as a separate component (through OCI).

•

Foreign exchange differences arise from:

1. Translating income and expenses at the transaction rate and assets/liabilities at the CR;

2. Translating opening net assets at an exchange rate different from that previously reported;

3. As any goodwill and fair value adjustments should be treated as assets and liabilities of the foreign operation, they therefore must be expressed in the functional currency of the foreign operation and translated at the CR.

If a foreign operation is not 100% owned by the parent company, then exchange differences should be allocated to NCI.


Disposal of foreign entity

Cumulative exchange differences should be recognised as income or expenses in the same period as the gain or loss on disposal is recognised


Disclosure

1. The amount of exchange differences included in arriving at profit or loss in the

SPLOCI except those arising from IAS 39;

2. Net exchange differences classified as a component of equity and a reconciliation of opening and closing equity at start and end of the year;

3. When the presentation currency is different from the functional currency, that fact should be disclosed as well as disclosure of the functional currency and the reason for using a different presentation currency;

4. When there is a change in the functional currency of either the reporting entity or a significant foreign operation, that fact and reason for the change should be disclosed;

5. When an entity presents its financial statements in a currency different from its functional currency, it should describe the statements as complying with IFRSs only if they comply with all of the requirements of each applicable standard and

SIC.

Where the requirements listed at item 5. above are not met an entity should:

• clearly identify the information as supplementary;

• disclose the currency in which the supplementary information is displayed;

• disclose the entity’s functional currency and method of translation used to determine the supplementary information.


Example 31.4: Translation of a foreign subsidiary

FUNCTIONAL CURRENCY # PRESENTATION CURRENCY

Quickbuck Limited

1. SPLOCI TRANSLATED USING AR

Revenue

$

544,275

ER

4

4 Cost of sales

Gross profit

Depreciation

Other expenses

PBT

Income tax expense

PAT

OCI: FX losses

(145,000)

399,275

(30,000)

(271,050)

98,225

(24,275)

73,950

4

4

4

(W5(b))

€

136,069

(36,250)

99,819

(7,500)

(67,762)

24,557

(6,069)

18,488

(3,198)

15,290


2. A & L TRANSLATED USING CR

3. OSC TRANSLATED USING HR

4. RE AS BALANCING FIGURE

PPE

Inventory

Receivables

Bank and cash

Ordinary share capital

RE & FC translation reserve (should be shown separately)

Loan

Payables

Taxation

Proposed dividends

$

270,000

48,525

45,500

9,475

373,500

ER

5

5

5

5

75,000 3

70,450 Balance (W6)

90,000 5

103,775 5

24,275

10,000

373,500

5

5


€

54,000

9,705

9,100

1,895

74,700

25,000

4,090

18,000

20,755

4,855

2,000

74,700

5. CALCULATE FX DIFFERENCE

(a) Opening NA at OR [Prior year CR]

Ordinary share capital [No change]

Retained earnings [$70,450 - $53,950]

Opening NA at CR

(b) Translate RE [SPLOCI at AR v SFP at CR)

PAT [See SPLOCI]

Dividends paid [Per Q]

Dividends proposed

RE per SPLOCI [mainly at AR]

RE per SFP [at CR]

Taken through OCI [W1 €18,488 - €3,198 = €15,290]

(c) TOTAL FX LOSS (Separate component of equity)


$ ER

75,000

16,500

91,500

91,500

3

(Balance)

3

5

73,950

(10,000)

(10,000)

53,950

53,950

4

4

5

5

€

25,000

5,500

30,500

18,300

12,200

18,488

(2,500)

(2,000)

13,988

(10,790)

3,198

15,398

6. MOVEMENT ON RETAINED EARNINGS

Opening RE at 1 January 2012

Retained profit for year

FX loss (to be presented separately)

Closing RE at 31 December 2012

(See w5a)

(See w5b)

(See w5c)

(See w4)


€

5,500

13,988

19,488

(15,398)

4,090

FUNCTIONAL CURRENCY = PRESENTATION CURRENCY

Quickbuck Limited

1. TRANSLATE SFP

Non monetary at HR

Monetary A&L at CR

PPE

Inventory

Receivables

Bank and cash

$

270,000

48,525

45,500

9,475

373,500

ER

2.5

4.8

5

5


Retained earnings

Loan

Payables

Taxation

Proposed dividends

75,000

70,450

90,000

103,775

24,275

10,000

373,500

3

(Balance)

5

5

5

5


€

108,000

10,109

9,100

1,895

129,104

25,000

58,494

18,000

20,755

4,855

2,000

129,104

FUNCTIONAL CURRENCY = PRESENTATION CURRENCY

2. SPLOCI TRANSLATED USING ER RULING AT DATES

AMOUNTS RECORDED IN FS

Revenue

Opening inventory

Purchases

Closing inventory

Cost of sales

$

544,275

41,000

152,525

(48,525)

145,000

ER

4

3

4

4.8

Gross profit

Depreciation

Other expenses

FX gain

PBT

Income tax expense

PAT

399,275

(30,000)

(271,050)

-

98,225

(24,275)

73,950

2.5

4

(W3(b))

4


€

136,069

13,667

38,131

(10,109)

41,689

94,380

(12,000)

(67,762)

28,945

43,563

(6,069)

37,494

3. CALCULATE EXCHANGE DIFFERENCE

(a) Translate opening SFP


Retained earnings [$70,450 - $53,950]

PPE

Inventory

Net monetary liabilities (to balance)

(b)

Opening RE (see above)

+ profit for year (PAT €8,549 – divs. Paid €2,500 – divs. Prop €2,000)

Closing RE per SFP

FX gain (include in SPLOCI – P/L)

$

75,000

16,500

91,500

300,000

41,000

(249,500)

91,500

ER

3

(Balance)

2.5

3

3


€

25,000

25,500

50,500

120,000

13,667

(83,167)

50,500

25,500

4,049

(58,494)

28,945

Presentation Currency - Chartered Accountants Ireland

FOREIGN CURRENCY

TRANSACTIONS AND

TRANSLATION OF FOREIGN

OPERATIONS

REVIEW QUESTION 31.1

Example 31.4: Translation of a foreign subsidiary

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Presentation Currency - Chartered Accountants Ireland

FOREIGN CURRENCY

TRANSACTIONS AND

TRANSLATION OF FOREIGN

OPERATIONS

REVIEW QUESTION 31.1

Example 31.4: Translation of a foreign subsidiary

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