CH. 16. Advanced Forex and Group Forex Flashcards
Define:
- Functional Currency
- Presentation Currency
The Functional Currency:- is the currency of the ‘primary economic environment where the entity operates’, In most cases, this will be the local currency.
The Presentation Currency is the ‘currency in which the entity presents its financial statements’, it can be different from the functional currency.
How to determine the functional currency of a foreign operation?
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A) Whether the activities of the foreign operation are carried out as an extension of the reporting entity,
- an example is when the foreign operation only sells goods imported from the reporting entity and remits the proceeds to it.
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- or rather than being carried out with a significant degree of autonomy.
- An example is when the operation accumulates cash and other monetary items, incurs expenses, generates income and arranges borrowings all substantially in its local currency.
- (B) Whether transactions with the parent are high or a low proportion of the foreign operation’s activities.
- (C) 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.
- (D) 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.
What are the translation rules for Consolidating a Sub with a presentation currency different from the functional currency?
- -The financial statements need to be translated before consolidation.
SPLOCI
- Income and Expenses* for all items in the P.L and OCI (i.e including comparatives)
- *⇒ Translated at actual exchange rates at the dates of the transactions
- (an average rate may be used if exchange rates do not fluctuate significantly)**
SOFP
- Assets and liabilities for each B/S item presented (i.e. including comparatives)
- *⇒ Translated at the Closing Spot rate on the reporting date of the SFP-B/S;**
- All resulting exchange differences.
- *⇒ Recognised in OCI (as a separate component of equity, as translation reserve).**
What Exchange differences occure on consolidation of subs
Exchange differences on consolidation of subs
The process of translating an overseas subsidiary gives rise to exchange
gains and losses. These gains and losses arise for the following reasons:
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Goodwill: is retranslated each year-end at the closing rate.
It will therefore increase or decrease in value simply because of exchange rate movements. -
Opening net assets: At the end of the prior year, the net assets of the subsidiary were translated at the prior year closing rate.
This year, those same net assets are retranslated at this year’s closing rate. Therefore, opening net assets will have increased or decreased simply because of exchange rate movements. - Profit: The income and expenses and the profit of the overseas subsidiary are translated at the average rate. However, making a profit increases the subsidiary’s assets which are translated at the closing rate. This disparity creates an exchange gain or loss.
Current year exchange gains or losses on the translation of an overseas
subsidiary and its goodwill are recorded in other comprehensive income.
How is the retranslation reserve treated in the accounts on disposal?
On the disposal of a foreign subsidiary, the cumulative exchange differences
recognised in the OCI and accumulated in a separate component of equity become realised.
IAS 21 requires that these exchanges differences are recycled (i.e. reclassified) on the disposal of the subsidiary as part of the profit or loss on disposal.