Chapter 3 Foreign currency translation Flashcards
1.1 Objectives and scope of IAS 21 The effects of changes in foreign exchange rates
Objective of IAS21 The effects of changes in foreign exchange rates is to produce rules that an entity should follow in the translation of foreign currency activities. IAS21 applies in the following:
- In accounting for transactions and balances in foreign currencies, except for those derivative transactions and balances that are within the scope of IFRS 9 Financial instruments.
- In translating the results and financial position of foreign operations that are included in the accounts of the entity by consolidation or the equity method, and
- In translating an entity’s results and financial position into a presentation currency
1.2 Definitions
Historic rate is the rate in place at the date the transaction takes place (aka spot rate). Closing rate is the rate at reporting date. Opening rate is the rate at the opening reporting date. Average rate is the rate throughout the accounting period.
Monetary assets/liabilities are items that represent right to receive or obligation to pay cash. Non-monetary items are items which give no right to receive or deliver cash.
Functional currency is the currency of the primary economic environment in which an entity operates. Presentational currency is the currency in which the financial statements are presented.
2.1 Functional currency
In determining the functional currency, the primary indicators include:
- The currency mainly influences sales prices for goods and services. The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
- The currency mainly influences labour, material and other costs of providing goods or services.
Secondary indicators include:
- The currency in which funds for financing activities are generated.
- The currency in which receipts from operating activities are retained.
There are four additional factors when considering whether a foreign operation has the same functional currency as the parent company:
- Whether the foreign operation is just an extension of the reporting entity and has no autonomy
- Whether intra-group transactions with the parent are a high percentage of the foreign operations turnover
- Whether cash flows of the foreign operation are remitted to the parent
- Whether cash flows from foreign operations activities are sufficient to fund it, without funds made available by the parent.
3.1 Individual company: translating transactions.
Initial transactions: translate using the historic rate prevailing at the transaction date. Average rate can also be used if it does not fluctuate significantly during the accounting period.
Settled transactions: translate at date of payment/receipt using historic rate. An exchange rate or loss will occur on settlement.
Unsettled transactions: outstanding asset or liabilities on SFP. If monetary item, retranslate at closing rate, movement to SPL. Disclosed in other operating income if trading transaction, if non-trade disclose in interest receivable and similar income/finance costs.
For non-monetary items the cost model is initially translated at the HR and carried forward, they are not retranslated. Using the fair value model, the asset held at fair value, is initially translated at the HR and retranslated at the spot rate at the date fair value is determined. If the change in fair value is recognised directly in equity, the exchange differences are in equity. If the change is recognised in the SPL, then exchange differences are also recognised in SPL.
4.1 Groups of companies, translating foreign subsidiaries
If a group of companies has a foreign subsidiary that prepares it accounts in a different currency to the presentation currency of the group, then the subsidiary must be translated into the presentational currency before consolidation can take place. We need to consider mechanics of translation, calculation of exchange differences and consolidation.
Mechanics of SPF:
Assets, share capital, pre-acquisition reserves and liabilities are all translated at closing rate. For post-acquisition reserves use a balancing figure. This includes all forex G/Ls from translation since acquisition and post-acq profits. The exchange differences can be recorded in a separate translation reserve.
Mechanics of SPL:
All income and expenses are translated at average rate.
4.2 Calculating the exchange difference.
Exchange differences arise on translation of the subsidiary. The differences comprise:
- Differences arising from the translation of the SPL at the average rate and the translation of assets and liabilities at closing rate.
- Differences arising on the opening net assets retranslated at a new closing rate.
- Calculated as: opening assets at CR less opening assets at OR plus profit at CR less profit at AR.
5.1 Consolidation of foreign subsidiary: goodwill
Once the subsidiary is translated into sterling, consolidation is the same, however there is an exchange difference arising from goodwill, this must be retranslated each year end at CR. This may give rise to exchange difference held in equity. The difference is calculated as:
- Calculate goodwill in foreign currency.
- Translate at the historic rate.
- Translate the goodwill at closing rate.
- The difference is added onto the parent company’s share of the exchange difference on the net assets of the subsidiary.
The difference on goodwill is shown as other comprehensive income.
6.1 IAS29 Financial reporting in hyperinflationary economies
In a hyperinflationary economy money losses purchasing power quickly. Comparisons of translations at therefore misleading. IAS29 requires accounts of entities operating in hyperinflationary economies to be restated in terms of a current measurement at reporting date.
SPF: any non-monetary items are restated by multiplying the original cost by a factor (price index at period end date / price index at acquisition). Monetary items are not restated.
SPL: all items are retranslated by multiplying the original value by a factor (price index at reporting date / average price index for the period).
Net monetary gains and losses: monetary items not retranslated, but there is an overall gain or loss. If an entity has net monetary assets, it will lose. If it has net liabilities it will gain. The net gain or loss is reported as part of net income.
7.1 Audit and assurance implications of foreign currency transactions
Key audit tests include confirm historic rate to initially record transactions, confirm closing rate for monetary assets and liabilities, reperform calculations to confirm year-end balances and recalculate gains/losses on settled/unsettled transactions.
7.2 Translating foreign subsidiaries.
Audit risks Audit tests
Non-compliance with IAS 21 Obtain working papers and recalculate exchange difference. Confirm exchange rates. Agree exchange differences to reserves working
Non-compliance with IFRS 3 Recalculate goodwill figure. Agree FV of consideration to contract. Agree any FV changes of NA’s to supporting documentation
Relying on work of other component auditors Evaluate other auditors’ reputation, experience and qualification to determine competence and independence. Provide clear audit instructions. Site visits
Elimination of intra-group balances Review last years working papers to identify any balances which are not repeated this year. Confirm there are no undisclosed intragroup transactions in the letter of representation
