D. FINANCIAL STATEMENTS OF GROUPS OF ENTITIES - FOREIGN TRANSACTIONS

Question 1

IAS 21 The Effects of Changes in Foreign Exchange Rates

Answer 1

IAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign currency transactions and operations in financial statements, and also how to translate financial statements into a presentation currency.

Question 2

There are two currency concepts:

Answer 2

There are two currency concepts:
 Functional currency – currency of the primary economic environment in which the entity operates.
 Presentation currency – currency in which the financial statements are presented.

Question 3

Monetary items:

Answer 3

Monetary items: Units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.

Question 4

Spot exchange rate:

Answer 4

Spot exchange rate: the exchange rate for immediate delivery.

Question 5

Closing rate:

Answer 5

Closing rate: the spot exchange rate at the end of the reporting period.

Question 6

Functional currency.

Answer 6

Functional currency. This is the currency in which the financial statement transactions are measured. An entity considers the following factors in determining its functional currency:
 The currency:
o That mainly influences sales prices for goods and services; and
o Of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
 The currency that mainly influences labour, material and other costs of providing goods or services.
The following factors may also provide evidence of functional currency:
 The currency in which funds from financing activities are generated
 The currency in which receipts from operating activities are usually retained.

Question 7

Initial recognition - foreign transactions

Answer 7

Initial recognition. Translate each transaction by applying the spot exchange rate between the functional currency and the foreign currency at the date of transaction. An average rate for a period may be used as an approximation if rates do not fluctuate significantly.

Question 8

At the end of reporting period - foreign transactions

Answer 8

At the end of reporting period. Foreign currency assets and liabilities are treated as follows:
 Monetary assets and liabilities – restated as the closing rate.
 Non-monetary assets measured in terms of historical cost (eg non-current assets) – Not restated (ie they remain at historical rate at the date of the original transaction).
 Non-monetary assets measured at fair value – translated using the exchange rate at the date when the fair value was measured.

Question 9

Exchange differences- foreign transactions

Answer 9

Exchange differences are recognized in profit or loss for the period in which they arise. However, if fair value changes for a non-monetary asset measured at fair value are recognized in other comprehensive income (OCI), the exchange difference component of the change in fair value is also recognized in OCI.

Question 10

Changes in functional currency

Answer 10

Once functional currency is determined, it cannot be changed unless there is a change to underlying transactions, events and conditions that are relevant to the entity. The effect of a change in functional currency is accounted for prospectively:
 The entity translates all items into the new functional currency using the exchange rate at the date of the change
 The resulting translated amounts for non-monetary items are treated as their historical cost
 Exchange differences arising from the transaction of a foreign operation previously recognized in other comprehensive income are not reclassified from equity to profit or loss until the disposal of the operation.

Question 11

Presentation currency.

Answer 11

Presentation currency. An entity may present its financial statements in any currency (or currencies).
The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy are translated into a different presentation currency as follows:
 Assets and liabilities for each statement of financial position presented  translated at the closing rate at the date of the statement of financial position
 Income and expenses for each statement of profit or loss and other comprehensive income  translated at actual exchange rates at the dates of the transactions (an average rate for the period may be used if exchange rates do not fluctuate significantly)
 All resulting exchange differences  recognized in other comprehensive income (and, as a separate component of equity, the translation reserve).

Question 12

Foreign operation:

Answer 12

Foreign operation: an entity that is a subsidiary, associate, joint arrangement 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.

Question 13

Translation method - Foreign operation

Answer 13

Translation method. The foreign operation determines its own functional currency and prepares its financial statements in that currency. Where different from the parent’s functional currency, the financial statements need to be translated before consolidation. The financial statements are translated into the presentation currency (functional currency of the reporting entity) using the presentation currency rules.

Question 14

Determining a foreign operation’s functional currency.

Answer 14

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 entity:
 Whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy.
 Whether transactions with the reporting entity are a high or a 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 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 obligation without funds being made available by the reporting entity.

Question 15

Exchange rates - foreign operation.

Answer 15

Exchange rates. The following approach is used when translating the financial statement of a foreign operation.
Statement of financial position
 All assets and liabilities Closing rate
 Share capital and pre-acquisition reserves  Historical rate at date of control
 Post-acquisition reserves:
o Profit for each year Actual (or average) rate for each year
o Dividends  Actual rate at date of payment
o Exchange differences on net assets  Balancing figure
Statement of profit or loss and other comprehensive income
 All items are translated at actual rate at date of the transaction (or average rate as an approximation)

Question 16

Calculation of exchange differences - foreign operation.

Answer 16

All exchange differences on translation of a foreign operation are recognized in other comprehensive income.
The exchange differences result from:
 Translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate;
 Translating the opening net assets at a closing rate that differs from the previous closing rate; and
 Translating goodwill on consolidation at the closing rate at each year end.

Question 17

Calculation of goodwill for a foreign operation.

Answer 17

Calculation of goodwill for a foreign operation. Any goodwill and fair value adjustments are treated as assets and liabilities of the foreign operation and translated at each year end at the closing rate.

Question 18

Disposal of foreign operations

Answer 18

Disposal of foreign operations. On disposal, the cumulative amount of the exchange differences accumulated in equity (and previously reported in OCI) relating to the foreign operation are reclassified to profit or loss (as reclassification adjustment) at the same time as the disposal gain/loss is recognized.

Question 19

Net investment in a foreign operation:

Answer 19

Net investment in a foreign operation: the amount of the reporting entity’s interest in the net assets of a foreign operation.
An entity may have a monetary item that is receivable from or payable to a foreign operation for which settlement is neither planned nor likely to occur in the foreseeable future (like long-term receivable or loan, but not trade receivables or payables). In substance such items are part of the entity’s net investment in a foreign operation. The amount could be due between the parent and the foreign operation, or a subsidiary and the foreign operation.

Question 20

Separate financial statement foreign operation

Answer 20

Separate financial statement
 Where denominated in the functional currency of the reporting entity or foreign operation any exchange differences are recognized in profit or loss in the separate financial statements of the reporting entity or foreign operation as appropriate.
 Where denominated in a currency other than functional currency of the reporting entity or foreign operation, exchange differences will be recognized in profit or loss in the separate financial statements of both parties

Question 21

Consolidated financial statements foreign operation

Answer 21

Consolidated financial statements
 Any exchange differences are recognized initially in other comprehensive income and
 Are reclassified from equity to profit or loss on disposal of the net investment.