Foreign currency translation

Question 1

Objectives and scope of IAS 21 The Effects
of Changes in Foreign Exchange Rates

Answer 1

1.1 Objective
If an entity wants to trade with foreign entities, it may do so in two different ways:
 It may buy and sell goods directly to foreign entities.
 It may have a foreign operation, which transacts on its behalf.
In either case it is likely to buy or sell assets in a foreign currency. As foreign
currency exchange rates fluctuate, these will affect the financial position of the entity.
The objective of IAS 21 The Effects of Changes in Foreign Exchange Rates is to
produce rules that an entity should follow in the translation of foreign currency
activities.
1.2 Scope
IAS 21 The Effects of Changes in Foreign Exchange Rates applies in
the following cases:
(a) ‘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
(b) in translating the results and financial position of foreign
operations that are included in the financial statements of the
entity by consolidation or the equity method, and
(c) in translating an entity’s results and financial position into a
presentation currency.’ (IAS 21, para 3)

Question 2

4 Exchange rates

Answer 2

 Historic rate (HR): rate in place at the date the transaction takes
place, sometimes referred to as the spot rate.
 Closing rate (CR): rate at the reporting date.
 Opening rate (OR): rate at the opening reporting date.
 Average rate (AR): average rate throughout the accounting period.

Question 3

FX: Assets and liabilities:

Answer 3

 Monetary assets/liabilities: items that represent right to receive or
obligation to pay cash e.g. Receivables, payables, loans.
 Non-monetary items: items that give no right to receive or deliver
cash e.g. Inventory, PPE.

Question 4

Currency

Answer 4

Functional currency: ‘the currency of the primary economic
environment in which an entity operates.’ (IAS 21, para 8)
 Presentational currency: ‘the currency in which the financial
statements are presented.’ (IAS 21, para 8)

Question 5

The functional currency
2.1 Determining the functional currency

Answer 5

List from the IAS

In determining the functional currency IAS 21 The Effects of Changes in
Foreign Exchange Rates gives primary and secondary indicators.
Primary indicators
(a) the currency:
(i) that mainly influences sales prices for goods and services (this will
often be the currency in which sales prices for its goods and
services are denominated and settled), and
(ii) of the country whose competitive forces and regulations mainly
determine the sales prices of its goods and services.
(b) the currency that mainly influences labour, material and other costs of
providing goods or services (this will often be the currency in which such
costs are denominated and settled).’ (IAS 21, para 9)
Secondary indicators
(a) The currency in which funds for financing activities […] are generated.
(b) The currency in which receipts from operating activities are retained.’
(IAS 21, para 10)
IAS 21 The Effects of Changes in Foreign Exchange Rates also gives 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 the foreign operations activities are sufficient to fund it,
without funds being made available from the parent.

Question 6

Individual company: translating
transactions
Initial transactions

Answer 6

 Translate using the historic rate prevailing at the transaction date.
 The average rate can also be used if it does not fluctuate
significantly during the accounting period.

Question 7

Individual company: translating
transactions
Settled transactions

Answer 7

 If a transaction is settled (payment or receipt occurs) during the accounting
period:
 Translate at the date of payment/receipt using the historic rate prevailing at that
date.
 As the spot rate on settlement may be different to the historic rate at the time of
the initial transaction, an exchange difference may arise which is posted to the
statement of profit or loss

Question 8

Individual company: translating
transactions
Unsettled transactions

If a transaction is still unsettled at the reporting date, there will be an outstanding asset or liability on the statement of financial position.

Answer 8

If the asset/liability is a monetary item: retranslate at closing rate, movement to SPL

 If the exchange difference relates to trading transactions, it is disclosed within
other operating income/operating expenses.

 If the exchange difference relates to non-trading transactions, it is disclosed
within interest receivable and similar income/finance costs.

Question 9

Individual company: translating
transactions
Non-monetary Items

Answer 9

Cost Model
Non-monetary items that are held at cost are initially translated at the HR and carried
forward at this value, they are not retranslated.

Fair Value Model
A non-monetary asset held at fair value, is initially translated at the HR
and retranslated at the spot rate at the date a fair value is determined.
If the change in the fair value of the item is recognised directly in equity, then any
related exchange differences are also recognised directly in equity e.g. Revalued
PPE (see Illustration 1).
If the change in the fair value of the item is recognised in the statement of profit or
loss, then any related exchange differences are also recognised in the statement of
profit or loss e.g. FVPL financial assets (see Chapter 4).

Question 10

Groups of companies, translating
foreign subsidiaries

Answer 10

If a group of companies has a foreign subsidiary that prepares it accounts in a
different currency to the presentational currency of the group, then that 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 accounting treatment
 Consolidation.

Question 11

Groups of companies, translating
foreign subsidiaries
4.1 Mechanics of translating the statement of financial position

Answer 11

Assets Translate at closing rate (CR)
Share Capital Translate at historic rate (HR)
Pre-acquisition reserves Translate at historic rate (HR)
(Total = Net assets at acquisition)

Post-acquisition reserves Balancing figure (β)
Includes all forex G/Ls from translation since acquisition and post-acqn profits. The exchange differences can be recorded in a separate translation reserve

Equity (Net assets at y/e)
Liabilities Translate at closing rate (CR)

Question 12

Groups of companies, translating
foreign subsidiaries
4.2 Mechanics of translating the statement of profit or loss

Answer 12

All income and expenses Translate at Average Rate (AR) X/(X)

Question 13

4.3 Calculating the exchange difference

*Exchange differences may arise on translation of a subsidiary. These differences
comprise: *

Answer 13

1. Differences arising from the translation of the statement of profit or loss at the average rate and the translation of assets and liabilities at closing rate.
2. Differences arising on the opening net assets retranslated at a new closing rate.
   It can be calculated as follows:

Opening net assets Translate @ CR X
Less: Opening net assets Translate @ OR (X)
Profit for the year Translate @ CR X
Less: Profit for the year Translate @ AR (X)

This difference which arises on translation is reported in other comprehensive income and is held in equity.

NB: The annual foreign currency gain or loss should be allocated between P’s share and NCI share within other comprehensive income (using % ownership).

Question 14

FX: Consolidation of foreign subsidiary 5.1 Treatment of goodwill

Answer 14

Once the subsidiary is translated into sterling, then the consolidation is exactly the
same as for the consolidation of a UK subsidiary, however there will also be an
exchange difference arising from the treatment of goodwill.
Goodwill is deemed to be an asset of the subsidiary and therefore must be
retranslated each year end at the closing rate.
This may give rise to a further exchange difference which is also held in
equity. This exchange difference is calculated as follows:
 Step 1: Calculate goodwill in the foreign currency
 Step 2: Translate at the historic rate (acquisition date)
 Step 3: Translate the goodwill at the closing rate
 Step 4: The difference between goodwill at the HR and CR will be
added onto the parent company’s share of the exchange
difference on the net assets of the subsidiary (assuming the
proportionate method is used to value goodwill).
Note: If the full goodwill/fair value method is utilised then the forex gain/loss on
goodwill should be allocated between NCI and P’s share of goodwill.
The exchange difference on goodwill between the opening and closing statements of
financial position, will be shown as other comprehensive income (i.e. this year’s
exchange movement).

Question 15

5.2 Statement of cash flows and foreign exchange

Answer 15

IAS 7 requires cash flows associated with foreign currency transactions
to be recorded at the exchange rate on the date of the cash flow.
Example:
Company X paid $200,000 on 31 December 20X6, when the exchange rate on that
day was $2: £1.
The only number recorded in the statement of cash flows would be £100,000.
In a question, to calculate the cash flow figure we usually compare the opening and
closing balances of items from the statement of financial position.
If the item is a monetary item arising from a foreign transaction or is an asset or
liability of a foreign subsidiary, it will have been retranslated at the year end.
When we compare the movement of the item year on year, part of this movement will
result from exchange differences not cash flows. Therefore, we need to take these
into account when preparing a statement of cash flows.

Question 16

IAS 29 Financial Reporting in
Hyperinflationary Economies IAS 29 Financial Reporting in Hyperinflationary Economies Accounting
treatment

Answer 16

Hyperinflationary economies are not necessarily foreign economies. However, given
the current level of UK inflation, the context in which it is most likely to be examined
would be with a foreign entity.
The syllabus weighting for IAS 29 Financial Reporting in
Hyperinflationary Economies is a weighting D, therefore awareness of
the scope of the standard is all that is required.
6.1 IAS 29 Financial Reporting in Hyperinflationary Economies Accounting
treatment
Identifying hyperinflationary economies
In a hyperinflationary economy money loses its purchasing power very quickly. As a
result, comparisons of transactions at different points in time are misleading.
IAS 29 Financial Reporting in Hyperinflationary Economies requires financial
statements of entities operating in hyperinflationary economies to be restated in
terms of a current measurement at the reporting date.

Items in the statement of financial position
 Any non-monetary items are restated by multiplying the original cost (or
revalued amount) by a factor:
Price index at the period end date
Price index at acquisition/date of valuation
 Monetary items are not restated as they are already carried at the current value.
Statement of profit or loss items
 All items are retranslated by multiplying the original value by a factor:
Price index at the reporting date
Average price index for the period
Net monetary gains and losses
 Although monetary items are not retranslated, there will be an overall gain or
loss. If an entity has net monetary assets, it will lose. If it has net monetary
liabilities, it will gain. This net gain or loss must be reported as part of net
income.

Question 17

IAS 29 Financial Reporting in Hyperinflationary Economies and IAS 21 The
Effects of Changes in Foreign Exchange Rates

Answer 17

If there is a foreign subsidiary operating in a hyperinflationary country, restate the
accounts per IAS 29 Financial Reporting in Hyperinflationary Economies first, and
then apply IAS 21 The Effects of Changes in Foreign Exchange Rates.

Question 18

Audit and assurance implications of
foreign currency transactions

Answer 18

Significant audit and assurance issues arise when a company enters into
transactions denominated in foreign currencies and when it acquires a new
subsidiary with a functional currency different to the presentational currency.

Question 19

Audit and assurance implications of
foreign currency transactions 7.1 Individual transactions

Answer 19

Key issues revolve around using the correct exchange rates to translate the foreign
currency balances into the functional currency and calculating the forex differences.
The audit tests are as follows:
 Confirm historic rate to initially record transactions
 Confirm closing rate for monetary assets and liabilities
 Reperform calculations to confirm year-end balances
 Recalculate gains/losses on settled/unsettled transactions.

Question 20

Audit and assurance implications of
foreign currency transactions 7.2 Translating foreign subsidiaries

Audit tests

Non-compliance with IAS 21 The
Effects of Changes in Foreign
Exchange Rates, for e.g.
 incorrect exchange rate
 incorrect posting of
exchange difference

Answer 20

Obtain working papers and recalculate
exchange difference
 Confirm exchange rates
 Agree exchange differences to reserves
working

Question 21

Audit and assurance implications of
foreign currency transactions 7.2 Translating foreign subsidiaries

Audit tests

Non-compliance with IFRS 3
Business Combinations rules, for
e.g.
 goodwill calculation
complex, including the use
of fair values etc.

Answer 21

Recalculate goodwill figure
 Agree FV of consideration to contract
 Agree any FV changes of NA’s to
supporting documentation

Question 22

Audit and assurance implications of
foreign currency transactions 7.2 Translating foreign subsidiaries

Audit tests

Relying on the work of other
auditors of the subsidiary who
may be concerned with local
GAAP requirements rather than
IFRS Standards

Answer 22

Evaluate other auditors reputation,
experience and qualification to determine
competence and independence
 Provide clear audit instructions
 Site visits

Question 23

Audit and assurance implications of
foreign currency transactions 7.2 Translating foreign subsidiaries

Audit tests

Elimination of intra-group
balances

Answer 23

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