Foreign currency week 8 and 9 Flashcards
What currency do we see in group accounts?
Presentation currency
Why do we care about accounting for foreign activities?
There are a lot of foreign activities in which businesses engage in, they don’t just operate in one country any more.
Why do business engage or set up foreign acitivites when starting or in business? ( 4 things)
1) Growth by expanding to a larger market ( EOS)
2) Lower tax rate
3) lower production costs
4) new technology in other countries.
So in short companies operate conglomerates
a subsidiary operating in Germany/Australia will be reporting to its parent company, which say based in the UK, in their currency unit Euro €/Australian
dollar AU$.. Whats the problem?
We cannot add the functional currency ( £) with euro, when we consolidate we do pound to pound. We then have to translate to presentation currency before we present.
What are 2 other problems with companies having global conglomerates?
1) Constant fluctuation of exchange rates ( so when we convert foreign currency of a subsidiary for consolidation, what exchange rate should we use and when should we use it??,
2) businesses have many different foreign activities around the world, so converting is costly and not time effective?
What is a massive problem if a company relies on many foreign operations?
There might be massive implications on profit.
What IAS rules will we be looking at?
IAS 21 the effects of changes in Foreign exchange rates
1) How to include foreign currency translations and foreign operations in the financial statements ( functional currency)
2) How to translate the amounts to presentation currency
What is the difference between conversion and translating?
Conversion = is exchange of one currency for another. Translation = translating the functional group account to presentation currency
We must translate every Financial statement item using some relevant exchange rate which are what and when would we use it and what will this create at point of translation?
1) the current exchange rate ( like balance sheet, closing rate, iAS 21 prescribes using this before consolidation)
2) the average exchange rate ( if exchange rate doesn’t fluctuate consistently)
3) the historical exchange rate ( Like ppe, that has been paid in cash)
imbalances will be created as you are using different currency, most items are not realised so go into SOCI, but when realised it is recognised in sofp.
What are arguments for and against Should financial statements of foreign
operations be translated into another currency?
FOR
1) we need it for comparability
2) so we can consolidate and present in one currency.
AGAINST
1) Differences in business environment are reflected in individual firm’s financial performance/FSs but translation does not deal with this matter. (e.g. like covid not relected)
What is another disadvantage of Should financial statements of foreign
operations be translated into another currency?
Translation of cash – although it is at closing/current
exchange rate, it is usually retained in the foreign
country to maintain a command over goods/services
in that environment. ( cash still remains in the country )
Remind me which rate ias 21 prescribes to use when translating into the presentation currency for consolidation. ?
Assets and liabilities translated at the current exchange
rate/closing rate (as per IAS 21
What are the rules of translating foreign currency to functional currency ( parent and subsidiary) before consolidation?
1) Foreign currency monetary amounts should be reported using the closing rate
2) non-monetary items at historical cost should be reported using the historical rate
3) non-monetary items that are carried at fair value ( investments carried at fair value are reported using the rate at the date at which the fair value was measured.
1) all exchange differences arising from monetary items
are reported in ………
2) with one exception which is what….
1) in the profit or loss
2) exceptions such net investment in a foreign operation ( owning subsidiary) are recognised in other comprehensive income and in profit or loss on disposal of net investment.
With equity items such as share capital, share premium what does Ias 21 say about reporting these items?
It is slient on this, so usually we just use historical rate
( HARD) lets say you live in the uk and the uk is your functional currency but you have euro as your foreign currency, if the euro appreciates against the pound, if you were to hold this do you have a gain or a loss ? and how do you report this
If you were to sell/hold you are making a gain. so if foreign currency appericates against parent company currency, here you are holding a net asset ( assets> liabilities, asset appreciated) = hence a positive translation gain if they were sell it)
You record this in other comprehensive income until its been reclassified into profit or loss from sale.
(HARD) When the currency appreciates, how can you have a net liability?
this is when the foreign currency (euro) appreciates against the functional currency ( pound ), if they were to make a payment to foreign currency, they are making a loss because pound is worse than foreign currency. So negative translation adjustment.
What happens if foreign currency deprecates? Assuming euro is foreign currency and pound is functional currency.
Net assets will become a loss ( when you sell deprecated currency, you make a loss)
Net liability will become a gain ( pound is stronger against the euro?
1) Many different exchange rates (current, average,
historical) are used to translate different accounts, the
resulting parent company currency denominated trial
balance will ………..
2)The change in this imbalance between accounting
periods is ……
1) will not balance
2) the foreign exchange (FX) translation
gain/loss.
So what are the general rules about translation ( hint we are talking about foreign to functional to presentation)
If you hold foreign currency, and you have a functional currency, you have to translate foreign currency into functional currency. If foreign and functional are the same you don’t have to do that.
Then after you translate, you have to translate the functional currency into presentation currency, for group consolidation. if the functional = presentation, then you don’t have to.
So what are the general rules about translation ( hint we are talking about foreign to functional to presentation)
If you hold foreign currency, and you have a functional currency, you have to translate foreign currency into functional currency. If foreign and functional are the same you don’t have to do that.
Then after you translate, you have to translate the functional currency into presentation currency, for group consolidation. if the functional = presentation, then you don’t have to.
Say i buy expensive $300000 euros of baguettes, ;ets say £1 = $2 where the euro is the foreign currency and pound is functional currency, this means you will pay £1500000 pounds to that company. At the end of the year you still have to pay the $300000 however the exchange rate has changed to £1 = $3 dollars, what does it mean?
The pound has appreciated, meaning the $300000 is worth £100000, so you pay £50000 less, in the balance sheet you would have payable £150000 but now you have only £100000, which you will pay so that means you only have to pay £50000, so you create foreign currency translation gain of 50000 as pound appreciated against euro.
Does IAS 21 CARE ABOUT ACCURAL ASPECTS?
No they just care about monetary aspects.
What is closing rate and spot exchange rate? ( learning definitions)
Closing rate = the spot exchange rate at the end of the reporting period
Spot exchange rate = the exchange rate for immediate delivery/transaction
What does Exchange rate and fair value mean?
Exchange rate: the ratio of exchange for two currencies
Fair value : the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm’s length transaction
What does foreign operation, local currency and presentation currency mean?
Foreign operation: an entity that is a subsidiary, associate, joint venture or branch of a reporting entity.
Local currency: the currency used in the country in which the foreign operation is located
Presentation currency: the currency in which the financial statements are presented
So to note the distinguishable factors depending on whether items are monetary or non monetary do not depend on whether they are current vs non current but asset vs liabilities, now what are examples of monetary items and monetary libailites)
Uses closing rate as there is obligation to pay.
Give exams of non-monetary assets and liailites.
Uses historical rates as no obligation to pay
What are the 3 criteria in determining functional currency?
A business has key operating activities of sales and expenses
If these criteria not clear e.g. its mixed so an entity in the uk has a large amount of sales denominated in euro and this determines the price at which they are selling but employees are based in the uk , so functional currency not decide, so you move to next factors which are ….
Currency in which funds from financing activities are generated ( where do they get the borrowings or loans from e.g. are they getting it in uk pound or euro)
Currency in which operating cash receipts are retained
The appropriate functional currency would be expected to be the
GBP £. Factors to support this decision would be:
– Sales are denominated in GBP £
– Plant and machinery acquisitions in GBP £
– Bank finance is denominated in GBP £
– It would appear that the UK is the primary economic environment in
which the entity operates.
The appropriate presentation currency would be the Euro €.
Given that most shares are held by Irish residents (investors), it would
seem appropriate for presentation currency to be Euro €.
What are these examples off?
Foreign currency transcations.
Has the dollar appreciated or depreciated against the pound also what are the dr and cr from 3 jan 2019 and 31 jan 2019?
So technically they have made a foreign currency translation gain of 20000 dollars
IAS 21 requires monetary items to be translated too…..
And the exhange differences relating to monetary items as we have seen in the last example….
spot rate at the initial transcation, then translate to closing rate at the end of the period.
2) go into the profit or loss statement except the net investment of foreign enitiy which goes into OCI.
So here Euros is functional currency.
1) Euro
2) Us dollars
There are 3 different situtations could arise in translating foreign currency FS’s, which are what? ( e.g. lets say there is euro, dollar and pound.
What is the translation approach and what are the exchange differences?
1) the exchange difference when translating into the presentation currency will go to OCI and equity component untill that foreign operation has been disposed off
Summary of rates used when translating SoCI items
into a functional currency
What are the rates used to translate into functional currency?
Revenue and expenses ( and purchases too) = uses the spot exchange rate at the date of transcation and your also allowed to use average rate.
Income tax expenses = ( closing rate = spot exchange rate at the at balance sheet date, as they are determined at end of year )
Non-monetary related expenses e.g. depreciation = translated at the rate used to translate the related non-monetary item.
Distrubtions ( which are out of RE)
Dividends paid = translated at the spot exchange rate at the date of payment.
Dividend declared = translated at the spot exchange rate at the date of the dividends are declared. ( NOTE IF IT DOESNT SAY OBLIGATION/COMMUNICATED DON’T CHANGE)
Remember IAS 21 doesnt prescribe rules to translating equity into a functional currency, but what can we argue about it.
Post accquistion reserves e.g. revalaution of like ppe
Share capital at accqusition = the rate at when it was accquired
Reserves and retained earnings at accquisition = the date it was accquired
Reserves – post acquisition = exchange rate when revalued
Now we are going to look at an example of Foreign exchange translation.( FIRSTLY What do we have to work out first and do it?
What are a few things we need to be careful on?
1) We have to work out The SOFP and we do not translate RE, we work out last , as it comprises of foreign currency gain or loss, included in the p/l statement.
YOU WORK OUT RE BACKWARDS, KNOWING THAT TOTAL ASSETS = TOTAL EQUITY. AND LIABILITIES.
2) we need to be careful on calculating the exchange rate sign, do we mutliply or divide and also what is the functional currency, we will not be given this in the exam.
Why do we need the RE from balance sheet for?
We need the retained earnings to work backwards to find foreign exchange gain or loss to be reported in income statement.
How will the SOCI look like ( HINT BE CAREFUL WHERE FOREIGN EXCHANGE GAIN/LOSS WILL BE) What working should we put under?
We should always put the working of the the working off Retained earnings under the statement of comprehensive income.
`Here dont worry about where the gross profit is.
Fill this.
What don’t we translate?
We dont translate profit before tax, profit for the year and closing RE we do the rest.
Just remember there is no OCI but can very much be part of a question.
KEY HERE IS WORKING BACKWARDS
Whats this trying to show?
Shows the reason we have foreign translation gain is due to the movement of the monetary items, has you can see its the use of the closing rate.
Now we are going to look at translating foreign operation from given functional currency to presentation currency.
so we want to provide a Summary of the method to be applied for translating SoCIs from a given functional currency to a specific presentation currency.
What are the rules here?
The spot exchange rate when the transcation happened, same case for funcrtional currency and average rate is allowed.
Summary of the method to be applied for translating SoCIs from a
given functional currency to a specific presentation currency
Income tax expense - when it happens ( current rate, same with functional currency)
Dividends paid/declared = Translated at the spot rate when paid/declared
Summary of the method to be applied for translating SoFPs from a
given functional currency to a specific presentation currency
So we know all the items in the SOFP except equity transalte from functional to presentation using closing rate, but now we will look at equity
What is post accquisiton earnings?
For the second remember we dont translate profit before tax, profit for the year and RE at the year end date. Post accquisition things include revaluation reserve
Post-acquisition retained earnings ( profits made and included in the retained earnings of the subsidiary company since acquisition)
Firstly when calculate this what FS shall we start with first?
We start with SOCI because we want the RE at the end of the year balancing figure to go into the B/S.
Now create a SOCI ( breaking down COS and underneath having working for retained earnings, we cannot find out OCI and Total comprehensive income for the year just yet.
Now complete present a SOFP?
Now how does the full SOCI look like now we have OCI?
