Foreign transactions and foreign subsidiaries

Question 1

What are the 2 currency concepts in IAS21 (The effects of changes in foreign exchange rates):

Answer 1

1.) Functional currency = currency of primary economic environment in which entity operates. Currency used for measurement in financial statements

2.) Presentation currency = Can be any currency. Currency in which the year-end financial statements are presented. Special rules apply to translation from functional currency to presentation currency.

Question 2

What factors should an entity consider when determining its functional currency?

Answer 2

1.) The currency:
- That mainly influences sales prices and services
- The country whose competitive forces and regulations mainly determine sales prices of its goods and services

2.) Currency that mainly influences labour, material and other costs of providing goods or services

3.) Currency in which funds from financing activities are generated

4.) Currency in which receipts from operating activities are usually retained

Question 3

When a parent has foreign subsidiaries, the following issues arise:

Answer 3

• Group accounts are typically prepared in functional currency of parent
• Foreign subsidiaries may have different functional currencies to their parent
• Foreign subsidiaries’ individual accounts must be translated into presentation currency of the group accounts before they can be consolidated into the group accounts

Question 4

If functional currency of foreign subsidiary is not provided, it must be determined using factors seen earlier in this chapter and following additional factors:

Answer 4

• Whether activities of foreign subsidiary are carried out as an extension of the parent, rather than being carried out with a significant degree of autonomy
• Whether transactions with parent are high or low proportion of foreign subsidiary’s activities
• Whether cash flows from activities of foreign subsidiary directly affect cash flows of parent and are readily available for remittance to it
• Whether cash flows from activities of foreign subsidiary are sufficient to service existing and normally expected debt obligations without funds being made available by the parent.

Question 5

Translating the Statement of Financial Position and Statement of Profit and Loss:

Answer 5

SOFP
1.) All assets and liabilities = Translate at closing rate (CR)
2.) Share capital,share premium and pre-acquisition reserves = at historic rate (HR) when subsidiary was acquired.
3.) Post-acquisition reserves = Find as a balancing figure
SOPL
1.) All income, expenses, other comprehensive income = translate at actual rate or average rate(AR) approximation