Week 3 - Foreign Currency

Question 1

What are foreign currency recognition issues?

Answer 1

• It is often not sufficiently probable that an inflow of benefits from a foreign exchange gain will result (or an outflow of benefits from a foreign exchange loss will result).
• Economic benefits – cash realization – will the entity receive cash when it recognises an FX gain or pay cash when it recognises an FX loss?
• Ultimate cash realization of foreign exchange gains/losses cannot be assessed with reasonable certainty

Question 2

What is functional currency?

Answer 2

Currency of primary economic environment in which the entity operates.

Question 3

What is presentation currency?

Answer 3

Currency in which financial statements are presented.

Question 4

What is an exchange rate?

Answer 4

A currency other than functional currency of the reporting entity

Question 5

What is exchange difference?

Answer 5

Difference resulting from translating one currency into another currency at different exchange rates.

Question 6

What is a foreign currency transaction?

Answer 6

A foreign currency transaction is a transaction that is either denominated or requires settlement in a foreign currency, including:

• Buying or selling goods or services whose price is denominated in a foreign currency.
• Borrowing or lending of funds in a foreign currency.
• Acquisition or disposal of assets denominated in a foreign currency.

Question 7

A foreign currency transaction has 2 parts.

What are they?

Answer 7

1 - The purchase or sale of an asset or the incurring of an expense or item of income.

2. The receipt or payment of monies (inflow/outflow of economic benefits) for these assets, expenses or items of income (Completion/settlement the of transaction)..

Question 8

What is the rule for translating transactions (such as sales or purchases?

Answer 8

Translate at the exchange rate at the transaction date (or at the contract rate if there is a contract).

Question 9

What is the rule for translating non-monetary amounts (measured at historical cost) (for example non-current assets, inventory, shares issues)?

Answer 9

Translate at the exchange rate at transaction date (or on the contract) and do not retranslate.

Question 10

What is the rule for translating unsettled monetary items (such as cash, receivables, payables)?

Answer 10

Translate at the exchange rate at the balance sheet date or (or at the contract rate if there is a contract).

Question 11

What is the rule for exchange gains or losses?

Answer 11

Recognise in the income statement (SPLOCI) in the profit or loss as part of ordinary activities

Question 12

In terms of foreign currency hedging, how are investments matched by borrowings managed?

Answer 12

Investments matched by borrowings:

• an asset, exposed to an exchange risk.
• a liability also exposed to an exchange risk.
• since asset and liability part of one overall transaction, effects of exchange rate movements cancelled out.

Question 13

Explain the rule for hedge accounting in relation to foreign currency hedging.

Answer 13

Hedge accounting:

• allowance to classify exchange differences as equity when arising on a foreign currency liability used as a hedge.

Question 14

What are the criteria for a hedge?

Foreign currency borrowing against a foreign currency non-current asset (Hedging)

Answer 14

The criteria for a hedge are as follows:

• Must be formal designation and documentation of the hedge at inception.
• The hedge must be expected to be highly effective (80% - 125%).
• A forecasted transaction which is subject to a hedge must be highly probable.
• The effectiveness of the hedge must be able to be reliably measured.
• The hedge must be assessed on an ongoing basis for effectiveness.

Question 15

What are the recognition issues of gains/losses in SPLOCI (profit or loss).

Answer 15

• Not sufficiently probably that economic benefit (i.e. cash inflow from foreign currency translations) will result.
• Some argue it is more appropriate to recognise a gain or loss on a monetary item in other comprehensive income rather than in profit or loss (SPLOCI).
• Closing rate might be abnormally high or low.
• Volatile rates may result in closing rate subsequently being reversed in later periods – exchange rates or losses at year end may not be realized i.e gains on long-term liabilities.

Question 16

What is the primary economic environment?

Answer 16

• the one in which the entity primarily generates and expends cash

Question 17

What are the factors to determine the functional currency of an entity?

Answer 17

The currency:

• that mainly influences sales prices for goods and services; and
• 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.

Question 18

What other factors provide evidence of functional currency?

Answer 18

• the currency in which funds from financing activities are generated.
• the currency in which receipts from operating activities are usually retained.

Question 19

If an entity is part of a group (i.e. a subsidiary of another company (a parent)), what are the ways to determine the functional currency?

Answer 19

• 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 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 obligations without funds being made available by the reporting entity.

Question 20

What is the rule for dealing managing financial reporting in hyperinflationary economies?

Answer 20

• Financial statements have to be dealt with in accordance with IAS 29 (i.e. Financial Reporting in Hyperinflationary Economies) before IAS 21 is applied.
• Financial statements stated in the measuring unit current at the balance sheet date.