Ias 21 Effects of Changes in Foreign Exchange Rates

Download as pdf or txt
Download as pdf or txt
You are on page 1of 8

IAS 21 EFFECTS OF CHANGES IN

FOREIGN EXCHANGE RATES


This standard prescribes
 How to include foreign currency transactions in the financial statements of the entity.
 How to include foreign operations in the financial statements of an entity.
 How to translate financial statements in a presentation currency different from the
presentation of the foreign currency of the entity.

Exchange difference
It is the difference in an entity’s FS resulting from translating a given number of units of one
currency at different exchange rates.

Closing rate
It is the spot exchange rate, that is, the rate at which a transaction is or could be undertaken at
the SFP date.

Functional currency
It is the currency of the primary economic environment in which the entity operates.

Foreign currency
It is a currency other than the functional currency of the entity.

Presentation currency
It is the currency in which the financial statements are presented.

An entity may select any presentation currency but a functional currency cannot be selected
and an entity will have to use a specific currency as its functional currency provided certain
criteria are met.

Individual company stage: Foreign currency transactions


In essence, there are two steps to dealing with a foreign currency transaction: initial recognition
and subsequent measurement.

1 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


Initial recognition
On the initial recognition, the amount of foreign currency involved has to be converted to the
entity’s functional currency by applying the spot exchange rate between the currencies at the
transaction date.

Subsequent recognition
The subsequent measurement step is more complicated because monetary items and non-
monetary items require different accounting treatments.

Monetary items are defined by IAS21 as “money held, and assets and liabilities to be received
or paid, in a fixed or determinable number of units of currency”. Examples include cash,
accounts receivable and accounts payable.

 At year-end report foreign currency monetary items using the closing rate

Recognition of exchange differences


Exchange differences occur when there is a change in the exchange rate between the
transaction date and the date of settlement of monetary items arising from a foreign currency
transaction. Exchange differences arising on the settlement of monetary items (receivables,
payables, loans, cash in a foreign currency) or on translating an entity's monetary items at rates
different from those at which they were translated initially, or reported in previous financial
statements, should be recognised in profit or loss in the period in which they arise.

Non-monetary items are characterised by the “absence of the right to receive, or obligation to
deliver, a fixed or determinable number of units of currency”. Examples include inventories,
plant and equipment, and investments in equity instruments.

At year end.
 Report non-monetary items (e.g. non-current assets, inventories) which are carried at
historical cost in a foreign currency using the exchange rate at the date of the transaction
(historical rate)
 Report non-monetary items which are carried at fair value in a foreign currency using the
exchange rates that existed when the values were measured.

Determining a functional currency


Each entity – whether an individual company, a parent of a group, or an operation within a
group (such as a subsidiary, associate or branch) – should determine its functional currency and
measure its results and financial position in that currency. For most individual companies the

2 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


functional currency will be the currency of the country in which they are located and in which
they carry out most of their transactions. Determining the functional currency is much more
likely to be an issue where an entity operates as part of a group.
To determine a functional currency the following factors are considered:

Primary indicators or factors


 The currency that mainly influences sales prices for goods and services (this will often be
the currency in which selling prices for its goods and services are denominated and settled)
 The currency of the country whose competitive forces and regulations mainly determine
the sales price of its goods and services.
 The currency that mainly influences labour, material and other costs of providing goods
and services (this will often be the currency in which such costs are denominated and
settled)

If you cannot make a definitive conclusion based on these, you will need to consider the
following secondary factors:

Secondary indicators or factors


 The currency in which funds from financing activities, that is, issuing debt and equity
instruments are generated and/ paid.
 The currency in which receipts from operating activities are usually retained.

These factors will normally need to be considered when the primary factors do not point to a
single currency, that is, when the “sales” factor shows “US Dollars” to be the functional
currency while the “cost” factor indicates “South African Rands”.

CONSOLIDATING FOREIGN SUBSIDIARIES


Definitions
Foreign operation - A subsidiary, associate, joint venture 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.
Net investment in a foreign operation - The amount of the reporting entity's interest in the net
assets of that operation.

Procedure
Translation of the foreign subsidiary’s SFP
 Translate all the assets and liabilities using the closing rate (SFP date exchange rate)

3 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


 Translate the share capital and pre-acquisition reserves using the ruling exchange rate
when the shares were acquired
 Complete the SFP and calculate post-acquisition reserves as a balancing figure
 If the subsidiary was acquired at the beginning of the reporting period the post-acquisition
reserves may be translated using the average rate.

Calculate the foreign exchange gain or loss to be recorded as other comprehensive income as
follows:
Closing net assets translated at closing rate x xx
Less: opening net assets translated at opening rate (xxx)
: retained profits for the year translated at (xxx)
xxx
Less/ add foreign exchange gain / loss on goodwill xxx
xxx

Translation of the foreign subsidiary’s Statement of profit or loss


Translate all the revenue and expenditure using the average exchange rate for the current
year
N.B. If given the date when tax was paid, translate it using the prevailing exchange rate when it
was paid

Calculation of goodwill
 Calculate goodwill by translating the equity acquired and purchase consideration by using
the ruling exchange rate on the date of acquisition.
 If there is impairment loss this should be deducted from goodwill before is retranslated.
Impairment loss should be translated using the average rate.
 Re-translate the goodwill from the date of acquisition to the SFP date to calculate the
foreign exchange gain or loss on acquisition.

Consolidated SFP
Prepare the consolidated SFP by adding P Ltd’s asset and liabilities with the translated figures of
S Ltd

Consolidated Statement of profit or loss


Prepare the consolidated SCI by adding P Ltd’s revenue and expenditure with the translated
figures of S Ltd

4 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


Question 1
Acoff Plc (Acoff) is a public limited company based in Ireland. It has shareholdings in two other
companies, Braggs Plc (Braggs) and Van Cleff Plc (Van Cleff). Van Cleff is based in Switzerland
and uses the Swiss Franc (CHF) as its functional currency. Statements of financial position are
shown below for all three companies as at 31 March 2016.

Statements of Financial Position as at 31 March 2016


Acoff Plc Braggs Plc Van Cleff Plc
€ million € million CHF million
Non-current assets
Property, plant & equipment 750 223 80
Investments (including group companies) 460 76 -
1,210 299 80
Current assets
Inventories 310 42 13
Trade receivables 122 75 17
Cash & bank 64 15 8
496 132 38
Total assets 1,706 431 118
Equity
Equity share capital of €1 / CHF1 each 400 100 50
Retained earnings 987 224 40
1,387 324 90
Non-current liabilities
10% Debenture Notes 200 60
Current liabilities
Trade payables 87 36 18
Current taxation 32 11 10
119 47 28
Total equity & liabilities 1,706 431 118

The following additional information may be relevant:


(i) Acoff bought an 80% holding in the equity shares in Braggs on 1 April 2014, when the
retained earnings of Braggs were €180 million. The consideration was agreed at €250
million for these shares. This amount was paid in cash. The “fair value” method is used

5 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


by the group for calculating goodwill on all acquisitions. On 1 April 2014, the fair value
of the non-controlling interest in Braggs was independently assessed at €58 million.
(ii) Acoff bought a 90% holding in the equity shares of Van Cleff on 1 April 2015, when the
retained earnings balance in Van Cleff’s books stood at CHF31.2 million. The
consideration consisted of an immediate cash payment of CHF84 million. Van Cleff
operates as an autonomous entity, although subject to managerial control by the
directors of Acoff. The fair value of the non-controlling interest in Van Cleff at 1 April
2015 was CHF9 million.
(iii) On 1 April 2014, certain patents formed part of the net assets of Braggs, but were not
recognised in its entity financial statements. These had a fair value of €20 million at the
date of acquisition by Acoff. These patents were due to expire 8 years after the date of
acquisition by Acoff.
(iv) During the financial year ended 31 March 2016, Acoff sold goods to Braggs amounting
to €20 million. The transfer price included a profit margin of 20%. Of these goods, 75%
remained in the closing inventory of Braggs at the reporting date. All these goods had
been paid for at the reporting date.
(v) No dividends were paid or proposed in the year by any group company.
(vi) Acoff exercised the option permitted under IAS 27 Separate Financial Statements to
carry all investments in subsidiaries and associates at cost in its individual financial
statements. All other investments are carried under IFRS 9 Financial Instruments, and
are correctly measured at the reporting date.
(vii) Goodwill was reviewed for impairment at each reporting date, and no losses were
considered to have been suffered since acquisition.
(viii) All workings may be rounded to the nearest €0.1m.
(ix) Relevant exchange rates were as follows:
1 April 2015 €1 = CHF 1.2
31 March 2016 €1 = CHF 1.05
Average for year ended 31 March 2016 €1 = CHF 1.15

REQUIREMENT:
Prepare the Consolidated Statement of Financial Position for the Acoff group as at 31 March
2016 in accordance with International Financial Reporting Standards.

6 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


Question 2
The following Statements of Profit or Loss and other Comprehensive Income relate to Allen Plc
(Allen) and its investee companies, Corrib Plc (Corrib) and Neagh Plc (Neagh). Neagh is based in
Northern Ireland. It produces, sells, and is managed autonomously in Northern Ireland.
Accordingly, its financial statements are presented in GB£ Sterling as the functional currency.

Statements of Profit or Loss and Other Comprehensive Income for year ended 31 July 2017
Allen Plc Corrib Plc Neagh Plc
€ million € million GB£ million
Revenue 225 240 60
Cost of sales (130) (123) (18)
Gross profit 95 117 42
Operating expenses (27) (75) (18)
Finance costs (12) (21) (2.4)
Other income 8
Investment income 14 - -
Profit before taxation 78 21 21.6
Taxation (10) (3) (4)
Profit for the year 68 18 17.6
Other comprehensive income (items that will not be reclassified to profit or loss):
Gains on revaluation of property 24 6 -
Total comprehensive income for the year 92 24 17.6
The following additional information is provided:
(i) Allen purchased a 70% holding in the equity of Corrib on 1 December 2016. The
purchase price was €200 million paid in cash. Goodwill arising on acquisition was
calculated at €30 million, using the fair value method. On 31 July 2017, impairment
losses amounting to €10 million had been incurred. No accounting entry was made to
reflect the impairment.
(ii) Allen purchased a 60% holding in Neagh on 1 August 2016, for an immediate cash
payment of £80 million. On that date, the fair values of the identifiable net assets of
Neagh totalled £100 million, which was the same as their carrying values in the books of
Neagh. The 40% non-controlling interest had a fair value of £50 million on 1 August
2016. No impairment of goodwill had occurred by 31 July 2017. The directors of Allen
wish to use the fair value method for all acquisitions.
(iii) On 1 December 2016, the fair value of certain plant & equipment held by Corrib was €3
million more than its carrying value. This plant & equipment had a useful economic life
of 5 years from the date of acquisition. The revised values have not been incorporated

7 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


into the books of Corrib and depreciation was accounted for based on the original
carrying values.
(iv) During the post-acquisition period Corrib sold goods to Allen for €4 million. These goods
were sold at a gross margin of 25% of transfer price. 30% of the goods remained in the
inventory of Allen at 31 July 2017.
(v) Corrib declared a dividend of €6 million during the year from post-acquisition profits.
Allen has recognised its share of this dividend within ‘investment income’.
(vi) All workings may be taken to the nearest €0.1 million. The £ / € exchange rate was as
follows during the relevant period:
Date £ per €1
1 August 2016 0.89
31 July 2017 0.81
Average for period 0.85

Required
Prepare a consolidated Statement of Profit or Loss and Other Comprehensive Income for the
Allen Group for year ended 31 July 2017 in accordance with IFRS. Your answer should show
clearly the amount of any exchange gains or losses recognised during the period.

8 Compiled by T T Herbert (0773 038 651 / 0712 560 772)

You might also like