Reporting Financial Performance

(chapter 03)

Mohammad Ibrahim Khalil, FCA

Class 3 and 4 CFO
Bank Asia Limited
IAS 21: The Effect of Changes in Foreign Exchange rates
Overview

IAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to

account for foreign currency transactions and operations in financial
statements, and also how to translate financial statements into a
presentation currency.

An entity is required to determine a functional currency (for each of its

operations if necessary) based on the primary economic environment in which
it operates and generally records foreign currency transactions using the spot
conversion rate to that functional currency on the date of the transaction.
Closing rate: Spot exchange rate at the end of the reporting period.

Exchange differences: The difference resulting from translating a given number of units of one
currency into another currency at different exchange rates. Exchange rate The ratio of exchange for
two currencies.

Foreign currency: A currency other than the functional currency of the entity.

Foreign operation: An entity that is a subsidiary, associate, joint arrangement 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.

Functional currency: The currency of the primary economic environment in which the entity operates.

Net investment in a foreign operation: The amount of the reporting entity’s interest in the net assets
of that operation.

Presentation currency : The currency in which the financial statements are presented. Spot
exchange rate The exchange rate for immediate delivery.
Determining the functional currency

The functional currency is the currency of the primary economic environment in which the
entity operates and it is normally the currency in which the entity primarily generates and
expends cash.

IAS-21 provides primary and secondary indicators for use in the determination of an
entity’s functional currency, as summarized below.

Primary Indicators:
• The currency that mainly influences sales prices for goods and services(often the
currency in which prices are denominated and settled).
Determining the functional currency

• The currency of the country whose competitive forces and regulations mainly
determine the sales prices of its goods and services; and

• The currency that mainly influences labour, material and other costs of providing
goods or services(often the currency in which prices are denominated and settled).

Secondary Indicators:
• The currency in which funds from financing activities (raising loans and issuing equity)
are generated; and

• The currency in which receipts from operating activities are usually retained.
Foreign Currency Transactions

Conversion gains and losses

Conversion is the process of exchanging amounts of one foreign currency for another.

Example: MerryCo, a US based company buys a consignment of goods from a supplier of

Germany. The order is placed on May 01, and agreed price is Euro124,250. At the time of
delivery the exchange rate Euro 2 to $1. MerryCo would record the amount as below:
Purchase Dr. (124,250/2) $62,125
Trade Payable Cr. $62,125
When MerryCo comes to pay, exchange rate altered to 2.05 to 1, so the cost of Euro124,250
would be $60,610 (124,250/2.05). Following transaction will occur:

Trade Payable Dr. $62,125

Cash Cr $60,610
Profit on conversion Cr $ 1,515

Profit on conversion would be included in PL for the year in which conversion takes place.
Foreign Currency Transactions

Example
Suppose that another YankiFed Co sells goods to a Mexican company and its is agreed that
payment should be made in Mexican pesos at a price of MXN116,000. We will further assume that
the exchange rate at the time of sale is MXN17.2 to $ 1, but when the debt is eventually paid, the
rate has altered to MXN 18.1 to $1. YankFed Co would record the sale as follows.

Trade Receivable Dr. (116,000/17.2) $6,744

Revenue Cr. $6,744
When MXN116,000 are paid, YankiFed co will convert them into $, to obtain (/18.1) $6,409. In this
example, there has been a loss on conversion of $335 which will be written off to profit of loss for
the year

Cash Dr. $6,409

Loss Dr $335
Trade Recivable Cr $ 6,744
Foreign Currency Transactions
Translation
Foreign currency translation as distinct from conversion does not involve the act of
exchanging one currency for another. Translation is required at the end of an
accounting period when a company still hold assets or liabilities in its statement of
financial position which were obtained or incurred in a foreign currency.

These assets or liabilities might consist of :

a) An individual home company holding individual assets or liabilities originating in a
foreign currency ‘deal’
b) An individual home company with a separate branch of the business operating
abroad which keeps its own books of account in the local currency
There has been great uncertainty about the method which should be used to translate
the value of assets and liabilities from a foreign currency into $ for the year end
statement of financial position.
Foreign Currency Transactions
Translation
Suppose for example, Belgian subsidiary purchases a piece of property for Euro 2,100,000
on Dec 2017. The rate of exchange at this time was E70 to $1. During 2018, the subsidiary
charged dep on building of E16,800 so that at Dec 31, 2018 subsidiary recorded as:
Property 2,100,000
Less: Ac Dep 16,800
Carrying amount 2,083,000
At this date the exchange rate E60 to $1.

The local holding company must translate to assets value into $ but there is a choice of
exchange rates:
a) Rate which existed at the date of purchase
b) Rate existing at the end of 2018
Similarly dep to be charged accordingly.
Foreign Currency Transactions

Initial Recognition
IAS 21 states that each transaction should be translated using the ER(Exchange rate) on
the date the transaction occurred. P-21

An average rate for a period may be used if exchange rates do not fluctuate significantly.
p-22
Foreign Currency Transactions

Subsequent measurement
A foreign currency transaction may give rise to assets or liabilities that are denominated in
a foreign currency. These assets and liabilities will need to be translated into the entity’s
functional currency at each reporting date.
How they will be translated depends on whether the assets and liabilities are
monetary or non-monetary items.
Foreign Currency Transactions
Monetary items: The essential feature of a monetary item, as the definition implies,
is the right to receive(or an obligation to deliver) a fixed or determinable number of
units of currency. Examples:
➢Cash and bank balances
➢Trade receivables an payables
➢Loan receivables an payables
➢Foreign currency bonds held as available for sale
➢Foreign currency bonds held to maturity
➢Pensions and other employee benefits to be paid in cash
➢Provisions that are to be settled in cash
➢Cash dividends that are recognised as a liability
➢A contract to receive (or deliver
Foreign Currency Transactions
Non-Monetary items
A Non-monetary item does not give the right to receive(or an obligation to deliver) a fixed or
determinable number of units of currency. Examples:
➢ Amounts prepaid for goods and services
➢ Goodwill
➢ Intangible assets
➢ PPE
➢ Provisions to be settled by the delivery of a non- monetary asset
➢ Equity instruments that are held as available for sale financial assets
➢ Equity instruments in subsidiaries, associates or joint ventures
Foreign Currency Transactions

Reporting at Subsequent Reporting Dates

➢ Monetary items at closing ER (e.g. trade receivables and payables)
➢ Non-monetary items measured at Historic Cost are not re-translated at
the reporting date (e.g. non-current assets and inventory)
➢ Non-monetary items measured at foreign currency fair value are re-
translated at each date of fair value measurement
p-23
 Recognition of exchange differences

Exchange difference occurs 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 transaction.

Those arising on settlement of monetary items should be recognized in profit or loss in the
period they arise. P-28

Two situation need to consider:

a) The transaction is settled in the same period as that in which it occurred: all exchange
difference is recognized in that period
b) The transaction is settled in as subsequent accounting period: the exchange difference
recognized in each intervening period up to the period of settlement is determined by the
change in exchange rates during that period.

In other words, where a monetary item has not been settled at the end of a period, it should be
restated using the closing exchange rate and any gain or loss taken to profit and loss. P-29
Example

Seattle Co. whose year end is 31 December, buys some goods from Telomer SA of France on
Sep 30. The invoice value is €60,000 and is due for settlement in equal instalments on 30 Nov
and 31 Jan. The exchange rate moved as follows:
€=$1
30 Sep 1.6
30 Nov 1.8
31 Dec 1.9
31 Jan 1.85

Required: state the accounting entries in the books of Seattle Co.

The purchase will be recorded in the books of seattle co using the rate of exchange rulling on 30 Sep.
Purchase Dr $37,500
Payable Cr $37,500

Being the $ cost of goods purchased for €60,000 (€60,000/1.6/1).

On 30 Nov, Seatlle co must pay €30,000. This will cost €30,000/ € 1.8/$1=$16,667 and the company has
therefore made an exchange gain of 18,750-16,667=$2,083.
Payables Dr $18,750
Exchange gain Cr $2,083
Cash Cr $16,667

On 31 Dec, the year end the outstanding liability will be recalculated using the rate applicable to that date:
€30,000/ € 1.9/$1=$15,789. A further exchange gain of 2,961 has been made and will be recorded as:
Payables Dr $2,961
Exchange gain Cr $2,961
Total exchange gain of $5,044 will be included in the operating profit for the year ending 31 Dec.

On 31, Jan, seattle co must pay the second installment of €30,000. This is will cost $16,216 (1.85)
Payables Dr $15,789
Exchange loss Dr $427
Cash Cr $16,216
Linnet Ltd has historically purchased all the components used to manufacture the hardware
from within the UK. On 1 November 2020 Linnet Ltd took delivery of components costing
€569,600 from a supplier based in mainland Europe. One half of these components
remained in Linnet Ltd’s inventories.
Because Linnet Ltd’s accounts department are unsure how to deal with foreign currency
transactions, this purchase has not been recorded in Linnet Ltd’s draft financial statements
for the year ended 31 December 2020. This includes not reflecting the goods still held at 31
December 2020 in closing inventories.
Spot exchange rates were:
1 November 2020 €1:£0.80
31 December 2020 €1:£0.70
IAS 21, The Effects of Changes in Foreign Exchange Rates, states that a foreign currency
transaction should be initially recorded in the functional currency, by applying the exchange
rate between the reporting currency and the foreign currency at the date of the
transaction/historic rate. When Linnet Ltd received the components on 1 November 2020
they should have been recorded in purchases and trade payables at the spot rate of
€1:£0.80, ie at an amount of £455,680 (569,600 x 0.80).

At the year end, IAS 21 requires that any foreign currency monetary items are retranslated
using the closing rate. Monetary items are defined as “units of currency held and asset and
liabilities to be received or paid in fixed or determinable number of units of currency”. The
trade payables in respect of this purchase meet the definition of a monetary item/should be
restated at the closing rate, giving a trade payable at 31 December 2020 of £398,720
(569,600 x 0.70). The exchange gain of £56,960 (455,680 – 398,720) should be recognised
in the statement of profit or loss for the year ended 31 December 2020.

Because inventories do not meet the definition of a monetary item, they should be left as
originally recorded/not be restated. Inventories at 31 December 2020 should therefore
include £227,840 (£455,680 x ½) in respect of these components.
IAS 24: Related Party Disclosure
Objective:
To ensure that entity’s financial statements contain the disclosure to draw attention to
the possibility that its position and results may have been affected by the existence of
related parties and transactions with them.

Scope:
a) Identifying related party relationships and transactions
b) Identifying outstanding balance between an entity and its related parties
c) Identifying circumstances in which disclosure of the items a) and b) is required and
d) Determining the disclosure to be made about those items
Identifying Related Parties:
A party is related to another entity if it:
• Controls, is controlled by, or is under common control with the entity
• Has significant influence over the entity
• Has join control over the entity
• Is an associate of the entity
• Is a joint venture of the entity
• Is a member of the key management personnel of the entity or its parent
• Is a close family member of anyone with control, joint control or significant influence
over the entity or of any members of key management personnel
• Is controlled, jointly controlled or significantly influenced by any individual referred to
above
• Is a post employment benefit plan for the benefit of employees of the entity or any of
its other related parties.
Definition:
Related party transaction is a transfer of resources, services, or obligations between
related parties, regardless of whether a price is charged

Close member of a person’s family are those family members who may be expected to
influence, or be influenced by, that person in their dealings with the entity, and include:
(a) that person’s children and spouse or domestic partner; (b) children of that person’s
spouse or domestic partner; and (c) dependents of that person or that person’s spouse
or domestic partner.

Key management personnel are those persons having authority and responsibility for
planning, directing and controlling the activities of the entity, directly or indirectly,
including any director (whether executive or otherwise) of that entity
Definition:
Control The power to govern the financial and operating policies of an entity so as to
obtain benefits from its activities.

Significant Influence

Joint Control: The contractually agreed sharing of control over an economic activity

A government-related entity is an entity that is controlled, jointly controlled or

significantly influenced by a government.
Example:
X is an 80% owned to subsidiary of T. The directors of X are A,B,C and D. Which of the
following are related parties of X?

a) V, which is not part of the T group, but which A is a director.

b) Y, who owns 20% of the shares in X.
c) K, the financial controller of X (who is not a director)
d) M, the wife of the chairman of Q, an entity in the T group.
Related Party Transactions:
Any transaction that occurs between a reporting entity and a related party.
• For a reporting entity employees to receive goods or services at reduced price ore for
free. If the employees fall within the definition of the reporting entity’s key
management personnel, they will be related parties and should disclose.
• Every transactions with a related party takes place at the full arm’s length price, the
reporting entity should disclose them.

Examples of transactions which should be disclosed:

o Transfers of resources for which no charge is made

o Transfers of resources for which an artificial charge is made
o Transfers of resource made at full, open market, prices (that is arm’s length prices)
Example of Related Party Transactions:
• Purchase or Sales of goods
• Purchase or sales of non-current assets
• Giving or receiving of services eg accounting or management services
• Leasing arrangements eg allowing the use of an asset
• Transfers of research and development
• Financing arrangements (including loans)
• Provision of guarantee or collateral
• Settlement of liabilities on behalf of the entity
Challenges of Related Party Transactions:
Directors may not to disclose related party relationships and transactions, because they
believe that disclosure will give users of financial statements the impression of poor
stewardship or wrong doing.

Unless disclosing related party transactions, users will assume that entity has entered
into all its transactions on the same terms that it could have obtained from third party.
Disclosure of control:
IAS 24 requires that relationships between parents and subsidiaries are disclosed including:
- Name of the parent
- Name of the ultimate controlling party
- Relationship, whether or not any transactions have taken place between the parties during
the period

Disclosure of Management compensation

Any compensation granted to key management personnel should be disclosed in total and for
each of the following categories:
• Short- term employee benefits
• Post- employment benefits
• Other long term benefits
• Termination benefits
• Share based payment
Disclosure of transactions and balance:
If there have transactions between related parties, the reporting entity should disclose:
• The nature of the related party relationship
• A description of the transactions
• The amount of the transactions
• The amounts and details of any outstanding balances
• Allowances for receivable in respect of the outstanding balances
• The irrecoverable debt expense in respect of outstanding balance
The objectives of IAS 24 is to ensure that an entity’s financial statements contain the disclosures necessary to
draw attention to the possibility that its financial position and profit or loss may have affected by the existence of
related parties and by transactions and outstanding balances with such parties.
On April 01, 2017, Ace owned 75% of the equity share capital of Deuce and 80% of the equity share capital of
Trey. On April 01, 2018, Ace purchased the remaining 25% of the equity shares of Deuce. In the two years
ended 31 March, 2019, the following transactions occurred between the three companies:
i) On June 2017 Ace manufactured a machine for use by Deuce. The cost of manufacture was 20,000. The
machine was delivered to Deuce for an invoiced price of 25,000. Deuce paid the invoice on 31 August 2017.
Deuce depreciated the machine over its anticipated useful economic life of five years, charging a full year’s
depreciation in the year of purchase
ii) On 30 September 2018, Deuce sold some goods to Trey at an invoiced price of 15,000. Trey paid the
invoice on 30 November 2018. The goods had cost Deuce 12,000 to manufacture. By 31 March 2019, Trey
had sold all the goods outside the group.
iii) For each of the two years ended 31 March 2019, Ace provided management services to Deuce and Trey.
Ace did not charge for these services in the year ended 31 March 2018 but in the year ended 31 March
2019 decided to impose a charge of 10,000 per annum to each company. The amounts of 10,000 are due to
be paid by each company on 31 May 2019.
Required:
a) Explain why related party disclosure needed. 6 Marks
b) Summarise the related party disclosure which will be required in respect of transactions i) to iii) above for
both of the years ended 31 March 2018 and 31 March 2019 in the financial statements of Ace, Deuce and
Trey. 14 Marks
You may assume that Ace Presents consolidated financial statements for both of the years dealt with above.
CB Ltd.is reputed multinational company in Bangladesh. The company was initially registered as a private
limited company but very recently the company was converted to a Public Limited Company. In the process, the
company had issued shares to a number of new investors.
The Head of Reporting of CB Ltd has just completed preparing the consolidated financial statements of the
company. During the audit kick-off meeting, the newly appointed audit manager had asked if all the related party
disclosures have been properly made. The audit junior has raised question about adequacy of related party
disclosure in below circumstances:
i. Mr. C, who owns 51% share in the company has acquired 20% stake in BZ limited, The audit managers
view is BZ Limited should be treated as a related party of CB Limited.
ii. CX is the only importer of raw material for the company. CB has significant amount of dues to CX. Mr X the
chair of CX, often visits CB premises. During his last visit, he had visited company warehouse and had
warned management about the working environment at factory premises. The audit manager asked why CX
or Mr X has not been considered as related party.
iii. Mr. Z is appointed as COO. His wife, Mrs P, has a raw material supply contract with the company since long.
However, upon appointment, Mr Z stopped ordering further material from her company, lest it should be
questioned by the board. The audit manager is convinced that the contract needs to be disclosed. Mr. Z will
not like to disclose such dormant contract as a related party disclosure.
Requirement: You as a newly appointed professional accountant, were asked to advise if related party
disclosure would be needed in above cases. Share your advice and underlying justification. 2*3=6
Thank you