Foreign Currency Translations - IAS 21 - CA Pooja Gupta

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Foreign Currency Translations - IAS 21 - CA Pooja Gupta

  1. 1. 01-06-20131Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  2. 2. 01-06-20132 Transactions in foreign currencies Foreign operations Subsidiaries Associates JVs Branches Translate financial statements into a presentation currencyWhat are Foreign Activities?Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Conceptual Issues• Foreign country operations usually prepare financial statements usinglocal currency as the monetary unit. These financial statements mustbe translated into home country currency.• These operations also typically use local GAAP. Financial statementsmust be translated into home country GAAP.• Which exchange rates to be used ?• How to report effects of changes in exchange rates in the financialstatements ?Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  3. 3. 01-06-20133IAS 21 DefinitionsFunctional CurrencyThe currency of the primary economic environment inwhich the entity operatesForeign CurrencyA currency other than the functional currency of an entityPresentation CurrencyThe currency in which the financial statements are presentedIAS 21 DefinitionsEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)• Example – Identification of foreign currency transactions• An entity trades in crude oil and has a US dollar functional currency,because substantially all of its sales and purchases are in US dollars.The entity is located in India and, therefore, has significant transactionsin rupees. It has issued euro-denominated share capital to its Germanparent. Transactions with the parent are denominated in euros.• The rupees transactions and euro transactions are foreign currencytransactions. The entitys physical location and the denomination of itsshare capital do not change the treatment of rupees and eurodenominated transactions. This is because the entity has a US dollarfunctional currency and, therefore, all transactions in other currenciesare foreign currency transactions.Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  4. 4. 01-06-20134Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)ThecurrencyThat mainly influences the price at which goods & servicesare soldOf the country whose competitive forces and regulationsmainly influence the entity’s pricing structureThat influences the costs of the entityIn which funds are generatedIn which receipts from operating activities are retainedFunctional Currency IndicatorsDetermination of functional currency - Foreign operations –Additional factorsForeign operation an integral part of reporting entityFunctional currency will always be the same.Factors to determine functional currency of foreign operation Activities an extension rather than autonomous; High proportion of transactions with reporting entity;Cash flows directly affect those of reporting entity and whetherreadily available for remittance; Cash flows sufficient for debt obligations.Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  5. 5. 01-06-20135Choice of functional currency? An entity does not have a free choice of functional currency An entity cannot change functional currency unless facts andcircumstances relevant to its determination change When the indicators are mixed and the functional currency is notobvious, management should use judgment to determine the functionalcurrency that most faithfully represents the economic effects oftransactions, events and conditions. As a part of this approachmanagement should give priority to first three indicators mentionedearlier.Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Identifying the functional currencyEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)V Co has identified the Euro as its functional currency. V Co establishes twoentities, N Co and A Co. N Co is incorporated in India and A Co is incorporatedin Australia. The following transactions occurred:• V Co loaned AUD 2 million each to N Co and A Co and both recognized theadvance as an intragroup payable;• A Co borrowed additional AUD 3 million from an unrelated 3rd party. N Coguaranteed this 3rd party loan;• A Co invested its entire AUD 5 million in building a manufacturing facility toserve domestic Australian market . A Co intends to repay the loan to the 3rdparty from the profit generated through its manufacturing operations; and• N Co used its AUD 2 million loan from V Co to invest in marketablesecurities in international markets . Its investing strategies are determinedby V Co.• What are the functional currencies of N Co and A Co?
  6. 6. 01-06-20136Identifying the functional currency – Contd..Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)• The functional currency identified for an entity should provide information about theentity that is useful and reflects the economic substance of the underlying eventsand circumstances relevant to that entity. If a particular currency is used to asignificant extent in, or has a significant impact on, the entity, that currency may beappropriate currency to be used as the functional currency.• In the circumstances described, it is likely that AUD would be identified as A Co’sfunctional currency because that is the currency of the country that influences thesale prices and costs of its goods, as well as the regulations and competitive forcesunder which it operates.• On the other hand, even though N Co is domiciled in India, it does not appear tohave a significant degree of autonomy and its activities (investing in marketablesecurities) appear to be carried out as an extension of V Co. Consequently, it islikely that the Euro would be identified as N Co’s functional currency.Functional currency of an oil refinery in Saudi Arabia• Entity A operates an oil refinery in Saudi Arabia. All of the entity’s income isdenominated and settled in US dollars. The oil price is subject to the worldwide supplyand demand and crude oil is routinely traded in US dollars around the world. Around45% of entity A’s cash costs are imports or expatriate salaries denominated in USdollars. The remaining 55% of cash expenses are incurred in Saudi Arabia anddenominated and settled in Riyal. The non-cash costs (depreciation) are US dollardenominated since the initial investment was in US dollars.Effects of Changes in Foreign Exchange RatesIAS 21In this case, the functional currency of entity A is the US dollar. Crude oil is globallytraded in US dollars around the world. The revenue analysis clearly points to the USdollar. The cost analysis is mixed. Depreciation (or any other non-cash expenses) is notconsidered, because the primary economic environment is where the entity generatesand expends cash. Operating cash expenses are influenced by the Riyal (55%) and theUS dollar (45%). Management is able to determine the functional currency as the USdollar, because the revenue is clearly influenced by the US dollar and expenses aremixed.Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  7. 7. 01-06-20137• Entity A is the holding company and has been set up by institutional investors in Cyprus. Entity Ahas obtained equity and loan financing and has invested in India. It pools cash from all groupentities, invests excess cash and obtains external financing, according to the group’s needs. Themajority of its financing is drawn in US dollars and all of its assets are denominated in USdollars.• Entity A’s functional currency is the Indian Rupees. The currency that reflects the economicsubstance of the underlying economic events is the Indian Rupees, because all of thesubsidiaries of the holding entity operate in India and the primary source of income of entity Awill be from India. The ability of entity A to service debts and pay dividends to shareholders isdependant on the Indian economy.Entity A ??Entity B – FCis INREntity C – FCis INREntity D – FCis INREffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Functional currency of a ‘money-box’ entity A French listed parent has significant French, UK and US operating subsidiaries, but no Japanese operations. TheFrench parent creates a new subsidiary incorporated and resident in France, Newco SA. Newco issues in Yen, 1bn ofequity capital to French parent, receiving Yen 1bn of cash. Newco also raises Yen 100m of external financing andplaces the Yen 1.1bn total cash on deposit with a bank in Japan, earning 0.1% interest per annum. The cash will bereinvested in Yen denominated financial instruments such as bonds and commercial paper. Newco has few staff thatmanage the entitys investing activities and incurs euro operational costs that are insignificant compared to theinterest paid on its Yen borrowing. Like any wholly-owned subsidiary, the retained profits are under the parentscontrol. In this example, Newco does not undertake any key operating activities on its own. Therefore, consideration of thecurrency that mainly influences sales and costs is not directly relevant. Therefore, it is necessary to look at thesecondary indicators. Consideration of the other factors appears to suggest that Newco is merely a ‘money-box type company with noindependent management/activity. Newco is simply a conduit for the parent entity that could readily invest the Yendirectly. It may be that the only reason the parent entity has invested the Yen through Newco is in the hope that itsexposure to changes in the euro/Yen exchange rate is reported in equity through the translation of its net investmentin Newco, rather than in the income statement that would be the case if the Yen deposits were treated as directlybelonging to the parent. The autonomy factor points to euro as the functional currency in that Newco is merely anextension of the activities of the parent. This would point to the functional currency being the same as that of itsparent, that is, euro in this example. This would be the answer if Newco carried out only the activities described.Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Effects of Changes in Foreign Exchange RatesIAS 21
  8. 8. 01-06-20138IAS 21 Definitions• Spot exchange rate:– The exchange rate for immediate delivery.• Closing rate:– The spot exchange rate at the end of the reportingperiod.• Monetary items:– Units of currency held;– And assets and liabilities to be received or paid in fixedor determinable number of units of currencyEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)CashBank balances and loan deposits*Accrued expenses / incomeTrade payables / receivablesTax payable / refundableDebt SecuritiesBad Debts allowances (because tradereceivables are monetary)Notes payable / receivableDeferred tax assets / liabilitiesPayables under finance leasesMonetary itemsProperty, plant and equipmentIntangible assetsGoodwillShareholder’s EquityPrepaid expenses*Investments in associatesAdvances received on sales or paid on purchasesInventoriesEquity securitiesProvisions to be settled by delivery of a non-monetaryassetNon-monetary items*Refundable – Monetary itemNon Refundable – Non-monetary
  9. 9. 01-06-20139Reporting foreign currency transactions in the functionalcurrency – Initial RecognitionKey StepsRecognize at the spot rate at the transaction dateMay use e.g. average rate for week or month as a practicalapproximation Average rates not reliable if currency fluctuatessignificantly In accounting policy note in FS disclose the policy,e.g. that rates at transaction dates are usedEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Reporting foreign currency transactions in the functionalcurrency – Subsequent MeasurementMonetaryItemsNon - monetaryItems at historical costRevaluednon-monetaryitemsRate at the reportingdateRate at the date oftransactionRate at the dateof valuationEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  10. 10. 01-06-201310Monetary Assets – Exchange gains and lossesMonetary AssetsRealizedExchange differencesRecognized in P/L (bothgains and losses)UnrealizedExchange differencesEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Non-monetary assetsUnderlying income/expenserecognized in P/LUnderlying income/expenserecognized inother comprehensive incomeExchange componentRecognized in P/LExchange componentRecognized in othercomprehensive incomeNon – monetary assets – Exchange gains and lossesEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  11. 11. 01-06-201311 Net investment in a foreign operation- the amount of the entity’s interest in the net assetsof that foreign operation If the settlement of monetary item receivable from or payable to a foreign operation isneither planned nor likely to occur in the foreseeable future, exchange differences on suchitem are recognized :– In profit or loss by both the reporting entity and the foreign operation in theirindividual financial statements– In other comprehensive income and accumulated in a separate component of equityin the consolidated financial statements• Accumulated exchange differences are reclassified from equity to profitor loss on disposal of the foreign operationExchange differences – Net investments in a foreign operationEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Assets and liabilitiesIncome and expensesRates at reporting dateRate at date of transaction(or average rate)All resulting exchange differences classified as a separatecomponent of equityReclassify to P/Lon disposalTranslation to the Presentation CurrencyEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  12. 12. 01-06-201312 Do not affect cash flows Are reported (net of tax) as a separate component of equity (inOCI) Are recognized in earnings when realized (i.e. when investmentin subsidiary is sold or liquidated) At which time, reclassify proportionately to gain/loss onsale or liquidation of net assets of subsidiaryForeign Currency Translation AdjustmentsEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)In addition to above, following procedures: Normal consolidation procedures Elimination of intra-group monetary asset/liability- not without showing results of currency fluctuations – inconsolidated P&L or consolidated OCI Difference in dates – adjustments after considering exchangerate Goodwill/FV adjustments on consolidation –closing rateTranslation of a Foreign OperationEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  13. 13. 01-06-201313 Exchange rate differences included in: P/L (except for financial instruments measured at FV) Other comprehensive income In accounting policy note disclose that P/L items aretranslated at rate at transaction datesSignificant DisclosuresEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Reasons (if applicable): Why there has been a change in the functional currency Why the presentation and functional currency are differentIf entity’s presentation currency is different from itsfunctional currency, its financial statements should onlybe described as compliant with IFRSs if all therequirements of IAS 21 are appliedAdditional disclosuresEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  14. 14. 01-06-201314 If entity’s additional financial information is displayed ina currency different from either its functional or itspresentation currency and all the requirements of IAS 21have not been met: Clearly identify such information as supplementary Disclose the currency of the supplementary information Disclose the entity’s functional currency and the method oftranslation used as a basis for presenting thesupplementary informationAdditional disclosures (continued)Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)An entity does not have a free choice of functional currencyTranslation of foreign currency assets and liabilities Monetary items at the reporting date’ Non-monetary items at the date of transaction or revaluation Unrealized and realized exchange gains and lossesrecognized in P/LSummaryEffects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  15. 15. 01-06-201315Monetary item forming part of a net investment in foreignoperation Exchange differences recognized in- other comprehensive income in the consolidated financialstatements- P or L in separate financial statementsTranslation into presentation currency Assets and liabilities at the reporting date Income, expenses and capital transactions at transactiondates Translation gain or loss recognized in other comprehensiveincomeSummary (Contd.)Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany) Goodwill and fair value adjustments arising from theacquisition of a foreign entity are treated asassets/liabilities of the foreign operation translated at therate at the reporting dateSummary (Contd.)Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)
  16. 16. 01-06-201316Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Effects of Changes in Foreign Exchange RatesIAS 21Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)Effects of Changes in Foreign Exchange RatesIAS 21
  17. 17. 01-06-201317Presenter’s contact detailsCA Pooja Guptacapooja@yahoo.com+91 – 9821504041www.capoojagupta.blogspot.inIFRS – International Financial Reporting StandardsEffects of Changes in Foreign Exchange RatesIAS 21

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