Foreign Currency Translations - IAS 21 - CA Pooja Gupta

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Presented by CA. Pooja Gupta – B.Com, FCA, LL.B, CS, Masters in Finance (Germany)

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 Transactions in foreign currencies
 Foreign operations
 Subsidiaries
 Associates
 JVs
 Branches
 Translate financial statements into a presentation currency
What are Foreign Activities?
Effects of Changes in Foreign Exchange Rates
IAS 21
Conceptual Issues
• Foreign country operations usually prepare financial statements using
local currency as the monetary unit. These financial statements must
be translated into home country currency.
• These operations also typically use local GAAP. Financial statements
must be translated into home country GAAP.
• Which exchange rates to be used ?
• How to report effects of changes in exchange rates in the financial
statements ?
IAS 21

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IAS 21 Definitions
Functional Currency
The currency of the primary economic environment in
which the entity operates
Foreign Currency
A currency other than the functional currency of an entity
Presentation Currency
The currency in which the financial statements are presented
IAS 21 Definitions
IAS 21
• 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 transactions
in rupees. It has issued euro-denominated share capital to its German
parent. Transactions with the parent are denominated in euros.
• The rupees transactions and euro transactions are foreign currency
transactions. The entity's physical location and the denomination of its
share capital do not change the treatment of rupees and euro
denominated transactions. This is because the entity has a US dollar
functional currency and, therefore, all transactions in other currencies
are foreign currency transactions.
IAS 21

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IAS 21
The
currency
That mainly influences the price at which goods & services
are sold
Of the country whose competitive forces and regulations
mainly influence the entity’s pricing structure
That influences the costs of the entity
In which funds are generated
In which receipts from operating activities are retained
Functional Currency Indicators
Determination 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 whether
readily available for remittance;
 Cash flows sufficient for debt obligations.
IAS 21

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Choice of functional currency?
 An entity does not have a free choice of functional currency
 An entity cannot change functional currency unless facts and
circumstances relevant to its determination change
 When the indicators are mixed and the functional currency is not
obvious, management should use judgment to determine the functional
currency that most faithfully represents the economic effects of
transactions, events and conditions. As a part of this approach
management should give priority to first three indicators mentioned
earlier.
IAS 21
Identifying the functional currency
IAS 21
V Co has identified the Euro as its functional currency. V Co establishes two
entities, N Co and A Co. N Co is incorporated in India and A Co is incorporated
in Australia. The following transactions occurred:
• V Co loaned AUD 2 million each to N Co and A Co and both recognized the
advance as an intragroup payable;
• A Co borrowed additional AUD 3 million from an unrelated 3rd party. N Co
guaranteed this 3rd party loan;
• A Co invested its entire AUD 5 million in building a manufacturing facility to
serve domestic Australian market . A Co intends to repay the loan to the 3rd
party from the profit generated through its manufacturing operations; and
• N Co used its AUD 2 million loan from V Co to invest in marketable
securities in international markets . Its investing strategies are determined
by V Co.
• What are the functional currencies of N Co and A Co?

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Identifying the functional currency – Contd..
IAS 21
• The functional currency identified for an entity should provide information about the
entity that is useful and reflects the economic substance of the underlying events
and circumstances relevant to that entity. If a particular currency is used to a
significant extent in, or has a significant impact on, the entity, that currency may be
appropriate currency to be used as the functional currency.
• In the circumstances described, it is likely that AUD would be identified as A Co’s
functional currency because that is the currency of the country that influences the
sale prices and costs of its goods, as well as the regulations and competitive forces
under which it operates.
• On the other hand, even though N Co is domiciled in India, it does not appear to
have a significant degree of autonomy and its activities (investing in marketable
securities) appear to be carried out as an extension of V Co. Consequently, it is
likely 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 is
denominated and settled in US dollars. The oil price is subject to the worldwide supply
and demand and crude oil is routinely traded in US dollars around the world. Around
45% of entity A’s cash costs are imports or expatriate salaries denominated in US
dollars. The remaining 55% of cash expenses are incurred in Saudi Arabia and
denominated and settled in Riyal. The non-cash costs (depreciation) are US dollar
denominated since the initial investment was in US dollars.
IAS 21
In this case, the functional currency of entity A is the US dollar. Crude oil is globally
traded in US dollars around the world. The revenue analysis clearly points to the US
dollar. The cost analysis is mixed. Depreciation (or any other non-cash expenses) is not
considered, because the primary economic environment is where the entity generates
and expends cash. Operating cash expenses are influenced by the Riyal (55%) and the
US dollar (45%). Management is able to determine the functional currency as the US
dollar, because the revenue is clearly influenced by the US dollar and expenses are
mixed.

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• Entity A is the holding company and has been set up by institutional investors in Cyprus. Entity A
has obtained equity and loan financing and has invested in India. It pools cash from all group
entities, invests excess cash and obtains external financing, according to the group’s needs. The
majority of its financing is drawn in US dollars and all of its assets are denominated in US
dollars.
• Entity A’s functional currency is the Indian Rupees. The currency that reflects the economic
substance of the underlying economic events is the Indian Rupees, because all of the
subsidiaries of the holding entity operate in India and the primary source of income of entity A
will be from India. The ability of entity A to service debts and pay dividends to shareholders is
dependant on the Indian economy.
Entity A ??
Entity B – FC
is INR
Entity C – FC
is INR
Entity D – FC
is INR
IAS 21
Functional currency of a ‘money-box’ entity
 A French listed parent has significant French, UK and US operating subsidiaries, but no Japanese operations. The
French parent creates a new subsidiary incorporated and resident in France, Newco SA. Newco issues in Yen, 1bn of
equity capital to French parent, receiving Yen 1bn of cash. Newco also raises Yen 100m of external financing and
places the Yen 1.1bn total cash on deposit with a bank in Japan, earning 0.1% interest per annum. The cash will be
reinvested in Yen denominated financial instruments such as bonds and commercial paper. Newco has few staff that
manage the entity's investing activities and incurs euro operational costs that are insignificant compared to the
interest paid on its Yen borrowing. Like any wholly-owned subsidiary, the retained profits are under the parent's
control.
 In this example, Newco does not undertake any key operating activities on its own. Therefore, consideration of the
currency that mainly influences sales and costs is not directly relevant. Therefore, it is necessary to look at the
secondary indicators.
 Consideration of the other factors appears to suggest that Newco is merely a ‘money-box' type company with no
independent management/activity. Newco is simply a conduit for the parent entity that could readily invest the Yen
directly. It may be that the only reason the parent entity has invested the Yen through Newco is in the hope that its
exposure to changes in the euro/Yen exchange rate is reported in equity through the translation of its net investment
in Newco, rather than in the income statement that would be the case if the Yen deposits were treated as directly
belonging to the parent. The 'autonomy factor' points to euro as the functional currency in that Newco is merely an
extension of the activities of the parent. This would point to the functional currency being the same as that of its
parent, that is, euro in this example. This would be the answer if Newco carried out only the activities described.
IAS 21

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IAS 21 Definitions
• Spot exchange rate:
– The exchange rate for immediate delivery.
• Closing rate:
– The spot exchange rate at the end of the reporting
period.
• Monetary items:
– Units of currency held;
– And assets and liabilities to be received or paid in fixed
or determinable number of units of currency
IAS 21
IAS 21
Cash
Bank balances and loan deposits*
Accrued expenses / income
Trade payables / receivables
Tax payable / refundable
Debt Securities
Bad Debts allowances (because trade
receivables are monetary)
Notes payable / receivable
Deferred tax assets / liabilities
Payables under finance leases
Monetary items
Property, plant and equipment
Intangible assets
Goodwill
Shareholder’s Equity
Prepaid expenses*
Investments in associates
Advances received on sales or paid on purchases
Inventories
Equity securities
Provisions to be settled by delivery of a non-monetary
asset
Non-monetary items
*Refundable – Monetary item
Non Refundable – Non-monetary

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Reporting foreign currency transactions in the functional
currency – Initial Recognition
Key Steps
Recognize at the spot rate at the transaction date
May use e.g. average rate for week or month as a practical
approximation
 Average rates not reliable if currency fluctuates
significantly
 In accounting policy note in FS disclose the policy,
e.g. that rates at transaction dates are used
IAS 21
Reporting foreign currency transactions in the functional
currency – Subsequent Measurement
Monetary
Items
Non - monetary
Items at historical cost
Revalued
non-monetary
items
Rate at the reporting
date
Rate at the date of
transaction
Rate at the date
of valuation
IAS 21

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Monetary Assets – Exchange gains and losses
Monetary Assets
Realized
Exchange differences
Recognized in P/L (both
gains and losses)
Unrealized
Exchange differences
IAS 21
Non-monetary assets
Underlying income/expense
recognized in P/L
Underlying income/expense
recognized in
other comprehensive income
Exchange component
Recognized in P/L
Exchange component
Recognized in other
comprehensive income
Non – monetary assets – Exchange gains and losses
IAS 21

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 Net investment in a foreign operation- the amount of the entity’s interest in the net assets
of that foreign operation
 If the settlement of monetary item receivable from or payable to a foreign operation is
neither planned nor likely to occur in the foreseeable future, exchange differences on such
item are recognized :
– In profit or loss by both the reporting entity and the foreign operation in their
individual financial statements
– In other comprehensive income and accumulated in a separate component of equity
in the consolidated financial statements
• Accumulated exchange differences are reclassified from equity to profit
or loss on disposal of the foreign operation
Exchange differences – Net investments in a foreign operation
IAS 21
Assets and liabilities
Income and expenses
Rates at reporting date
Rate at date of transaction
(or average rate)
All resulting exchange differences classified as a separate
component of equity
Reclassify to P/L
on disposal
Translation to the Presentation Currency
IAS 21

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 Do not affect cash flows
 Are reported (net of tax) as a separate component of equity (in
OCI)
 Are recognized in earnings when realized (i.e. when investment
in subsidiary is sold or liquidated)
 At which time, reclassify proportionately to gain/loss on
sale or liquidation of net assets of subsidiary
Foreign Currency Translation Adjustments
IAS 21
In addition to above, following procedures:
 Normal consolidation procedures
 Elimination of intra-group monetary asset/liability
- not without showing results of currency fluctuations – in
consolidated P&L or consolidated OCI
 Difference in dates – adjustments after considering exchange
rate
 Goodwill/FV adjustments on consolidation –closing rate
Translation of a Foreign Operation
IAS 21

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 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 are
translated at rate at transaction dates
Significant Disclosures
IAS 21
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 its
functional currency, its financial statements should only
be described as compliant with IFRSs if all the
requirements of IAS 21 are applied
Additional disclosures
IAS 21

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 If entity’s additional financial information is displayed in
a currency different from either its functional or its
presentation currency and all the requirements of IAS 21
have 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 of
translation used as a basis for presenting the
supplementary information
Additional disclosures (continued)
IAS 21
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 losses
recognized in P/L
Summary
IAS 21

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Monetary item forming part of a net investment in foreign
operation
 Exchange differences recognized in
- other comprehensive income in the consolidated financial
statements
- P or L in separate financial statements
Translation into presentation currency
 Assets and liabilities at the reporting date
 Income, expenses and capital transactions at transaction
dates
 Translation gain or loss recognized in other comprehensive
income
Summary (Contd.)
IAS 21
 Goodwill and fair value adjustments arising from the
acquisition of a foreign entity are treated as
assets/liabilities of the foreign operation translated at the
rate at the reporting date
Summary (Contd.)
IAS 21

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IAS 21
IAS 21

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Presenter’s contact details
CA Pooja Gupta
capooja@yahoo.com
+91 – 9821504041
www.capoojagupta.blogspot.in
IFRS – International Financial Reporting Standards
IAS 21

Foreign Currency Translations - IAS 21 - CA Pooja Gupta

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