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Financial Reporting
Lecture 11 & 12
IAS 21 Effect of Changes in Foreign Exchange Rates
Foreign Subsidiary Consolidation
Practice and Revision
Definitions
Closing rate is the spot exchange rate at the end of the reporting period.
Exchange difference is the difference resulting from translating a given number of units of one currency into
another currency at different exchange rates.
Exchange rate is the ratio of exchange for two currencies.
Foreign currency(FCY) is a currency other than the functional currency of the entity.
Foreign operation(FO) is an entity that is a subsidiary, associate, JV 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 is the currency of the primary economic environment in which the entity operates.
Monetary items are units of currency held and assets and liabilities to be received
or paid in a fixed or determinable number of units of currency.
Net investment in a foreign operation is the amount of the reporting entitys interest in the net assets of that
operation.
Presentation currency (PC)is the currency in which the FS are presented.
Monetary items Closing rate (i.e. the spot exchange rate at the end of the
reporting period)
Non-monetary items measured at historical Cost Rate of exchange at the date of the original transaction
(i.e. the date of purchase of the non-current asset)
Non-monetary items measured at fair value Exchange rate at the date when fair value was determined
On 29 November 2007, Warrilow received a loan from a foreign bank for N$1,520,000. The proceeds
were used to finance, in part, the purchase of a new office block. The loan remained unsettled at the
year end.
Exchange rates:
29 November 2007 CU1 = N$1.52
31 December 2007 CU1 = N$1.66
The following amounts should be recorded by Warrilow, ignoring interest payable on the loan.
29 November 2007
The cash advance from the bank is translated at the rate on the date that it was received (N$1,520,000 /
1.52 = CU1,000,000) and a liability recorded for the same amount.
31 December 2007
As the loan was still outstanding at the end of the period and it is a monetary item, it should be
retranslated at the exchange rate at the end of the reporting period (N$1,520,000 / 1.66 = CU915,663 ).
The exchange difference should be recognised as a gain in profit or loss for the period. (CU1,000,000
less CU915,663 = CU84,337).
(b) If the supplier had remained unpaid at the year-end, the following transactions would have been recognised:
25 October 2007.
The initial transaction is recorded as above at CU25,627.
31 December 2007.
The year-end balance is retranslated at the year-end exchange rate as it is a monetary liability. (N$286,000 / 11.25 =
CU25,422) The difference should be reported as part of the profit or loss for the period. The exchange gain
recognised in profit or loss will be CU205 (CU25,627 less CU25,422 = CU205). The value of inventories at the year end
will be CU25,627 (as recorded above).
IAS 21, Consolidation of Foreign Subsidiary Practice Qs 11
Net Investment in a Foreign Operation
An entity may have a monetary amount receivable from, or payable to, a foreign entity (for
example an overseas subsidiary) that is not intended to be settled in the foreseeable future.
For a receivable, this amount essentially forms part of the overall investment in the foreign
entity. At the period-end, monetary amounts such as this are retranslated and any
differences recognised in profit or loss of the appropriate entity. But IAS 21 operates on the
basis that as such differences are part of the overall investment in the foreign entity, they
should only be recognised in profit or loss when the foreign entity is disposed of.
In the preparation of the consolidated FS, any exchange difference arising from the net
investment in a foreign operation should be reported initially in OCI and not in the
consolidated profit or loss for the period. If the foreign entity is subsequently sold, any such
exchange differences will form part of the reported profit or loss on disposal by reclassifying
the amount from equity to profit or loss.
The loan could be made by a group entity other than the parent entity. For example, an
entity has two subsidiaries, A and B. Subsidiary B is a foreign operation. Subsidiary A grants a
loan to Subsidiary B. Subsidiary As loan receivable from Subsidiary B would be part of the
entitys net investment in Subsidiary B if settlement of the loan is neither planned nor likely
to occur in the foreseeable future. This would also be true if Subsidiary A were itself a foreign
operation.
It is only differences relating to the overall investment in the foreign entity which are
recognised in other comprehensive income; differences on intra-group trading balances
which will be settled in the short term remain in the profit or loss of the period.
IAS 21, Consolidation of Foreign Subsidiary
12
Practice Qs
Change in Functional Currency
If the underlying economic activities change in
such a way that there is a change in the
functional currency of an entity, the new
functional currency should be applied
prospectively from the date of the change in
circumstances.
The entity should not restate amounts previously
recorded as these reflected the economic reality
at that time.
All amounts should be retranslated into the new
functional currency at the date of the change.
IAS 21, Consolidation of Foreign Subsidiary
13
Practice Qs
Translation into Presentation Currency
Procedures for translation into presentation currency
The translation into a PC can be undertaken by an individual entity, if it decides to present its FS in a currency
different to its functional currency.
Much more commonly, it is undertaken when entities within a group have functional currencies different from
the PC of the parent. For the preparation of the groups CFS, such entities will need to retranslate their FS into
the PC being used.
The steps to translate financial statements into a different presentation currency are:
retranslate the assets and liabilities for each SFP presented (i.e. the current period end and the
comparative period) at the closing rate at the date of that statement of financial position;
retranslate income and expenditure recorded in each SCI presented (i.e. the current period and the
comparative period) at the exchange rates at the dates of the transactions; for practical reasons an
average rate may be used for each period, assuming that the exchange rate does not fluctuate
significantly during the period; and
recognise all resulting exchange differences in other comprehensive income.
Where exchange differences relate to a FO that is not wholly owned, accumulated exchange differences
attributable to the NCI should be allocated to NCI in the consolidated SFP.
Hyperinflationary economies
Where an entity has a functional currency that is the currency of a hyperinflationary economy, it is required to
restate its functional currency FS in accordance with IAS 29
If, however, such an entity chooses to use a different PC, the requirements in IAS 21 for the retranslation of the
FS into the PC should be applied