reserve or component of equity, then any period-end balance should represent the
cumulative translated amounts of such gains and losses. However, as IAS 21 is silent on
the matter it would seem that it would be acceptable to translate these equity balances
at the closing rate.
The treatment of equity balances that are subsequently reclassified to profit or loss, for
example cash flow hedge reserves of a foreign operation, typically depends on the
exchange rate used to translate the reclassification adjustments (a topic which is
discussed at 6.1.1 above). Where reclassification adjustments are translated using the
exchange rate at the date of reclassification, translating the equity balance at closing rate
should mean no residual balance is left in the reserve once the hedge accounting is
completely accounted for. Conversely, where reclassification adjustments are
translated using exchange rates at the dates the original gains or losses arose, an entity
would avoid a residual balance remaining in the reserve by not retranslating the equity
balance. However, whether such balances are maintained at the original translated
rates, or are translated at closing rates, the treatment has no impact on the overall equity
of the entity.
6.3
Exchange differences on intragroup balances
The incorporation of the results and financial position of a foreign operation with those
of the reporting entity should follow normal consolidation procedures, such as the
elimination of intragroup balances and intragroup transactions of a subsidiary. [IAS 21.45].
On this basis, there is a tendency sometimes to assume that exchange differences on
intragroup balances should not impact on the reported profit or loss for the group in the
consolidated financial statements. However, an intragroup monetary asset (or liability),
whether short-term or long-term, cannot be eliminated against the corresponding
intragroup liability (or asset) without the entity with the currency exposure recognising
an exchange difference on the intragroup balance.
This exchange difference will be reflected in that entity’s profit or loss for the period
(see 5.3.1 above) and, except as indicated below, IAS 21 requires this exchange
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difference to continue to be included in profit or loss in the consolidated financial
statements. This is because the monetary item represents a commitment to convert one
currency into another and exposes the reporting entity to a gain or loss through
currency fluctuations.
6.3.1
Monetary items included as part of the net investment in a foreign
operation – general
As an exception to the general rule at 6.3 above, where an exchange difference arises
on an intragroup balance that, in substance, forms part of an entity’s net investment in a
foreign operation, then the exchange difference is not to be recognised in profit or loss
in the consolidated financial statements, but is recognised in other comprehensive
income and accumulated in a separate component of equity until the disposal of the
foreign operation (see 6.6 below). [IAS 21.32, 45].
The ‘net investment in a foreign operation’ is defined as being ‘the amount of the
reporting entity’s interest in the net assets of that operation’. [IAS 21.8]. This will include
a monetary item that is receivable from or payable to a foreign operation for which
settlement is neither planned nor likely to occur in the foreseeable future (often referred
to as a ‘permanent as equity’ loan) because it is, in substance, a part of the entity’s net
investment in that foreign operation. Such monetary items may include long-term
receivables or loans. They do not include trade receivables or trade payables. [IAS 21.15].
In our view, trade receivables and payables can be included as part of the net investment
in the foreign operation, but only if cash settlement is not made or planned to be made in
the foreseeable future. However, if a subsidiary makes payment for purchases from its
parent, but is continually indebted to the parent as a result of new purchases, then in these
circumstances, since individual transactions are settled, no part of the inter-company
balance should be regarded as part of the net investment in the subsidiary. Accordingly,
exchange differences on such balances should be recognised in profit or loss.
These requirements are illustrated in the following example.
Example 15.12: Receivables/payables included as part of net investment in a
foreign operation
A UK entity, A, has a Belgian subsidiary, B. A has a receivable due from B amounting to £1,000,000.
In each of the following scenarios, could the receivable be included as part of A’s net investment in B?
Scenario 1
The receivable arises from the sale of goods, together with interest payments and dividend payments which
have not been paid in cash but have been accumulated in the inter-company account. A and B agree that A
can claim at any time the repayment of this receivable. It is likely that there will be a settlement of the
receivable in the foreseeable future.
Although the standard states that trade receivables and payables are not included, we do not believe that it
necessarily precludes deferred trading balances from being included. In our view, such balances can be
included as part of the net investment in the foreign operation, but only if cash settlement is not made or
planned to be made in the foreseeable future.
In this scenario, the settlement of A’s receivable due from B is not planned; however, it is likely that a
settlement will occur in the foreseeable future. Accordingly, the receivable does not qualify to be treated as
part of A’s net investment in B. The term ‘foreseeable future’ is not defined and no specific time period is
implied. It could be argued that the receivable should only be considered as part of the net investment if it
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will be repaid only when the reporting entity disinvests from the foreign operation. However, it is recognised
that in most circumstances this would be unrealistic and therefore a shorter time span should be considered
in determining the foreseeable future.
Scenario 2
The receivable represents a loan made by A to B and it is agreed that the receivable will be repaid in 20 years.
In this scenario, A’s receivable due from B has a specified term for repayment. This suggests that settlement
is planned. Accordingly, the receivable does not qualify to be treated as part of A’s investment in B.
Scenario 3
A and B have previously agreed that the receivable under scenario 2 will be repaid in 20 years but A now
decides that it will replace the loan on maturity either with a further inter-company loan or with an injection
of equity. This approach is consistent with A’s intention to maintain the strategic long-term investment in B.
In this scenario, the words from paragraph 15 of IAS 21 ‘... settlement is neither planned nor likely to occur
in the foreseeable future ...’ are potentially problematic, since a loan with a fixed maturity must, prima facie,
have a planned settlement. However, from the date A decides that it will re-finance the inter-company debt
upon maturity with a further long-term instrument, or re
place it with equity, the substance of the inter-
company loan is that it is part of the entity’s net investment in the foreign operation, and there is no actual
‘intent’ to settle the investment without replacement. On this basis, loans with a stated maturity may qualify
to be treated in accordance with paragraph 32 of IAS 21, with foreign currency gains and losses recognised
in other comprehensive income and accumulated in a separate component of equity in the consolidated
financial statements. However, in our view, management’s intention to refinance the loan must be
documented appropriately, for example in the form of a minute of a meeting of the management board or
board of directors. In addition, there should not be any established historical pattern of the entity demanding
repayment of such inter-company debt without replacement.
Consequently, when the purpose of the loan is to fund a long-term strategic investment then it is the entity’s
overall intention with regard to the investment and ultimate funding thereof, rather than the specific terms of
the inter-company loan funding the investment, that should be considered.
Scenario 4
The receivable arises from the sale of goods, together with interest payments and dividend payments which
have not been paid in cash but have been accumulated in the inter-company account. However, in this
scenario, A and B agree that A can claim the repayment of this receivable only in the event that the subsidiary
is disposed of. A has no plans to dispose of entity B.
In this scenario, the settlement of A’s receivable due from B is not planned nor is it likely to occur in the
foreseeable future. Although the term ‘foreseeable future’ is not defined, it will not go beyond a point of time
after the disposal of a foreign operation. Accordingly, the receivable does qualify for being treated as part of
a net investment in a foreign operation.
The question of whether or not a monetary item is as permanent as equity can, in certain
circumstances, require the application of significant judgement.
6.3.2
Monetary items included as part of the net investment in a foreign
operation – currency of the monetary item
When a monetary item is considered to form part of a reporting entity’s net investment
in a foreign operation and is denominated in the functional currency of the reporting
entity, an exchange difference will be recognised in profit or loss for the period when it
arises in the foreign operation’s individual financial statements. If the item is
denominated in the functional currency of the foreign operation, an exchange
difference will be recognised in profit or loss for the period when it arises in the
reporting entity’s separate financial statements. Such exchange differences are only
recognised in other comprehensive income and accumulated in a separate component
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of equity in the financial statements that include the foreign operation and the reporting
entity (i.e. financial statements in which the foreign operation is consolidated or
accounted for using the equity method). [IAS 21.32, 33].
Example 15.13: Monetary item in functional currency of either the reporting
entity or the foreign operation
A UK entity has a Belgian subsidiary. On the last day of its financial year, 31 March 2018, the UK entity
lends the subsidiary £1,000,000. Settlement of the loan is neither planned nor likely to occur in the foreseeable
future, so the UK entity regards the loan as part of its net investment in the Belgian subsidiary. The exchange
rate at 31 March 2018 was £1=€1.40. Since the loan was made on the last day of the year there are no
exchange differences to recognise for that year. At 31 March 2019, the loan has not been repaid and is still
regarded as part of the net investment in the Belgian subsidiary. The relevant exchange rate at that date was
£1=€1.50. The average exchange rate for the year ended 31 March 2019 was £1=€1.45.
In the UK entity’s separate financial statements no exchange difference is recognised since the loan is
denominated in its functional currency of pound sterling. In the Belgian subsidiary’s financial
statements, the liability to the parent is translated into the subsidiary’s functional currency of euros at
the closing rate at €1,500,000, giving rise to an exchange loss of €100,000, i.e. €1,500,000 less
€1,400,000 (£1,000,000 @ £1=€1.40). This exchange loss is reflected in the Belgian subsidiary’s profit
or loss for that year. In the UK entity’s consolidated financial statements, this exchange loss included
in the subsidiary’s profit or loss for the year will be translated at the average rate for the year, giving
rise to a loss of £68,966 (€100,000@ £1=€1.45). This will be recognised in other comprehensive income
and accumulated in the separate component of equity together with an exchange gain of £2,299, being
the difference between the amount included in the Belgian subsidiary’s income statement translated at
average rate, i.e. £68,966, and at the closing rate, i.e. £66,667 (€100,000@ £1=€1.50). The overall
exchange loss recognised in other comprehensive income is £66,667. This represents the exchange loss
on the increased net investment of €1,400,000 in the subsidiary made at 31 March 2018, i.e. £1,000,000
(€1,400,000 @ £1=€1.40) less £933,333 (€1,400,000 @ £1=€1.50).
If, on the other hand, the loan made to the Belgian subsidiary had been denominated in the equivalent amount
of euros at 31 March 2018, i.e. €1,400,000, the treatment would have been as follows:
In the UK entity’s separate financial statements, the amount receivable from the Belgian subsidiary would be
translated at the closing rate at £933,333 (€1,400,000 @ £1=€1.50), giving rise to an exchange loss of
£66,667, i.e. £1,000,000 (€1,400,000 @ £1=€1.40) less £933,333, which is included in its profit or loss for
the year. In the Belgian subsidiary’s financial statements, no exchange difference is recognised since the loan
is denominated in its functional currency of euros. In the UK entity’s consolidated financial statements, the
exchange loss included in its profit or loss for the year in its separate financial statements will be recognised
in other comprehensive income and accumulated in the separate component of equity. As before, this
represents the exchange loss on the increased net investment of €1,400,000 in the subsidiary made at
31 March 2018, i.e. £1,000,000 (€1,400,000 @ £1=€1.40) less £933,333 (€1,400,000 @ £1=€1.40).
In most situations, intragroup balances for which settlement is neither planned nor likely
to occur in the foreseeable future will be denominated in the functional currency of
either the reporting entity or the foreign operation. However, this will not always be the
case. If a monetary item is denominated in a currency other than the functional currency
of either the reporting entity or the foreign operation, the exchange difference arising
in the reporting entity’s separate financial statements and in the foreign operation’s
individual financial statements are also recognised in other comprehensive income and
accumulated in the separate component of equity in the financial statements that
include the foreign operation and the reporting entity (i.e. financial statements in which
the foreign operati
on is consolidated or accounted for using the equity method).
[IAS 21.33].
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6.3.3
Monetary items included as part of the net investment in a foreign
operation – treatment in the individual financial statements
The exception for exchange differences on monetary items forming part of the net
investment in a foreign operation applies only in the financial statements that include
the foreign operation (for example consolidated financial statements when the foreign
operation is a subsidiary). In the individual financial statements of the entity (or entities)
with the currency exposure the exchange differences have to be reflected in that entity’s
profit or loss for the period.
6.3.4
Monetary items transacted by other members of the group
As illustrated in the examples above, the requirements of IAS 21 whereby exchange
differences on a monetary item that forms part of the net investment in a foreign
operation are recognised in other comprehensive income clearly apply where the
monetary item is transacted between the parent preparing the consolidated financial
statements and the subsidiary that is the foreign operation. However, loans from any
entity (and in any currency) qualify for net investment treatment, so long as the
conditions of paragraph 15 are met. [IAS 21.15A].
6.3.5
Monetary items becoming part of the net investment in a foreign
operation
An entity’s plans and expectations in respect of an intragroup monetary item may
change over time and the status of such items should be assessed each period. For
example, a parent may decide that its subsidiary requires refinancing and instead of
investing more equity capital in the subsidiary decides that an existing inter-company
account, which has previously been regarded as a normal monetary item, should
become a long-term deferred trading balance and no repayment of such amount will be
requested within the foreseeable future. In our view, such a ‘capital injection’ should be
regarded as having occurred at the time it is decided to redesignate the inter-company
account. Consequently, the exchange differences arising on the account up to that date
should be recognised in profit or loss and the exchange differences arising thereafter
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 227