International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

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  a very simple structure with operations having only two functional currencies, a short

  Foreign

  exchange

  1169

  history and few (external and internal) equity transactions. Whilst entities should strive for

  a theoretically perfect restatement, in practice it is unlikely to be such an easy exercise.

  As noted above, where an accounting policy is changed, IAS 8 requires retrospective

  application except to the extent that this is impracticable, in which case an entity should

  adjust the comparative information to apply the new accounting policy prospectively

  from the earliest practicable date. A similar approach is, in our view, appropriate when

  an entity changes its presentation currency. In this context the most important

  component of equity to determine correctly (or as near correctly as possible) is normally

  the foreign exchange reserve because that balance, or parts of it, has to be reclassified

  from equity to profit or loss in the event of any future disposal of the relevant foreign

  operation, and could therefore affect future earnings.

  Where an entity applies the direct method of consolidation, it could be impracticable to

  determine precisely the amount of exchange differences accumulated within the

  separate component of equity relating to each individual entity within the group. In

  these circumstances, approximations will be necessary to determine the amounts at the

  beginning of the earliest comparative period presented, although all subsequent

  exchange differences should be accumulated in accordance with the requirements of

  IAS 21. For an entity that set its foreign exchange reserve to zero on transition to IFRS

  (see Chapter 5 at 5.7) it may be able to go back to that date and recompute the necessary

  components of equity. This should be less of an issue for entities applying the step-by-

  step method.

  BBA Aviation changed its presentation currency in 2011 and included the following

  explanation in its accounting policies.

  Extract 15.5: BBA Aviation plc (2011)

  Accounting policies [extract]

  Presentation currency

  The Group’s revenues, profits and cash flows are primarily generated in US dollars, and are expected to remain

  principally denominated in US dollars in the future. During the year, the Group changed the currency in which it

  presents its consolidated financial statements from pounds sterling to US dollars, in order to better reflect the

  underlying performance of the Group.

  A change in presentation currency is a change in accounting policy which is accounted for retrospectively. Statutory

  financial information included in the Group’s Annual Report and Accounts for the year ended 31 December 2010

  previously reported in sterling has been restated into US dollars using the procedures outlined below:

  –

  assets and liabilities denominated in non-US dollar currencies were translated into US dollars at the closing

  rates of exchange on the relevant balance sheet date;

  –

  non-US dollar income and expenditure were translated at the average rates of exchange prevailing for the

  relevant period;

  –

  the cumulative hedging and translation reserves were set to nil at 1 January 2004, the date of transition to IFRS,

  and these reserves have been restated on the basis that the Group has reported in US dollars since that date.

  Share capital, share premium and the other reserves were translated at the historic rates prevailing at 1 January

  2004, and subsequent rates prevailing on the date of each transaction;

  –

  all exchange rates were extracted from the Group’s underlying financial records.

  1170 Chapter 15

  8

  INTRODUCTION OF THE EURO

  From 1 January 1999, the effective start of Economic and Monetary Union (EMU), the

  euro became a currency in its own right and the conversion rates between the euro and

  the national currencies of those countries who were going to participate in the first

  phase were irrevocably fixed, such that the risk of subsequent exchange differences

  related to these currencies was eliminated from that date on.

  In October 1997, the SIC issued SIC-7 which deals with the application of IAS 21 to the

  changeover from the national currencies of participating Member States of the

  European Union to the euro. Consequential amendments have been made to this

  interpretation as a result of the IASB’s revised version of IAS 21.

  Although the Interpretation is no longer relevant with respect to the national currencies

  of those countries that participated in the first phase, SIC-7 makes it clear that the same

  rationale applies to the fixing of exchange rates when countries join EMU at later stages.

  [SIC-7.3].

  Under SIC-7, the requirements of IAS 21 regarding the translation of foreign currency

  transactions and financial statements of foreign operations should be strictly applied to

  the changeover. [SIC-7.3].

  This means that, in particular:

  (a) Foreign currency monetary assets and liabilities resulting from transactions should

  continue to be translated into the functional currency at the closing rate. Any

  resultant exchange differences should be recognised as income or expense

  immediately, except that an entity should continue to apply its existing accounting

  policy for exchange gains and losses related to hedges of the currency risk of a

  forecast transaction. [SIC-7.4].

  The effective start of the EMU after the reporting period does not change the

  application of these requirements at the end of the reporting period; in accordance

  with IAS 10 – Events after the Reporting Period – it is not relevant whether or not

  the closing rate can fluctuate after the reporting period. [SIC-7.5].

  Like IAS 21, the Interpretation does not address how foreign currency hedges should

  be accounted for. The effective start of EMU, of itself, does not justify a change to

  an entity’s established accounting policy related to hedges of forecast transactions

  because the changeover does not affect the economic rationale of such hedges.

  Therefore, the changeover should not alter the accounting policy where gains and

  losses on financial instruments used as hedges of forecast transactions are initially

  recognised in other comprehensive income and reclassified from equity to profit or

  loss to match with the related income or expense in a future period; [SIC-7.6]

  (b) Cumulative exchange differences relating to the translation of financial statements

  of foreign operations recognised in other comprehensive income should remain

  accumulated in a separate component of equity and be reclassified from equity to

  profit or loss only on the disposal (or partial disposal) of the net investment in the

  foreign operation. [SIC-7.4].

  Foreign

  exchange

  1171

  The fact that the cumulative amount of exchange differences will be fixed under

  EMU does not justify immediate recognition as income or expenses since the

  wording and the rationale of IAS 21 clearly preclude such a treatment. [SIC-7.7].

  9

  TAX EFFECTS OF ALL EXCHANGE DIFFERENCES

  Gains and losses on foreign currency transactions and exchange differences arising on

  translating the results and financial position
of an entity (including a foreign operation)

  into a different currency may have tax effects to which IAS 12 applies. [IAS 21.50]. The

  requirements of IAS 12 are discussed in Chapter 29. In broad terms the tax effects of

  exchange differences will follow the reporting of the exchange differences, i.e. they will

  be recognised in profit or loss except to the extent they relate to exchange differences

  recognised in other comprehensive income, in which case they will also be recognised

  in other comprehensive income. [IAS 12.58].

  The tax base of a non-monetary asset such as property, plant or equipment, will

  sometimes be determined in a currency other than the entity’s functional currency.

  Consequently, changes in the exchange rate will give rise to temporary differences

  that result in a recognised deferred tax liability or asset (subject to recoverability).

  The resulting deferred tax should be recognised in profit or loss [IAS 12.41] and

  presented with other deferred taxes rather than with foreign exchange gains or

  losses (see Chapter 29 at 10.1.1).20

  10 DISCLOSURE

  REQUIREMENTS

  10.1 Exchange

  differences

  IAS 21 requires the amount of exchange differences recognised in profit or loss (except

  for those arising on financial instruments measured at fair value through profit or loss in

  accordance with IFRS 9) to be disclosed. [IAS 21.52]. Since IAS 21 does not specify where

  such exchange differences should be presented in the income statement entities should

  apply judgement in the light of the requirements of IAS 1 – Presentation of Financial

  Statements – to determine the appropriate line item(s) in which exchange differences

  are included. For example, an entity which has an operating and a financing section

  within its income statement might include exchange differences arising on operating

  items (such as trade payables and receivables) in other operating income or expense and

  exchange differences on financing items (such as loans and borrowings) in the financing

  section. In the light of this, we recommend that entities in disclosing the amount of such

  exchange differences indicate the line item(s) in which they are included. Further, the

  classification of exchange differences (both gains and losses) arising from transactions

  of a similar nature should be classified consistently throughout the periods presented.

  The standard also requires disclosure of the net exchange differences recognised in

  other comprehensive income and accumulated in a separate component of equity, and

  a reconciliation of such amounts at the beginning and end of the period. [IAS 21.52].

  1172 Chapter 15

  10.2 Presentation and functional currency

  When the presentation currency is different from the functional currency, that fact

  should be stated, together with disclosure of the functional currency and the reason for

  using a different presentation currency. [IAS 21.53]. For this purpose, in the case of a

  group, the references to ‘functional currency’ are to that of the parent. [IAS 21.51].

  When there is a change in the functional currency of either the reporting entity or a

  significant foreign operation, that fact and the reason for the change in functional

  currency should be disclosed. [IAS 21.54].

  10.3 Convenience translations of financial statements or other

  financial information

  Paragraph 55 of IAS 21 indicates that when an entity presents its financial statements in

  a currency that is different from its functional currency, it should describe the financial

  statements as complying with IFRS only if they comply with all the requirements of each

  applicable standard and interpretation of those standards, including the translation

  method set out in IAS 21 (see 6.1 above). [IAS 21.55].

  However, the standard recognises that an entity sometimes presents its financial

  statements or other financial information in a currency that is not its functional currency

  without meeting the above requirements. Examples noted by IAS 21 are where an entity

  converts into another currency only selected items from its financial statements or

  where an entity whose functional currency is not the currency of a hyperinflationary

  economy converts the financial statements into another currency by translating all items

  at the most recent closing rate. Such conversions are not in accordance with IFRS;

  nevertheless IAS 21 requires disclosures to be made. [IAS 21.56].

  The standard requires that when an entity displays its financial statements or other

  financial information in a currency that is different from either its functional currency

  or its presentation currency and the requirements of paragraph 55 are not met, it should:

  [IAS 21.57]

  (a) clearly identify the information as supplementary information to distinguish it from

  the information that complies with IFRS;

  (b) disclose the currency in which the supplementary information is displayed; and

  (c) disclose the entity’s functional currency and the method of translation used to

  determine the supplementary information.

  For the purpose of these requirements, in the case of a group, the references to

  ‘functional currency’ are to that of the parent. [IAS 21.51].

  10.4 Judgements made in applying IAS 21 and related disclosures

  IAS 1 requires disclosure of the significant judgements that management has made in the

  process of applying the entity’s accounting policies and that have the most significant

  effect on the amounts recognised in the financial statements (see Chapter 3 at 5.1.1.B).

  [IAS 1.122]. The application of IAS 21 can, in certain circumstances, require the exercise

  of significant judgement, particularly the determination of functional currency (see 4

  above) and assessing whether intragroup monetary items are permanent as equity

  Foreign

  exchange

  1173

  (see 6.3.1 above). Where relevant, information about these particular judgements should

  be disclosed.

  Whilst considering a number of issues associated with the Venezuelan currency

  (see 5.1.4.C and 6.1.3 above), the Interpretations Committee drew attention to a number

  of disclosure requirements in IFRS that might be relevant when an entity has material

  foreign operations subject to extensive currency controls, multiple exchange rates

  and/or a long-term lack of exchangeability. In particular, the committee highlighted the

  importance of providing information that is relevant to an understanding of the entity’s

  financial statements. [IAS 1.122].

  In addition to disclosing the significant judgements in applying an entity’s accounting

  policies, the committee also considered the following disclosures to be important:21

  • significant accounting policies applied; [IAS 1.117-121]

  • sources of estimation uncertainty that have a significant risk of resulting in a

  material adjustment to the carrying amounts of assets and liabilities within the next

  financial year, which may include a sensitivity analysis; [IAS 1.125-133] and

  • the nature and extent of significant restrictions on an entity’s ability to access or

  use assets and settle the liabilities of the group, or its joint ventures or associates.

  [IFRS 12.10, 13, 20, 22].

  Finally, the following may also be
relevant:22

  • the nature and extent of risks (including foreign exchange risk) arising from

  financial instruments (from a qualitative and quantitative perspective and including

  sensitivity analyses); [IFRS 7.31-42, B6-B24]

  • significant cash held by the entity that is not available for use by the group,

  including due to exchange controls; [IAS 7.48, 49] and

  • the amount of foreign exchange differences recognised in profit or loss and other

  comprehensive income. [IAS 21.52].

  11 FUTURE

  DEVELOPMENTS

  IAS 21 has caused a degree of concern in recent years, especially in certain emerging

  economies. In particular, some have criticised IAS 21 as designed for companies that

  operate in a reserve currency, e.g. the US dollar or euro; and volatility in exchange rates,

  including during the financial crisis, led some to ask the IASB to reconsider IAS 21.

  However, after performing research and outreach as part of its periodic agenda

  consultations, the IASB decided in May 2016 not to include in its work plan any further

  work on the topic.23

  Therefore it seems unlikely there will be any significant changes to the standard in the

  foreseeable future, although it is possible that narrow-scope amendments or

  interpretative guidance will be considered. In fact, at the time of writing, the

  Interpretations Committee had tentatively decided to research possible narrow-scope

  standard-setting aimed at addressing the matters considered in respect of the

  Venezuelan currency (see 5.1.4.C and 6.1.3 above).24

  1174 Chapter 15

  References

  1 After applying IFRS 9 an entity can actually

  10 IFRIC Update, November 2014 and Staff Paper

  continue applying some or all of the hedge

  (Agenda reference

  16), Foreign exchange

  accounting requirements of IAS 39. These

  restrictions and hyperinflation, IASB, July 2014.

  options are considered further in Chapter 40

  11 IFRIC Update, March 2008, p.2.

  at 1.4 and in Chapter 49 at 13.3 but are not dealt

  12 IFRIC Update, March 2008, p.2.

  with any further in this chapter.

  13 IASB Update, February 2003, p.5.

  2

 

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