Non ‐ Controlling Interests
When a foreign entity is consolidated, but it is not wholly owned by the reporting entity, there will be non‐controlling interest reported in the consolidated statement of financial position. IAS 21 requires that the accumulated exchange differences resulting from translation and attributable to the non‐controlling interest be allocated to and reported as non‐controlling interest in net assets.
Goodwill and Fair Value Adjustments
Any goodwill arising on the acquisition of a foreign entity and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation should be treated as assets and liabilities of the foreign operation. Thus, they should be expressed in the functional currency of the foreign operation and translated at the closing rate in accordance with IAS 21.
Exchange Differences Arising From Elimination of Intragroup Balances
While incorporating the financial statements of a foreign entity into those of the reporting entity, normal consolidation procedures such as elimination of intragroup balances and transactions are undertaken as required by IAS 28 and IFRS 3, 10, 11 and 12.
Different Reporting Dates
The financial statements of the parent and its subsidiaries used in the preparation of the consolidated financial statements shall have the same reporting date. When the end of the reporting period of the parent is different from that of a subsidiary, the subsidiary prepares, for consolidation purposes, additional financial information as of the same date as the financial statements of the parent to enable the parent to consolidate the financial information of the subsidiary, unless it is impracticable to do so.
If it is “impracticable” to do so, the parent shall consolidate the financial information of the subsidiary using the most recent financial statements of the subsidiary adjusted for the effects of significant transactions or events that occur between the date of those financial statements and the date of the consolidated financial statements. In any case, the difference between the date of the subsidiary's financial statements and that of the
consolidated financial statements shall be no more than three months, and the length of the reporting periods and any difference between the dates of the financial statements shall be the same from period to period.
Disposal of a Foreign Operation
On the disposal of a foreign operation, the cumulative amount of the exchange differences relating to that foreign operation, recognised in other comprehensive income and accumulated in the separate component of equity, shall be reclassified from equity to profit or loss (as a
reclassification adjustment) when the gain or loss on disposal is recognised.
Disposal has been defined to include a sale, liquidation, repayment of share capital or abandonment of all or part of the entity. Normally, payment of dividends would not constitute a repayment of capital. However, in rare circumstances, it does; for instance, when an entity pays dividends out of capital instead of accumulated profits, as defined in the companies’ acts of certain countries, such as the United Kingdom, this would constitute repayment of capital. In such circumstances, obviously, dividends paid would constitute a disposal for the purposes of this standard.
In addition to the disposal of an entity's entire interest in a foreign operation, the following partial disposals are accounted for as disposals:
1. When the partial disposal involves the loss of control of a subsidiary that includes a foreign operation, regardless of whether the entity retains a non‐controlling interest in its former subsidiary after the partial disposal; and
2. When the retained interest after the partial disposal of an interest in a joint arrangement or a partial disposal of an interest in an associate that includes a foreign operation is a financial asset that includes a foreign operation.
On disposal of a subsidiary that includes a foreign operation:
1. The cumulative amount of the exchange differences relating to that foreign operation that have been attributed to the non‐controlling interests shall be derecognised, but shall not be reclassified to profit or loss;
2. On partial disposal of such a subsidiary the entity shall reattribute the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income to the non‐controlling interests in that foreign operation. In any other partial disposal of a foreign operation the entity shall reclassify to profit or loss only the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income.
Change in Functional Currency
If there is a change in the functional currency, an entity should apply the translation procedures applicable to the new functional currency prospectively from the date of this change.
Reporting a Foreign Operation's Inventory
Under IAS 21, only a single method can be used for translating functional currency financial statements into the presentation currency. Specifically, the reporting entity is required to translate the assets and liabilities of its foreign operations and foreign entities at the closing (end of the reporting period) rate, and required to translate income and expenses at the exchange rates at the dates of the transactions (or at the average rate for the period, if this offers a reasonable approximation of actual transaction date rates).
As noted previously, sometimes an adjustment may be required to reduce the carrying amount of an asset in the financial statements of the reporting entity even though such an adjustment was not necessary in the separate, foreign currency‐based financial statements of the foreign operation. This stipulation of IAS 21 can best be illustrated by the following case study.
Example
Inventory of merchandise owned by a foreign operation of the reporting entity is being carried by the foreign operation at 3,750,000 SR (Saudi riyals) in its statement of financial position. Suppose that the indirect exchange rate fluctuated from 3.75 SR = 1 US dollar at September 15, 2, when the merchandise was bought, to 4.25 SR = 1 US dollar at December 31, 202X (i.e., the end of the reporting period). The translation of this item into the functional currency will necessitate an adjustment to reduce the carrying amount of the inventory to its NRV if this value when translated into the functional currency is lower than the carrying amount translated at the rate prevailing on the date of purchase of the merchandise.
Although the NRV, which in terms of Saudi riyals is 4,000,000 (SR), is higher than the carrying amount in Saudi riyals (i.e., 3,750,000 SR) when translated into the functional currency (i.e., US dollars) at the end of the reporting period, the NRV is lower than the carrying amount (translated into the functional currency at the exchange rate prevailing on the date of acquisition of the merchandise). Thus, on the financial statements of the foreign operation the inventory would not have to be adjusted. However, when the NRV is translated at the closing rate (which is 4.25 SR = 1 US dollar) into the functional currency, it will require the following adjustment:
1. Carrying amount translated at the exchange rate on September 15, 202X (i.e., the date of acquisition) = SR 3,750,000 ÷ 3.75 =
$1,000,000.
2. NRV translated at the closing rate = SR 4,000,000 ÷ 4.25 = $941,176.
3. Adjustment needed = $1,000,000 − $941,176 = $58,824.
Conversely, IAS 21 further stipulates that an adjustment that already exists on the financial statements of the foreign operation may need to be reversed in the financial statements of the reporting entity. To illustrate this point, the facts of the example above are repeated, with some variation, below.
Example
All other factual details remaining the same as the preceding example, it is now assumed that the inventory, which is carried on the books of the foreign operation at SR 3,750,000, instead has an NRV of SR 3,250,000 at year‐end. Also assume that the indirect exchange rate fluctuated from 3.75 SR = 1 US dollar at the date of acquisition of the merchandise to 3.00 SR = 1 US dollar at the end of the reporting period.
Since in terms of Saudi riyals, the NRV at the end of the reporting period was lower than the carrying value of the inventory, an adjustment must have been made in the statement of financial position of the foreign operation (in Saudi riyals) to reduce the carrying amount to the lower of cost or NRV. In other words, a contra asset account (i.e., a lower of cost or NRV) representing the difference between the carrying amount (SR 3,750,000) and the NRV (SR 3,250,000) must have been created on the books of the foreign operation.
On translating the financial statements of the foreign operation into the functional currency, however, it is noted that due to the fluctuation of the exchange rates the NRV when converted to the functional currency (SR 3,250,000 ÷ 3.00 = $1,083,333) is no longer lower than the translated carrying value which is to be converted at the exchange rate prevailing on the date of acquisition of the merchandise (SR 3,750,000 ÷ 3.75 =
$1,000,000).
Thus, a reversal of the adjustment (for lower of cost or NRV) is required on the financial statements of the reporting entity, upon translation of the financial statements of the foreign operation.
Translation of Foreign Currency Transactions in Further Detail
According to IAS 21, a foreign currency transaction is a transaction that is “denominated in or requires settlement in a foreign currency.”
Denominated means that the amount to be received or paid is fixed in terms of the number of units of a particular foreign currency, regardless of changes in the exchange rate.
Example
From the viewpoint of a US company, for instance, a foreign currency transaction results when it imports or exports goods or services to a foreign entity or makes a loan involving a foreign entity and agrees to settle the transaction in currency other than the US dollar (the presentation currency of the US company). In these situations, the US company has “crossed currencies” and directly assumes the risk of fluctuating exchange rates of the foreign currency in which the transaction is denominated. This risk may lead to recognition of foreign exchange differences in the profit or loss of the US company. Note that exchange differences can result only when the foreign currency transactions are denominated in a foreign currency.
When a US company imports or exports goods or services and the transaction is to be settled in US dollars, the US company will incur neither gain nor loss because it bears no risk due to exchange rate fluctuations. The following example illustrates the terminology and procedures applicable to the translation of foreign currency transactions.
Assume that a US company, an exporter, sells merchandise to a customer in Germany on December 1, 202X, for €10,000. Receipt is due on January 31, 202X+1, and the US company prepares financial statements on December 31, 202X. At the transaction date (December 1, 202X), the spot rate for immediate exchange of foreign currencies indicates that €1 is equivalent to $1.18.
To find the US dollar equivalent of this transaction, the foreign currency amount, €10,000, is multiplied by $1.18 to get $11,800. At December 1, 202X, the foreign currency transaction should be recorded by the US company in the following manner:
Accounts receivable—Germany $11,800
Sales $11,800
The accounts receivable and sales are measured in US dollars at the transaction date using the spot rate at the time of the transaction. While the accounts receivable is measured and reported in US dollars, the receivable is denominated or fixed in euros.
Foreign exchange gains or losses may occur if the spot rate for euros changes between the transaction date and the date of settlement (January 31, 202X+1). If financial statements are prepared between the transaction date and the settlement date, all receivables and payables that are denominated in a currency different than that in which payment will ultimately be received or paid (the euro) must be restated to reflect the spot rates in existence at the end of the reporting period.
Assume that on December 31, 202X, the spot rate for euros is €1 = $1.20. This means that the €10,000 is now worth $12,000 and that the accounts receivable denominated in euros should be increased by $200. The following journal entry would be recorded as of December 31, 202X:
Accounts receivable—Germany $200 Foreign currency exchange difference $200
Note that the sales account, which was credited on the transaction date for $11,800, is not affected by changes in the spot rate. This treatment exemplifies what may be called a two‐transaction viewpoint. In other words, making the sale is the result of an operating decision, while bearing the risk of fluctuating spot rates is the result of a financing decision. Therefore, the amount determined as sales revenue at the transaction date should not be altered because of a financing decision to wait until January 31, 202X+1, for payment of the account.
The risk of a foreign exchange transaction loss can be avoided either by demanding immediate payment on December 1 or by entering into a forward exchange contract to hedge the exposed asset (accounts receivable). The fact that the US company in the example did not act in either of these two ways is reflected by requiring the recognition of foreign currency exchange differences (transaction gains or losses) in its profit or loss (reported as financial or non‐operating items) in the period during which the exchange rates changed.
On the settlement date (January 31, 202X+1), assume that the spot rate is €1 = $1.17. The receipt of €10,000 and their conversion into US dollars would be journalised in the following manner:
Foreign currency $11,700 Foreign currency transaction loss $300
Accounts receivable—Germany $12,000
The net effect of this foreign currency transaction was to receive $11,700 from a sale that was measured originally at $11,800. This realised net foreign currency transaction loss of $100 is reported on two income statements: a $200 gain in 202X and a $300 loss in 202X+1. The reporting of the gain or loss in two income statements causes a temporary difference between pre‐tax accounting and taxable income. This results because the transaction loss of $100 is not deductible until 202X+1 as it concerns an unrealised transaction, the year the transaction was completed or settled. Accordingly, inter‐period tax allocation is required for foreign currency transaction gains or losses.
DISCLOSURE
A number of disclosure requirements have been prescribed by IAS 21. Primarily, disclosure is required of the amounts of exchange differences included in profit or loss for the period, exchange differences that are included in the carrying amount of an asset and those that are recognised in other comprehensive income.
When there is a change in classification of a foreign operation, disclosure is required as to the nature of the change, reason for the change and the impact of the change on the current and each of the prior years presented. When the presentation currency is different from the currency of the country of domicile, the reason for this should be disclosed, and in case of any subsequent change in the presentation currency, the reason for making this change should also be disclosed. An entity should also disclose the method selected to translate goodwill and fair value adjustments arising on the acquisition of a foreign entity. Disclosure is encouraged of an entity's foreign currency risk management policy.
The following additional disclosures are required:
When the functional currency is different from the currency of the country in which the entity is domiciled, the reason for using a different currency;
The reason for any change in functional currency or presentation currency;
When financial statements are presented in a currency other than the entity's functional currency, the reason for using a different presentation currency and a description of the method used in the translation process;
When financial statements are presented in a currency other than the functional currency, an entity should state the fact that the functional currency reflects the economic substance of underlying events and circumstances;
When financial statements are presented in a currency other than the functional currency, and the functional currency is the currency of a hyperinflationary economy, an entity should disclose the closing exchange rates between functional currency and presentation currency existing at the end of each reporting period presented;
When additional information not required by IFRS is displayed in financial statements and in a currency other than presentation currency, as a matter of convenience to certain users, an entity should:
Clearly identify such information as supplementary information;
Disclose the functional currency used to prepare the financial statements and the method of translation used to determine the supplementary information displayed;
Disclose the fact that the functional currency reflects the economic substance of the underlying events and circumstances of the entity and the supplementary information is displayed in another currency for convenience purposes only; and
Disclose the currency in which supplementary information is displayed.