Ias 21 – Foreign Currencies

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IAS 21 – Foreign Currencies


Foreign Currencies

• Objective• Scope• Local Currency, Functional Currency & Presentation Currency• Determination of functional currency• Change in Functional Currency• Foreign Currency Transactions• Recognition of exchange differences• Translation to presentation currency• Consolidated financial statements• Different reporting dates• Net investment in foreign operations• Presentation & Disclosure


Objective• Include foreign currency transactions and foreign operations in an entity’s

financial statements

• Specify which exchange rates to use and how to report the effects of changes in exchange rates in financial statements

• Translate the financial statements into a presentation currency


Scope• Accounting for transactions and balances in foreign currencies

• Translating the results and financial position of foreign operations that are included in the entity’s financial statements by consolidation, proportionate consolidation or by equity accounting

• Translating an entity’s result and financial position into a presentation currency


Types of Currencies

Local •Recording of transactions

Functional• Currency of the economic

environment in which the entity operates

Presentation •Reporting Currency


Currency Determination

Presentation Currency

Functional

Currency

Local Currenc

y Maintaining books of accounts

Reporting Currency (Legal requirements / Consolidation)

This may be the local currency


Indicators

Primary Indicators

Secondary Indicators

Primary

•Sales & Cash Inflows

Indicators

•Expenses & Cash Outflows


Indicators

Primary Indicators


Secondary

•Financing Activities

Indicators

•Retention of Operating Income


Primary Indicators

Sales & cash inflows

•Currency of the economy which determines the pricing of transactions; denomination of transactions is not relevant•Currency of the country whose competitive forces and regulations mainly determine the sales prices of goods and services

Expenses and Cash Outflows•Currency that mainly influences the labour, material and other costs of providing goods and services


Sales and Cash inflows• A US company (X) appoints a distributor (Y) in India for distribution of its goods

across India. This is the business model adopted by the X to sell its goods through distributors who have market penetration and expertise to distribute goods. X sells goods to Y in USD and maximum price per item is quoted to Y in USD on a weekly basis. The price of goods tends to decline with time. Therefore, the rebates are given to Y in USD on the closing inventory on a weekly basis.

• What is the functional currency where Y quotes the price in USD to the eventual customer? The invoices carry the INR value to arrive at the VAT amount.


Sales and Cash Inflows

• Miracle Inc sells consulting services through Miracle India Pvt. Ltd, its India subsidiary, to Pinnacle India and invoices to latter in USD on an hourly basis (US $ 200 per hour).

• What is the functional currency of Miracle India?


Expenses and Cash Outflows

• Miracle Inc sells consulting services through Miracle India Pvt. Ltd, its India subsidiary, to Pinnacle India and invoices to latter in USD on an hourly basis (US $ 200 per hour or INR 10,000 per hour), depending upon its clientele. Miracle India incurs all expenditure in INR.



Sales & Cash Inflows and Expenses Outflows

• Miracle Inc sells consulting services through Miracle India Pvt. Ltd, its India subsidiary, to Pinnacle India and invoices to latter in USD on an hourly basis (US $ 200 per hour). Miracle India incurs all expenditure in INR, other than the royalty payment to Miracle Inc made in USD, which is the biggest component of its expenditure.




Financing Activities•Currency in which funds from financing activities are generated (debt / equity)

Retention of operating Income•Currency in which the receipts of operating activities are usually retained


Secondary Indicators Miracle Inc sells consulting services through Miracle India Pvt.

Ltd its India subsidiary to Pinnacle India and invoices to latter in USD on an hourly basis (US $ 200 per hour or INR 10,000 per hour), depending upon its clientele. Miracle India incurs all expenditure in INR. Miracle India’s funding is all in USD through Miracle Inc.

What is the functional currency of Miracle India?


Foreign entity

• Additional indicators:

• Degree of autonomy• Frequency of transactions with reporting entity• Cash flow impact on reporting entity• Financing


Determination of Functional Currency

X (Parent)

Y (Intermediate Parent)

A (Subsidia

ry)

B (Subsidia

ry)

C (Subsidia

ry)

X ($ functional currency) appoints Y for funding its eventual subsidiaries A (Euro), B (Yen) & C (INR). The only source of inflow to Y is funding from X in USD, and Y in turn funds to A, B & C in their respective currencies. Y charges fee & receives dividends from subsidiaries and remits these back to X.


Determination of Functional Currency

X (Parent)

Y (Treasury Centre)

A (Subsidia

ry)

B (Subsidia

ry)

C (Subsidia

ry)

X ($ functional currency) appoints Y as treasury centre for providing treasury professional services to its eventual subsidiaries A (Euro), B (Yen) & C (INR). Y charges the fee from subsidiaries in Euro, Yen & INR respectively. Y remits back the surplus to X. Y’s local expenses are incurred in GBP.


Mixed Indicators

• Management judgment is required


Change in functional currency

• Used consistently, unless significant changes in economic facts, events and conditions clearly indicate that the functional currency has changed

• Accounted for prospectively


Foreign Currency Transactions

• Foreign currency is a currency which is not the functional currency

• Recorded on the spot exchange rate (date of transaction)

• Average rate is permitted


Subsequent Measurement

Monetary Items

Non-monetary Items

Fair value or historical cost

Closing rate


Non-monetary items

Fair Value •Exchange rate at the date of fair value

Historical Cost

•Exchange rate at the date of transaction•No retranslation on subsequent balance sheet dates


Recognition of exchange differences

Profit & Loss Account Profit & Loss AccountMonetary Items

Non-Monetary Items


Non-monetary Items

Exchange gain / loss in equity

Gain / loss

identified in equity

Investment property purchased on 3rd Jan = $ 10 million (Exchange rate = Rs 50 / USD)

Value = 500 millionRevalued on 31st Mar = $ 12 million(Exchange rate = Rs 40 / USD)Value = 480 million

Revaluation Loss : 20 million


Non-monetary Items

Exchange gain / loss in Profit /

Loss

Gain / loss identified in Profit /

Loss

Investment property purchased on 3rd Jan = $ 10 million (Exchange rate = Rs 50 / USD)

Value = 500 millionImpaired on 31st Mar = $ 9 million(Exchange rate = Rs 60 / USD)Value = 540 million

Gain : 40 million


Translation to Presentation Currency

• Assets & liabilities at closing rate

• Income and expenses at transaction date

• All difference should be recognized as a separate component of equity

• Equity may be translated either historic rate or closing rate (management policy choice)


Resulting exchange difference

•Differences arising from translating the income statement at exchange rate at the transactions dates or average date and assets and liabilities at the closing rate

•Differences arising on the opening net assets’ retranslation at a closing rate that differs from previous closing rate


Translation of foreign operations

P & L 08 - LC 08 - FC Rates

PBT 100 120 Avg 1.2

Tax (20) (24) Op 2.0

PAT 80 96 Closing 1.5

B Sheet 08 07 08 (FC) 07 (FC)

FA 120 120 180 240

W Cap 205 100 307.5 200

Loan 40 15 60 30

Equity 80 80 160 160

R / Earnings

205 125 267.5 250

• Analysis of exchange differenceOpening Net Assets: = (205 x 2) – (205 x 1.5) => 102.5Income (Profit): = 80 x (1.2 - 1.5) – 96 => 120.0

Net Impact = > 17.5


Different Reporting Dates

• Reporting date must not exceed by 3 months of the reporting entity’s balance sheet date

• Exchange rate of reporting currency’s balance sheet may be used

• Any significant transaction should be adjusted


Minority Interest

• Exchange difference allocating to Minority on proportional basis

•


Disposal / partial disposal of a foreign operation

• Such exchange differences are recognised in profit or loss when the gain / loss on disposal is recognised

• In case of partial disposal, only the proportionate share of the related accumulated exchange is included in gain / loss


Disclosures• Amount of exchange differences recognised in profit or loss;

• Net exchange differences classified in a separate component of equity, and a reconciliation of amount of such exchange differences at the beginning and end of period

Economy & Finance

Ias 21 – Foreign Currencies