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

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  which rate is actually used. However, in other situations the difference can be

  quite significant.

  In these circumstances, what rate should be used? IAS 21 states that ‘when several

  exchange rates are available, the rate used is that at which the future cash flows

  represented by the transaction or balance could have been settled if those cash flows

  had occurred at the measurement date’. [IAS 21.26]. Companies should therefore look at

  the nature of the transaction and apply the appropriate exchange rate.

  5.1.4.B

  Suspension of rates: temporary lack of exchangeability

  Another practical difficulty which could arise is where for some reason exchangeability

  between two currencies is temporarily lacking at the transaction date or subsequently

  at the end of the reporting period. In this case, IAS 21 requires that the rate to be used

  is ‘the first subsequent rate at which exchanges could be made’. [IAS 21.26].

  5.1.4.C

  Suspension of rates: longer term lack of exchangeability

  The standard does not address the situation where there is a longer-term lack of

  exchangeability and the rate has not been restored. The Interpretations Committee has

  considered this in the context of a number of issues associated with the Venezuelan

  currency, the Bolivar, initially in 2014 and again in 2018.

  A number of official exchange mechanisms have been operating in the country, each

  with different exchange rates and each theoretically available for specified types of

  transaction. In practice, however, there have for a number of years been significant

  restrictions on entities’ ability to make more than limited remittances out of the country

  using these mechanisms.

  Addressing the issue in 2014 the committee noted it was not entirely clear how IAS 21

  applies in such a situation and thought that addressing it was a broader-scope project

  than it could take on.3 Consequently, determining the appropriate exchange rate(s) for

  financial reporting purposes for any particular entity required the application of

  judgement. The rate(s) selected depended on the entity’s individual facts and

  circumstances, particularly its legal ability to convert currency or to settle transactions

  using a specific rate and its intent to use a particular mechanism, but typically

  represented an official rate.

  When the committee considered the issue in 2018 it described the circumstances in

  Venezuela in the following terms:

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  • the exchangeability of the foreign operation’s functional currency with other

  currencies is administered by jurisdictional authorities and this exchange

  mechanism incorporates the use of an exchange rate set by the authorities, i.e. an

  official exchange rate;

  • the foreign operation’s functional currency is subject to a long-term lack of

  exchangeability with other currencies, i.e. the exchangeability is not temporarily

  lacking and has not been restored after the end of the reporting period;

  • the lack of exchangeability with other currencies has resulted in the foreign

  operation being in effect unable to access foreign currencies using the exchange

  mechanism described above.

  In order to comply with IAS 21, the committee tentatively decided the rate to be used

  in these circumstances is the one which an entity would have access to through a legal

  exchange mechanism at the end of the reporting period (or at the date of a transaction).

  Consequently it said an entity should assess whether the official exchange rate

  represents such a rate and use that rate if it does.4

  The committee did not say what rate should be used if using the official exchange rate did

  not comply with IAS 21, but acknowledged that some entities had started to use an

  estimated exchange rate, an approach that has been accepted by at least one European

  regulator. They also tentatively decided to research a possible narrow-scope standard-

  setting exercise aimed at addressing the situation when an exchange rate is not observable.5

  The committee noted that economic conditions are in general constantly evolving and

  highlighted the importance of reassessing at each reporting date whether the official

  exchange rate should be used. It also drew attention to disclosure requirements in IFRS

  that might be relevant in these circumstances and these are covered at 10.4 below.6

  The extreme circumstances in Venezuela which has led some entities to estimate an

  exchange rate rather than use an official or otherwise observable rate could in theory

  arise elsewhere. However, at the time of writing, there is no evidence of any such

  situation elsewhere.

  5.2

  Reporting at the ends of subsequent reporting periods

  At the end of each reporting period: [IAS 21.23]

  (a) foreign currency monetary items should be translated using the closing rate;

  (b) non-monetary items that are measured in terms of historical cost in a foreign

  currency should be translated using the exchange rate at the date of the

  transaction; and

  (c) non-monetary items that are measured at fair value in a foreign currency should be

  translated using the exchange rate at the date when the fair value was determined.

  The carrying amount of an item should be determined in conjunction with the relevant

  requirements of other standards. For example, property, plant and equipment may be

  measured in terms of fair value or historical cost in accordance with IAS 16 – Property,

  Plant and Equipment. Irrespective of whether the carrying amount is determined on the

  basis of historical cost or fair value, if the amount is determined in a foreign currency,

  IAS 21 requires that amount to be translated into the entity’s functional currency. [IAS 21.24].

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  The carrying amount of some items is determined by comparing two or more amounts.

  For example, IAS 2 requires the carrying amount of inventories to be determined as the

  lower of cost and net realisable value. Similarly, in accordance with IAS 36 –

  Impairment of Assets – the carrying amount of an asset for which there is an indication

  of impairment should be the lower of its carrying amount before considering possible

  impairment losses and its recoverable amount. When such an asset is non-monetary and

  is measured in a foreign currency, the carrying amount is determined by comparing:

  • the cost or carrying amount, as appropriate, translated at the exchange rate at the

  date when that amount was determined (i.e. the rate at the date of the transaction

  for an item measured in terms of historical cost); and

  • the net realisable value or recoverable amount, as appropriate, translated at the

  exchange rate at the date when that value was determined (e.g. the closing rate at

  the end of the reporting period).

  The effect of this comparison may be that an impairment loss is recognised in the

  functional currency but would not be recognised in the foreign currency, or vice versa.

  [IAS 21.25].

  5.3

  Treatment of exchange differences

  5.3.1 Monetary

  items

  The general rule in IAS 21 is that exchange differences on the settlement or retranslation

  of monetary items should be
recognised in profit or loss in the period in which they

  arise. [IAS 21.28].

  When monetary items arise from a foreign currency transaction and there is a change

  in the exchange rate between the transaction date and the date of settlement, an

  exchange difference results. When the transaction is settled within the same accounting

  period as that in which it occurred, all the exchange difference is recognised in that

  period. However, when the transaction is settled in a subsequent accounting period, the

  exchange difference recognised in each period up to the date of settlement is

  determined by the change in exchange rates during each period. [IAS 21.29].

  These requirements can be illustrated in the following examples:

  Example 15.5: Reporting an unsettled foreign currency transaction in the

  functional currency

  A French entity purchases plant and equipment on credit from a Canadian supplier for C$328,000 in January 2019

  when the exchange rate is €1=C$1.64. The entity records the asset at a cost of €200,000. At the French entity’s

  year end at 31 March 2019 the account has not yet been settled. The closing rate is €1=C$1.61. The amount

  payable would be retranslated at €203,727 in the statement of financial position and an exchange loss of €3,727

  would be reported as part of the profit or loss for the period. The cost of the asset would remain as €200,000.

  Example 15.6: Reporting a settled foreign currency transaction in the functional

  currency

  A UK entity sells goods to a German entity for €87,000 on 28 February 2019 when the exchange rate is

  £1=€1.45. It receives payment on 31 March 2019 when the exchange rate is £1=€1.50. On 28 February the

  UK entity will record a sale and corresponding receivable of £60,000. When payment is received on 31 March

  the actual amount received is only £58,000. The loss on exchange of £2,000 would be reported as part of the

  profit or loss for the period.

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  There are situations where the general rule above will not be applied. The first

  exception relates to exchange differences arising on a monetary item that, in substance,

  forms part of an entity’s net investment in a foreign operation (see 6.3.1 below). In this

  situation the exchange differences should be recognised initially in other

  comprehensive income until the disposal of the investment (see 6.6 below). However,

  this treatment only applies in the financial statements that include the foreign operation

  and the reporting entity (e.g. consolidated financial statements when the foreign

  operation is a consolidated subsidiary or equity method investment). It does not apply

  to the reporting entity’s separate financial statements or the financial statements of the

  foreign operation. Rather, the exchange differences will be recognised in profit or loss

  in the period in which they arise in the financial statements of the entity that has the

  foreign currency exposure. [IAS 21.32]. This is discussed further at 6.3.1 below.

  The next exception relates to hedge accounting for foreign currency items, to which

  IFRS 9 applies. The application of hedge accounting requires an entity to account for

  some exchange differences differently from the treatment required by IAS 21. For

  example, IFRS 9 requires that exchange differences on monetary items that qualify as

  hedging instruments in a cash flow hedge or a hedge of a net investment in a foreign

  operation are recognised initially in other comprehensive income to the extent the

  hedge is effective. Hedge accounting is discussed in more detail in Chapter 49.

  Another situation where exchange differences on monetary items are not recognised in

  profit or loss in the period they arise would be where an entity capitalises borrowing

  costs under IAS 23 – Borrowing Costs – since that standard requires exchange

  differences arising from foreign currency borrowings to be capitalised to the extent that

  they are regarded as an adjustment to interest costs (see Chapter 21 at 5.4). [IAS 23.6].

  One example of a monetary item given by IAS 21 is ‘provisions that are to be settled in cash’.

  In most cases it will be appropriate for the exchange differences arising on provisions to be

  recognised in profit or loss in the period they arise. However, it may be that an entity has

  recognised a decommissioning provision under IAS 37 – Provisions, Contingent Liabilities

  and Contingent Assets. One practical difficulty with such a provision is that due to the long

  timescale of when the actual cash outflows will arise, an entity may not be able to say with

  any certainty the currency in which the transaction will actually be settled. Nevertheless if

  it is determined that it is expected to be settled in a foreign currency it will be a monetary

  item. The main issue then is what should happen to any exchange differences. IFRIC 1 –

  Changes in Existing Decommissioning, Restoration and Similar Liabilities – applies to any

  decommissioning or similar liability that has been both included as part of the cost of an

  asset and measured as a liability in accordance with IAS 37 (see Chapter 27 at 6.3.1). IFRIC 1

  requires, inter alia, that any adjustment to such a provision resulting from changes in the

  estimated outflow of resources embodying economic benefits (e.g. cash flows) required to

  settle the obligation should not be recognised in profit or loss as it occurs, but should be

  added to or deducted from the cost of the asset to which it relates. The requirement of

  IAS 21 to recognise the exchange differences arising on the provision in profit or loss in the

  period in which they arise conflicts with this requirement in IFRIC 1. Accordingly, we

  believe that either approach could be applied as an accounting policy choice. However, in

  our experience, such exchange differences are most commonly dealt with in accordance

  with IFRIC 1, particularly by entities with material long-term provisions.

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  5.3.2 Non-monetary

  items

  When non-monetary items are measured at fair value in a foreign currency they should

  be translated using the exchange rate as at the date when the fair value was determined.

  Therefore, any re-measurement gain or loss will include an element relating to the

  change in exchange rates. In this situation, the exchange differences are recognised as

  part of the gain or loss arising on the fair value re-measurement.

  When a gain or loss on a non-monetary item is recognised in other comprehensive

  income, any exchange component of that gain or loss should also be recognised in other

  comprehensive income. [IAS 21.30]. For example, IAS 16 requires some gains and losses

  arising on a revaluation of property, plant and equipment to be recognised in other

  comprehensive income (see Chapter 18 at 6.2). When such an asset is measured in a

  foreign currency, the revalued amount should be translated using the rate at the date

  the value is determined, resulting in an exchange difference that is also recognised in

  other comprehensive income. [IAS 21.31].

  Conversely, when a gain or loss on a non-monetary item is recognised in profit or loss,

  e.g. financial instruments that are measured at fair value through profit or loss in

  accordance with IFRS 9 (see Chapter 46 at 2.4) or an investment property accounted

  for u
sing the fair value model (see Chapter 19 at 6), any exchange component of that

  gain or loss should be recognised in profit or loss. [IAS 21.30].

  An example of an accounting policy dealing with the reporting of foreign currency

  transactions in the functional currency of an entity is illustrated below.

  Extract 15.1: ING Groep N.V. (2015)

  Notes to the consolidated annual accounts of ING Group [extract]

  1 ACCOUNTING POLICIES [extract]

  FOREIGN CURRENCY TRANSLATION [extract]

  Functional and presentation currency

  Items included in the financial statements of each of the Group’s entities are measured using the currency of the

  primary economic environment in which the entity operates (‘the functional currency’). The consolidated financial

  statements are presented in euros, which is ING Group’s functional and presentation currency.

  Transactions and balances [extract]

  Foreign currency transactions are translated into the functional currency using the exchange rate prevailing at the date

  of the transactions. Exchange rate differences resulting from the settlement of such transactions and from the

  translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are

  recognised in the profit and loss account, except when deferred in equity as part of qualifying cash flow hedges or

  qualifying net investment hedges.

  Exchange rate differences on non-monetary items, measured at fair value through profit and loss, are reported as part

  of the fair value gain or loss. Non-monetary items are retranslated at the date fair value is determined. Exchange rate

  differences on non-monetary items measured at fair value through the revaluation reserve are included in the

  revaluation reserve in equity.

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  5.4

  Determining whether an item is monetary or non-monetary

  IAS 21 generally requires that monetary items denominated in foreign currencies be

  retranslated using closing rates at the end of the reporting period and non-monetary items

  should not be retranslated (see 5.2 above). Monetary items are defined as ‘units of

  currency held and assets and liabilities to be received or paid in a fixed or determinable

  number of units of currency’. [IAS 21.8]. The standard elaborates further on this by stating