that ‘the essential feature of a monetary item is a right to receive (or an obligation to
deliver) a fixed or determinable number of units of currency’. Examples given by IAS 21
are pensions and other employee benefits to be paid in cash; provisions that are to be
settled in cash; cash dividends that are recognised as a liability; and, if IFRS 16 – Leases –
is applied (see Chapter 24), lease liabilities. [IAS 21.16]. More obvious examples are cash and
bank balances; trade receivables and payables; and loan receivables and payables.
IFRS 9 also indicates that where a foreign currency bond is held as a debt instrument
measured at fair value through other comprehensive income, it should first be
accounted for at amortised cost in the underlying currency, thus effectively treating
that amount as if it was a monetary item. This guidance is discussed further in
Chapter 46 at 4.1.
IAS 21 also states that ‘a contract to receive (or deliver) a variable number of the entity’s
own equity instruments or a variable amount of assets in which the fair value to be
received (or delivered) equals a fixed or determinable number of units of currency is a
monetary item’. [IAS 21.16]. No examples of such contracts are given in IAS 21. However,
it would seem to embrace those contracts settled in the entity’s own equity shares that
under IAS 32 – Financial Instruments: Presentation – would be presented as financial
assets or liabilities (see Chapter 43 at 5.2).
Conversely, the essential feature of a non-monetary item is the absence of a right to
receive (or an obligation to deliver) a fixed or determinable number of units of
currency. Examples given by the standard are amounts prepaid for goods and
services (e.g. prepaid rent, at least until IFRS 16 is applied); goodwill; intangible
assets; inventories; property, plant and equipment; provisions that are to be settled
by the delivery of a non-monetary asset; and, once IFRS 16 is applied, right-of-use
assets. [IAS 21.16]. IFRS 9 states that investments in equity instruments are non-
monetary items. [IFRS 9.B5.7.3]. It follows that equity investments in subsidiaries,
associates or joint ventures are non-monetary items.
Even with this guidance there will clearly be a number of situations where the
distinction may not be altogether clear.
5.4.1
Deposits or progress payments
Entities may be required to pay deposits or progress payments when acquiring certain
assets, such as property, plant and equipment or inventories, from foreign suppliers. The
question then arises as to whether such payments should be retranslated as monetary
items or not.
1128 Chapter 15
Example 15.7: Deposits or progress payments
A Dutch entity contracts to purchase an item of plant and machinery for US$10,000 on the following terms:
Payable on signing contract (1 August 2019)
– 10%
Payable on delivery (19 December 2019)
– 40%
Payable on installation (7 January 2020)
– 50%
At 31 December 2019 the entity has paid the first two amounts on the due dates when the respective exchange
rates were €1=US$1.25 and €1=US$1.20. The closing rate at the end of its reporting period, 31 December
2019, is €1=US$1.15.
(i)
(ii)
€
€
First payment –
US$1,000
800
870
Second payment
– US$4,000
3,333
3,478
4,133
4,348
(i) If the payments made are regarded as prepayments or as progress payments then the amounts should be
treated as non-monetary items and included in the statement of financial position at €4,133. This would
appear to be consistent with US GAAP which in defining ‘transaction date’ states: ‘A long-term
commitment may have more than one transaction date (for example, the due date of each progress
payment under a construction contract is an anticipated transaction date).’
(ii) If the payments made are regarded as deposits, and are refundable, then the amounts could possibly be
treated as monetary items and included in the statement of financial position at €4,348 and an exchange
gain of €215 recognised in profit or loss. A variant of this would be to only treat the first payment as a
deposit until the second payment is made, since once delivery is made it is less likely that the asset will
be returned and a refund sought from the supplier.
In practice, it will often be necessary to consider the terms of the contract to ascertain the nature of the
payments made in order to determine the appropriate accounting treatment and this may well require the
application of judgement, something acknowledged in IFRIC 22 (see 5.1.2 above). [IFRIC 22.BC17].
5.4.2
Investments in preference shares
Entities may invest in preference shares of other entities. Whether such shares are
monetary items or not will depend on the rights attaching to the shares. IFRS 9 states
that investments in equity instruments are non-monetary items (see 5.4 above).
[IFRS 9.B5.7.3]. Thus, if the terms of the preference shares are such that they are classified
by the issuer as equity, rather than as a financial liability, then they are non-monetary
items. However, if the terms of the preference shares are such that they are classified
by the issuer as a financial liability (e.g. a preference share that provides for mandatory
redemption by the issuer for a fixed or determinable amount at a fixed or determinable
future date) and by the holder as a financial asset measured at amortised cost or at fair
value through other comprehensive income (see Chapter 46 at 4.1), they should be
treated as monetary items.
5.4.3
Foreign currency share capital
An entity may issue share capital denominated in a currency that is not its functional
currency or, due to changes in circumstances that result in a re-determination of its
functional currency, may find that its share capital is no longer denominated in its
functional currency. Neither IAS 21, IAS 32 nor IFRS 9 address the treatment of
translation of share capital denominated in a currency other than the functional
Foreign
exchange
1129
currency. In theory two treatments are possible: the foreign currency share capital
(and any related share premium or additional paid-in capital) could be maintained
at a fixed amount by being translated at a historical rate of exchange, or it could be
retranslated annually at the closing rate as if it were a monetary amount. In the latter
case a second question would arise: whether to recognise the difference arising on
translation in profit or loss or in other comprehensive income or to deal with it
within equity.
Where the shares denominated in a foreign currency are ordinary shares, or are
otherwise irredeemable and classified as equity instruments, in our experience the most
commonly applied view is that the shares should be translated at historical rates and not
remeasured. This view reflects the fact that the effect of rate changes is not expected to
have an impact on the entity’s cash flows associated with those shares. Such ca
pital
items are included within the examples of non-monetary items listed in US GAAP
(FASB ASC 830 – Foreign Currency Matters) as accounts to be remeasured using
historical exchange rates when the temporal method is being applied. IAS 21 requires
non-monetary items that are measured at historical cost in a foreign currency to be
translated using the historical rate (see 5.2 above).
Where such share capital is retranslated at the closing rate, we do not believe that it is
appropriate for the exchange differences to be recognised in profit or loss, since they
do not affect the cash flows of the entity. Further, because the retranslation of such
items has no effect on assets or liabilities it is not an item of income or expense to be
recognised in other comprehensive income. Instead, the exchange differences should
be taken to equity. Consequently, whether such share capital is maintained at a
historical rate, or is dealt with in this way, the treatment has no impact on the overall
equity of the entity.
Where the shares are not classified as equity instruments, but as financial liabilities,
under IAS 32, e.g. preference shares that provide for mandatory redemption by the
issuer for a fixed or determinable amount at a fixed or determinable future date,
then, as with investments in such shares (see 5.4.2 above), they should be treated as
monetary items and translated at the closing rate. Any exchange differences will be
recognised in profit or loss, unless the shares form part of a hedging relationship and
IFRS 9 would require the exchange differences to be accounted for differently (see
Chapter 49).
5.4.4 Deferred
tax
One of the examples of a monetary item included within the exposure draft that
preceded IAS 21 was deferred tax.7 However, this was dropped from the list of examples
in the final standard. No explanation is given in IAS 21 as to why this is the case. Until
2007, IAS 12 – Income Taxes – suggested that any deferred foreign tax assets or
liabilities are monetary items since it stated that ‘where exchange differences on
deferred foreign tax liabilities or assets are recognised in the income statement, such
differences may be classified as deferred tax expense (income) if that presentation is
considered to be the most useful to financial statement users’.8 The reference to ‘income
statement’ has now been changed to ‘statement of comprehensive income’, although the
suggestion remains the same.
1130 Chapter 15
5.4.5
Post-employment benefit plans – foreign currency assets
For most entities, benefits payable under a defined benefit post-employment plan will
be payable in the functional currency of the entity. However, such a plan may have
monetary assets that are denominated in a foreign currency and/or non-monetary
assets, the fair value of which are determined in a foreign currency. (Where benefits are
payable in a currency that is different to the entity’s functional currency, the
considerations at 5.4.6 below will be relevant.)
Consider, for example, a UK company with the pound sterling as its functional currency
which has a funded pension scheme in which benefit payments are based on the
employees’ sterling denominated salaries and are paid in sterling. The majority of plan
assets comprise a mix of sterling denominated bonds, UK equities and UK properties.
However, those assets also include a number of US dollar denominated bonds and equities
issued by US companies that are listed on a US stock exchange. IAS 19 – Employee
Benefits – requires all these assets to be measured at their fair value at the end of the
reporting period, but how should the entity deal with any exchange differences or changes
in fair value attributable to changes in exchange rates arising on the US assets?
IAS 21 gives as an example of a monetary item ‘pensions and other employee benefits to
be paid in cash’. Further, the accounting for defined benefit schemes under IAS 19 requires
an entity to reflect net interest on the net defined benefit asset or liability in profit or loss
and any difference between this amount and the actual return on plan assets in other
comprehensive income (see Chapter 31 at 10.3 and 10.4.2). [IAS 19.120, 127(b)]. Consequently,
it would seem appropriate to view the net pension asset or liability as a single unit of
account measured in sterling. Therefore the gains and losses on all the US plan assets
attributable to changes in foreign exchange rates would be dealt with as remeasurements
in accordance with IAS 19 and recognised in other comprehensive income.
5.4.6
Post-employment benefit plans – foreign currency plans
For some entities the pension benefits payable under a post-employment benefit plan
will not be payable in the functional currency of the entity. For example, a UK entity in
the oil and gas industry may determine that its functional currency is the US dollar, but
its employee costs including the pension benefits are payable in sterling. How should
such an entity account for its post-employment benefit plan?
One of the examples of a monetary item given by IAS 21 is ‘pensions and other employee
benefits to be paid in cash’. However, the standard does not expand on this, and does
not appear to make any distinction between pensions provided by defined contribution
plans or defined benefit plans. Nor does it distinguish between funded or unfunded
defined benefit plans.
Clearly for pensions that are payable under a defined contribution plan (or one that is
accounted for as such) this is straightforward. Any liability for outstanding contributions
at the end of the reporting period is a monetary item that should be translated at the
closing rate, with any resulting exchange differences recognised in profit or loss. For an
unfunded defined benefit plan in which the benefit payments are denominated in a
foreign currency, applying IAS 21 would also seem to be straightforward. The defined
benefit obligation is regarded as a monetary liability and exchange differences on the
entire balance are recognised in profit or loss.
Foreign
exchange
1131
A funded defined benefit plan is a more a complex arrangement to assess under IAS 21,
particularly if the plan assets include items that considered in their own right would be
non-monetary and/or foreign currency monetary items. However, in the light of the
guidance in IAS 21 noted above, our preferred view is to consider such arrangements as
a single monetary item denominated in the currency in which the benefit payments are
made. Therefore the requirements of IAS 19 will be applied in the currency in which
the benefit payments are denominated and foreign currency gains or losses on the net
asset or liability would be recognised in profit or loss.
Another approach would be to argue that a funded scheme is more akin to a non-
monetary item and the exchange differences relating to the defined benefit obligation are
similar to actuarial gains and losses. The calculation of the obligation under IAS 19 will be
based on actuarial assumptions that reflect the currency of the obligation to the employee
(for example, the discount rate used ‘shall be consistent wit
h the currency and estimated
term’ of the obligation [IAS 19.83]). Any variations from those assumptions on both the
obligation and the assets are dealt with in the same way under IAS 19. Actuarial
assumptions are ‘an entity’s best estimates of the variables that will determine the ultimate
cost of providing post-employment benefits’ and include financial assumptions. [IAS 19.76].
Although IAS 19 does not refer to exchange rates, it is clearly a variable that will determine
the ultimate cost to the entity of providing the post-employment benefits. On that basis,
the exchange differences relating to the defined benefit obligation would be accounted
for in a similar manner to actuarial gains and losses. Although not our preferred accounting
treatment, we consider this to be an acceptable approach.
Some might argue that the plan should be regarded as a ‘foreign operation’ under IAS 21
(see 2.3 above). However, in this situation it is very difficult to say that its ‘functional
currency’ can be regarded as being different from that of the reporting entity given the
relationship between the plan and the reporting entity (see 4 above). Thus, it would
appear that the entity cannot treat the plan as a foreign operation with a different
functional currency from its own.
5.5
Change in functional currency
IAS 21 requires management to use its judgement to determine the entity’s functional
currency such that it most faithfully represents the economic effects of the underlying
transactions, events and conditions that are relevant to the entity (see 4 above).
Accordingly, once the functional currency is determined, it may be changed only if there
is a change to those underlying transactions, events and conditions. For example, a
change in the currency that mainly influences the sales prices of goods and services may
lead to a change in an entity’s functional currency. [IAS 21.36].
When there is a change in an entity’s functional currency, the entity should apply the
translation procedures applicable to the new functional currency prospectively from
the date of the change. [IAS 21.35].
In other words, an entity translates all items into the new functional currency using the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 223
