In practice, contracts can be more complex than suggested above and often give rise
to situations where the purchaser can influence or control the crystallisation of the
contingent payments, e.g. where the contingent payments are dependent on the
purchaser’s future actions – such as those that take the form of production-based
royalties. These complexities can raise broader questions about the nature of the
obligations and, as in the case of royalty-based contingent payments, the appropriate
accounting standard to apply initially, as well as how to account for subsequent
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adjustments to any liability that may have been recognised. To date, these
complexities and lack of clarity as to the appropriate accounting have led to various
treatments, including:
• the cost of the asset does not initially include any amount relating to the contingent
element. Any subsequent payments made in relation to the contingent element are
either adjusted against the cost of the asset (once paid) or recognised in profit or
loss as incurred;
• the cost of the asset includes an estimate of the contingent consideration at the
date of purchase. Subsequent changes in the liability relating to the contingent
consideration are then recognised in profit or loss; or
• the cost of the asset includes an estimate of the contingent consideration at the
date of purchase. Subsequent changes in the liability relating to the contingent
consideration that do not reflect the passage of time are adjusted against the cost
of the asset.
The first approach (which is relatively common in the extractive industries) considers
that the applicable standard is IAS 37, and applies the concepts of obligating events,
probability, contingencies and not providing for future operations. This means that
nothing relating to the contingent payment is recognised at the date of purchase. The
second approach applies the methodology in IFRS 3, while the third is based on the
principles of IFRIC 1.106
Given this divergence in practice, this issue was referred to the Interpretations
Committee in January 2011. The Committee and the IASB have discussed this issue for
a number of years since this date. They had been attempting to clarify how the initial
recognition and subsequent changes in relation to such contingent consideration should
be recognised but did not conclude.
In March 2016, the Interpretations Committee determined that this issue was too
broad for it to address within the confines of existing IFRSs. The Interpretations
Committee decided not to add this issue to its agenda and concluded that the IASB
should address the accounting for variable payments comprehensively. In
February 2018, the IASB decided that in the following few months, staff should aim to
carry out work on ‘Variable and Contingent Consideration’ to assess how broad that
research project should be. This research project is not yet active, but the IASB
expects to start, or restart work before the next Agenda Consultation, which is
expected to begin around 2021.
Until the Interpretations Committee and/or IASB progress this issue and the matter is
resolved, an entity must capitalise expenditure that meets the definition of an asset,
although it may choose not to recognise these costs until incurred. For other variable
costs, it has the option to either:
(i) not capitalise on initial recognition and expense variable payments; or
(ii) capitalise them at their fair value on initial recognition and recognise the changes
in contingent consideration in profit or loss or as an asset if certain conditions
are met.
The accounting policy must be applied consistently.
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For further information on this issue see Chapter 17 at 4.5, Chapter 18 at 4.1.9 and
Chapter 41 at 3.8.
8.4.2
Accounting for land acquisitions
Obtaining the legal rights to explore for, develop and produce minerals can be achieved
in a number of ways, as outlined at 5 above. One of these ways is through the outright
purchase of the minerals and the land on, or under, which the minerals are located. In
undertaking such a transaction, it is not uncommon for an entity to pay an amount in
excess of the intrinsic value of the land itself. In such a situation, an entity needs to
ensure it appropriately allocates the purchase price between the fair value of the land
and the fair value of the mineral or surface mining rights acquired. The amount allocated
to land will be capitalised and not depreciated, whereas the amount allocated to the
minerals or surface mining rights will form part of the total cost of mining assets and will
ultimately be depreciated on a units of production basis over the economically
recoverable reserves to which it relates.
9 FUNCTIONAL
CURRENCY
9.1
Determining functional currency
Determining functional currency correctly is important because it will, for example,
affect volatility of revenue and operating profit resulting from exchange rate
movements, determine whether transactions can be hedged or not and influence the
identification of embedded currency derivatives. The movements may give rise to
temporary differences that affect profit or loss. [IAS 12.41]. While under IAS 21 – The
Effects of Changes in Foreign Exchange Rates – an entity can select any presentation
currency, it does not have a free choice in determining its functional currency. Choice
of functional currency is discussed in detail in Chapter 15 at 4; below is a summary of
the application of the requirements to the extractive industries.
IAS 21 requires an entity to determine separately the functional currency of each entity
within a consolidated group. There is no concept of the functional currency of the
group, only a presentation currency. Therefore, the functional currency of an operating
subsidiary may differ from that of the group’s parent and/or foreign sales company to
which it sells its production. The factors taken into account in determining functional
currency may differ for operating companies and for group entities that are financing or
intermediate holding companies (see Chapter 15 at 4.2). IAS 21 requires an entity to
consider the following factors in determining its functional currency:
(a) the currency that mainly influences sales prices for goods and services (this will
often be the currency in which sales prices for its goods and services are
denominated and settled);
(b) the currency of the country whose competitive forces and regulations mainly
determine the sales prices of its goods and services; and
(c) the currency that mainly influences labour, material and other costs of providing
goods or services (this will often be the currency in which such costs are
denominated and settled). [IAS 21.9].
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While the currency referred to under (a) above will often be the currency in which
sales prices for its goods and services are denominated and settled, this is not always
the case. The US dollar is used for many commodities as the contract or
settlement
currency in transactions (e.g. iron ore, oil), but the pricing of transactions is often
driven by factors completely unrelated to the US dollar or the US economy (e.g. it
may be influenced more by demand from the local economy or other economies
such as China).
As the extractive industries are international, it is often difficult to determine the
currency of the country whose competitive forces and regulations mainly determine the
sales prices of its goods and services. Therefore, factor (b) above will often prove to be
inconclusive when a particular product is produced in many different countries.
It will generally be fairly straightforward to identify the currency that mainly
influences an entity’s key inputs (i.e. factor (c) above). In developing countries an
entity will often need to import a significant proportion of its key inputs (e.g. fuel,
equipment and expatriate workers) and even local inputs in an economy with a high
inflation rate will often be linked to the US dollar. In such a case, the local currency is
less likely to be the main currency that influences an entity’s key inputs. In most
developed countries, however, the inputs tend to be denominated in the local
currency, although some inputs (e.g. major items of equipment) may be denominated
in another currency. As the extractive industries are capital intensive, the cost of
equipment often far exceeds the operating expenses incurred. Equipment is often
purchased in US dollars.
When the factors (a) to (c) above are mixed, as they often are in practice, and the
functional currency is not obvious, management should use ‘its judgement to determine
the functional currency that most faithfully represents the economic effects of the
underlying transactions, events and conditions’. [IAS 21.12]. If the above factors are
inconclusive then an entity should also consider the following secondary factors:
• the currency in which funds from financing activities (i.e. issuing debt and equity
instruments) are generated;
• the currency in which receipts from operating activities are usually retained; and
• the functional currency of the reporting entity that has the foreign operation as its
subsidiary, branch, associate or joint venture. [IAS 21.10, 11].
After considering both the primary and secondary factors the functional currency may
not be obvious because, for example, revenue is denominated in US dollars while
virtually all expenses are denominated in the local currency. In that situation
management may conclude that revenue, while denominated in US dollars, is in fact
influenced by a basket of currencies. It is therefore possible that companies operating
in a similar environment can reach different conclusions about their functional
currency. Even in developed countries there is a general bias towards the US dollar as
the functional currency.
Although local statutory and tax requirements should be ignored in determining the
functional currency, there may be a requirement to keep two sets of accounting records
when an entity concludes that its local currency is not its functional currency.
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The extract below from Rio Tinto illustrates a typical currency translation accounting
policy of a mining company.
Extract 39.15: Rio Tinto plc (2017)
Notes to the 2017 financial statements [extract]
1 Principal accounting policies [extract]
(d) Currency translation
The functional currency for each entity in the Group, and for joint arrangements and associates, is the currency of the
primary economic environment in which that entity operates. For many of these entities, this is the currency of the
country in which they are located. Transactions denominated in other currencies are converted to the functional
currency at the exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in
foreign currencies are retranslated at period-end exchange rates.
The Group’s financial statements are presented in US dollars, as that presentation currency most reliably reflects the
global business performance of the Group as a whole. On consolidation, income statement items for each entity are
translated from the functional currency into US dollars at average rates of exchange, except for material one-off
transactions, which are translated at the rate prevailing on the transaction date. Balance sheet items are translated into US dollars at period-end exchange rates.
Exchange differences arising on the translation of the net assets of entities with functional currencies other than the
US dollar are recognised directly in the currency translation reserve. These translation differences are shown in the
statement of comprehensive income, with the exception of translation adjustments relating to Rio Tinto Limited’s
share capital which are shown in the statement of changes in equity.
Where an intragroup balance is, in substance, part of the Group’s net investment in an entity, exchange gains and
losses on that balance are taken to the currency translation reserve.
Except as noted above, or in note 1(p) relating to derivative contracts, all other exchange differences are charged or
credited to the income statement in the year in which they arise.
9.2
Changes in functional currency
IAS 21 requires management to use its judgement to determine the entity’s functional
currency so that it most faithfully represents the economic effects of the underlying
transactions, events and conditions that are relevant to the entity. Note that IAS 21
requires the functional currency to be determined by reference to factors that exist
during the reporting period. Therefore, an entity should ignore future developments
in its business, no matter how likely those developments are. For example, even if an
entity is convinced that in three years’ time it will have revenues that will be
denominated in US dollars, this is not a factor to be considered in determining its
functional currency today. This is particularly relevant for entities in the extractive
industries given the nature of their operations. For example, a company may conclude
that during the development phase of the project the local currency is its functional
currency but that once production and sales commence the US dollar will become its
functional currency. Alternatively, exposure to a particular currency may increase
during a period.
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This is illustrated in the extract below from Woodside Petroleum’s 2010 financial
statements.
Extract 39.16: Woodside Petroleum Ltd (2010)
Overview
CHIEF FINANCIAL OFFICER’S REPORT [extract]
Funding our growth plans and sustaining superior shareholder returns [extract]
US dollar functional currency implemented
With approximately 90% of revenue and more than 90% of debt denominated in US dollars, Woodside’s directors
adopted a US dollar functional currency and presentation currency for the purpose of all financial reporting, effective
1 January 2010. This change provides shareholders with a more accurate reflection of the company’s underlying
performance, while increasing comparability of our financial results with those of our industry peers.
The
one-off impacts of this change are highlighted in the Notes to the Financial Report.
Notes to and forming part of the Financial Report continued [extract]
For the year ended 31 December 2010
1. Summary of significant accounting policies (continued) [extract]
(a) Basis of preparation (continued) [extract]
Change in functional and presentation currency
An entity’s functional currency is the currency of the primary economic environment in which the entity operates.
Woodside Petroleum Ltd has experienced a period of sustained growth in US dollar revenue streams and in the period
up to 31 December 2009 increased its US dollar debt levels significantly. Consequently, the company announced on
22 March 2010 that the directors had determined that the functional currency of the company and all its subsidiaries
is US dollars. The change in functional currency has been applied prospectively with effect from 1 January 2010 in
accordance with the requirements of the Accounting Standards.
Following the change in functional currency, Woodside Petroleum Ltd has elected to change its presentation currency
from Australian dollars to US dollars. The directors believe that changing the presentation currency to US dollars
will enhance comparability with its industry peer group, the majority of which report in US dollars. The change in
presentation currency represents a voluntary change in accounting policy, which has been applied retrospectively.
To give effect to the change in functional currency, the assets and liabilities of entities with an Australian dollar
functional currency at 31 December 2009 were converted into US dollars at a fixed exchange rate on 1 January 2010
of US$1:A$1.1193 and the contributed equity, reserves and retained earnings were converted at applicable historical
rates. In order to derive US dollar comparatives (presentation currency), the Australian dollar functional currency
assets and liabilities at 31 December 2009 were converted at the spot rate of US$1:A$1.1193 on the reporting date;
revenue and expenses for the year ended 31 December 2009 were converted at the average exchange rate of
US$1:A$1.261 for the reporting period, or at the exchange rates ruling at the date of the transaction to the extent
practicable, and equity balances were converted at applicable historical rates.
The above stated procedures resulted in a foreign currency translation reserve of US$594 million on 1 January 2009. Earnings per share for 2009 has also been restated in US dollars to reflect the change in the presentation currency (refer to Note 5).
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 648
