Transcript date of the transaction

Implementation and Applications of
IFRS on Currencies
Vienna, March 14, 2006
By Thierry Bertrand, Partner, E&Y
Olivier Lemaire, Partner, E&Y
Renaud Breyer, Manager, E&Y
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Agenda
A. Foreign exchange
• Functional currencies
• Practical issues when identifying the
functional currency
• Branches
• Non-monetary items
• From the functional currency to the
presentation currency
• Recycling CTA
• First-time adoption issues
B. Financial reporting in hyperinflationary
economies
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Functional currencies
• Functional currency is the currency (IAS 21.9):
– That mainly influences sales prices (i.e. often currency in which
revenue is denominated)
– Of the country whose competitive forces and regulations
determine the sales prices
– That mainly influences labour, material and other costs
• Sometimes the functional currency may be the one in
which
– Funds from financing activities are generated
– Receipts from operating activities are usually retained
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Functional currencies
• Additional factors to be considered (IAS 21.10 & 11):
– Is the foreign operation an extension of the parent
– Foreign operation mainly deals with parent
– Foreign operation cash flows directly affect parent cash flows
and are available for remittance
– Foreign operation cash flows are sufficient to service existing
and expected debts without funding from parent
• Where the functional currency is not obvious,
management needs to use its judgement and document
its decision
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Functional currencies – Case study
• Case
–
–
–
–
The owner is Chinese
Customers are mainly Chinese
Employees are Chinese
30% of the inputs are Chinese
• Q: What is the functional currency of this company?
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Functional currencies – Case study
• Case
–
–
–
–
The owner is Chinese
Customers are mainly Chinese
Employees are Chinese
30% of the inputs are Chinese
• Q: What is the functional currency of this company?
• A: Chinese restaurant near Leicester Square, therefore the
functional currency is Sterling.
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Practical issue when identifying the
functionnal currency
Issue
• Do the additional factors described in paragraphs 10 and
11 of IAS 21 always have to be considered by
management in determining an entity’s functional
currency?
Conclusion
• No, the additional factors described in paragraphs 10 and
11 only have to be considered when it is not obvious from
the primary indicators described in paragraph 9 what the
entity’s functional currency is.
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Branches
• Branches are not defined in IFRS
• In practice a branch contains some assets, usually a
foreign currency liability and sometimes an activity
• No activity (business or employees) means that it is an
extension of another entity
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Practical issue when identifying the
functional currency for a branch
Issue
• What is a foreign operation? Can a single asset or group
of assets be a foreign operation with its own functional
currency?
Conclusion
• Applying guidance in IAS 21(§ 9, 10, 11) may provide
mixed results in such case. The key is to determine
whether a separate business exists.
The activities of the asset or group of assets may be an
extension of the parent company and as such should
have the functionnal currency of the parent
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Branches - Scenario
• What are the functional currencies of the various entities?
UK parent
GBP functional
US Holding
German Shipping AG
???
???
Several US operating
subsidiaries
???
Treasury
(Netherlands) BV
???
Single Ship GmbH
???
ShipCo Inc.
???
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Non-monetary items
• Monetary items are
– Units of currency held and assets and liabilities to be received or
paid in a fixed or determinable number of units of currency
• Everything else is non-monetary
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Non-monetary items - reporting
• Foreign currency monetary items shall be translated
using the closing rate
• Non-monetary items at historical cost … translated
using the exchange rate at the date of the transaction
(i.e. no retranslation at balance sheet date)
• Non-monetary items at fair value … translated using
exchange rate at the date of the valuation
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Non-monetary items – date of transaction
• Sometimes, the date of transaction may be difficult to
determine.
For instance:
Date Event
• 14 April 2005 - Goods are ordered
• 5 May 2005 - Goods are shipped from
Canada and invoice dated that day
• 7 May 2005 - Invoice is received
• 10 May 2005 - Goods are received
• 14 May 2005 - Invoice is recorded
• 7 June 2005 - Invoice is paid
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€1=C$
1.50
1.53
1.51
1.54
1.56
1.60
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Non-monetary items – Examples
• Non-monetary items that are not to be translated:
PP&E, deferred income, goodwill, intangible assets,
inventories
• Non-monetary items are always recorded in the
functional currency of the entity that uses them
• Difficult to classify
–
–
–
–
–
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Decommissioning provisions
Progress payments vs. Refundable deposits
Defined benefit schemes
Deferred tax
Provisions
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Practical issue when considering a caption
being monetary or non-monetary
Issue
• Should deposits or progress payments made when
acquiring fixed assets or inventories from foreign
suppliers be retranslated as monetary items or as non
monetary items?
Conclusion
• Conclusion depends on the nature of the payments
– If payments are regarded as prepayments or as progress
payments, they should be treated as non monetary items
– If payments are regarded as deposits which are refundable, they
could possibly be treated as monetary items depending on the
terms of the contract
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From the functional currency to the
presentation currency
• Translate all the assets and liabilities in the balance sheet
at the closing rate
• Translate all the items in the income statement at the
rates when the transactions were undertaken
– For practical purposes, average rates may be used if not
significant fluctuation
• All resulting exchange differences are taken to equity
until disposal of the foreign entity
• Exchange differences on loans that hedge the net
investment in a foreign operation are also taken to equity
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Recycling of currency translation
adjustments
• When should a company recycle currency translation
adjustments?
– Sale of the foreign net investment or partial disposal
– Dividends paid out of pre-acquisition profits
– Liquidation or abandonment of investment
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Recycling of currency translation
adjustments
• No recycling of currency translation adjustments
– Upon write-down of the foreign operations, this is not considered
a partial disposal
– When monetary items ceases to be part of the foreign net
investment, but has not been settled in cash
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First-Time Adoption Issues
1. Cumulative translation differences: there is an exemption to
recognise the cumulative exchange differences that existed at
the date of transition to IFRS: deemed to be zero.
2. Goodwill and fair value adjustments: there is also an exemption
to IAS 21 for first-time adopters. Previously recognized goodwill
and fair value adjustments can be considered as assets and
liabilities of the entity rather than as assets and liabilities of the
acquiree.
3. In the circumstances where the functional currency under IFRS
is different from the functional currency under previous GAAP, it
may be difficult to apply the historical rates to non-monetary
items. It may then be easier to use the option in IFRS 1 of the
fair value treated as being the deemed cost.
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Financial reporting in hyperinflationary
economies
• Applies to the primary financial statements of any entity
whose functional currency is the currency of a
hyperinflationary economy
• Hyperinflation is indicated by a number of factors and its
identification requires judgement
– Cumulative inflation over 3 years is approaching or exceeding
100 %
International Financial Statistics published by the
International Monetary Fund
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Adjustments required to balance sheet items
• Monetary items and non-monetary items at current cost:
no adjustment
– If any items are contractually adjusted by reference to inflation,
such as index-linked bonds, they are restated in accordance with
the terms of that contract
• Non-monetary items carried at historical cost: updated
by the index movement since they were acquired
• Non-monetary items carried at fair value: updated by the
index movement since they were valued
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Adjustments required to income
• All items of income and expense should be restated by
the change in the index from the date at which they were
first recorded in the accounts
– Depreciation will be adjusted on the same basis as the asset to
which it relates
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Adjustments to equity
• On first application of the standard, the components of
opening equity (other than retained earnings and any
revaluation surplus) are restated by indexation from the
date they arose
• Restated retained earnings is the balancing figure after
restating all assets and liabilities
• Each year, all components of equity are restated by
indexation from the beginning of the year, or the date of
contribution if later
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Economy ceasing to be hyperinflationary
• Companies should cease to apply the standard
• The carrying values are not restated, but left at the
amounts at which they were stated when the standard
was last applied
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Economy ceasing to be hyperinflationary
after Q2
Issue
• The fiscal year of Entity A agrees with the calendar year and Entity A
prepares interim financial reports on a quarterly basis. Until July the
economy was hyperinflationary. Accordingly, Entity A applied IAS 29
in its interim reports for the first two quarters of the year. However, in
August hyperinflation ceased. Can Entity A stop applying IAS 29 on
its interim report for the third quarter of the year?
Answer
• Yes, if an entity concludes that the economy ceases to be
hyperinflationary it should stop applying the requirements of IAS 29
during the relevant interim period. However, determining when a
currency stops becoming hyperinflationary is not easy in practice.
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Q&A
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