sewale1000

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IAS 21

• Effects of Changes in Foreign Exchange rates

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1. Applicable IFRS

• Accounting and reporting effects of foreign
  exchange are addressed by IAS 21 of full IFRS and
  Section 30 of IFRS for SMEs.

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Objectives of IAS 21

• To prescribe
• How to include (Foreign currency)FC Transaction
  in Financial Statement(FS)
• How to include Foreign operations in to entity FS
• How to translate Financial statements in to
  presentation Currency

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Scope of Application of IAS 21

• This Standard shall be applied
• In accounting for transactions and balances in
  foreign currencies,
• In translating the results and financial position
  of foreign operations (subsidiaries) and
• In translating an entitys results and financial
  position into a presentation currency.

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Important terms

• Exchange rate. The ratio of exchange for two
  currencies.
• Spot exchange rate The exchange rate for
  immediate delivery. Usually on date of
  transaction.
• Closing rate. The spot exchange rate at the
  year-end date.
• Foreign currency. A currency other than the
  functional currency of the entity.
• Functional currency. The currency of the primary
  economic environment in which the entity
  operates.

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Terms and concepts.

• Presentation currency. The currency in which the
  financial statements are presented.
• Exchange differences. The difference resulting
  from translating a given number of units of one
  currency into another currency at different
  exchange rates.

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Important terms/definitions

• Monetary items Units of currency held and assets
  and liabilities to be received or paid in a fixed
  or determinable number of units of currency.
• Foreign Operation is an entity that is a
  subsidiary, associate, joint venture or branch of
  a reporting entity, the activities of which are
  based or conducted in a country or currency other
  than those of the reporting entity.

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Foreign Currency Transaction

• Foreign Currency Transaction Transactions whose
  terms are denominated in foreign currency or
  require settlement in foreign currency.
• It includes
• 1. Buying or selling goods or services whose
  prices are denominated in foreign currency
• 2. Borrowing or lending funds and the amounts
  payable or receivable denominated in foreign
  currency
• 3. For other reasons acquires or disposes of
  assets or incurs or settles liabilities
  denominated in foreign currency.

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Conversion and translation.

• An entity must convert/translate its foreign
  currency items to Functional currency by applying
  following rules at each subsequent year end.
• Report foreign currency monetary items using the
  closing rate
• Report non-monetary items (e.g non-current
  assets, inventories) which are carried at
  historical cost in a foreign currency using the
  exchange rate at the date of the transaction
  (historical rate)
• Report non-monetary items which are carried at
  fair value in a foreign currency using the
  exchange rates that existed when the values were
  measured.
• Translate foreign currency revenue and expenses
  using actual rate (average is allowed for
  practical reason)
• NB. If functional currency is different from
  Presentation currency, translate
  asset/liabilities from functional currency to
  presentation currency using closing rate and any
  resulting gain/loss goes to OCI

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Conversion and translation.

• Discussion
• What if there are several exchange rates?
• What if exchange rate is temporally lacking?

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How Functional Currency is determined?

• Currency influencing prices
• The currency that mainly influences sales prices
  for goods and services(the currency in which
  prices are denominated and settled)
• The currency of the country whose competitive
  forces and regulations mainly determine the
  sales prices of its goods and services
• The currency that mainly influences labour,
  material and other costs of providing goods or
  services (often the currency in which prices are
  denominated and settled)

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How Functional Currency is determined?

• Currency influencing fund flow and depositing
• The currency in which funds from financing
  activities (raising loans and issuing equity) are
  generated
• The currency in which receipts from operating
  activities are usually retained

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How Functional Currency is determined?

• Example
• A stand-alone entity (ie not a foreign operation
  of another entity) manufactures a product for the
  local market in country A. Its sales are
  denominated in the local currency (LCA). The
  price of its product in country A is affected
  mainly by local supply and demand and
  regulations. All of the entitys inputs are
  sourced in country A and the prices of the inputs
  are denominated in LCA and are mainly influenced
  by economic forces and regulations in country A.
  is Local currency functional currency?

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How Functional Currency is determined?

• Example
• A stand-alone entity (ie not a foreign operation
  of another entity) based in country A
  manufactures a product in country A for export to
  country B. Labour and raw materials are
  relatively inexpensive in country A.
• The entitys sales prices are nearly always
  denominated in LCB (the local currency of country
  B) and established predominantly based on prices
  set by competitive forces in country B and by
  country Bs regulations. Customers settle in LCB
  and the entity holds its excess cash in LCB, only
  converting sufficient LCB into LCA (the local
  currency of country A) to settle its operating
  costs as they fall due.
• The majority of the entitys borrowings are in
  LCB. Most costs are paid in LCA. Specialised
  machinery is purchased from suppliers in country
  C. Those purchases are denominated in LCC (ie
  the local currency of country C). Such costs are
  not significant when compared to the
  LCA-denominated operating costs.

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Recognition of exchange differences

• Exchange differences
• arise on the settlement of monetary items
  (receivables, payables, loans, cash in a foreign
  currency) or
• on translating an entity's monetary items at
  rates different from those at which they were
• translated initially, or
• reported in previous financial statements,
• Are recognized in the period they arise as either
  Profit and loss
• Some exchange differences may be recognized in OCI

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Change in functional currency

• Change in functional currency
• The functional currency of an entity can be
  changed only if there is a change to the
  underlying transactions, events and conditions
  that are relevant to the entity.
• For example, an entity's functional currency may
  change if there is a change in the currency that
  mainly influences the sales price of goods and
  services.
• Prospective application of translation procedures
  from the date of change
• Translate all items in to new functional currency
  using the exchange rate on the date of change
• The translated amounts for non-monetary items are
  treated as historical costs.

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Food For Thought

• What will be effect of foreign currency change on
  L/C execution.
• Assume a local customer established an L/C on a
  local bank for 100, 000 Tir 1, 2001 and the L/C
  is settled on Tir 28, 2001. Indirect exchange
  rate to ETB is ETB 22(Tir 1) and ETB 22.5 (Tir
  28).What is the effect of that exchange rate
  change on the banks performance and financial
  liability? What if the rate is ETB21.5(Tir 28)?
• What is the Foreign Exchange Gain/loss?
• Effect on balance sheet?

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Exercise
LO 7

• On July 1, 2013, an Ethiopian financer lent 1
  billion Kenyan Sh.(KS). Assume 5 annual interest
  rate.
• Spot exchange rates
• Date
  ETB per KS
• July 1, 2013
  ETB0.00921
• December 31, 2013
  ETB 0.00932
• July 1, 2014
  ETB0.00937

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Exercise
LO 7

• Required
• How do we recognize the receivable on July 1,
  2013
• Record accrued interest on December 31, 2013
• Recognize foreign exchange gain or loss on the
  receivable and recognize interest accrued.
• Recognize the collection of principal and
  interest, and the related exchange gain/loss.

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Exercise
LO 7

• a. Receivable recognition
• Debit Notes receivable..ETB 9,210,00
• Credit cash/customer account.ETB9,210,000
  
• b. To record interest accrued from July to
  December 31, computed as 1billion KS51/2
  25million KSETB 0.00932 ETB233,000
• Debit Interest receivable.233,000
• Credit Interest Income..233,000
• c. Foreign exchange gain/loss on revaluation of
  Loan receivable at the spot rate of 0.00932
• KS 1
  billion(0.00932-0.00921) ETB 110,000
• Debit Notes Receivable.110,000
• Credit Foreign Exchange gain.110,000

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Exercise
LO 7

• d. To record receipt of interest and principal
  payments and related exchange gains
• Collection of Interest 50 million KS converted
  at the spot rate of ETB 0.00937 ETB 468,500
  (which is accrued interest of 25 Million KS and
  interest income from January 1 to July 1, 2014 of
  25 million KS) and a foreign exchange gain on the
  accrued interest receivable of KS 25
  million(0.00937-0.00932)
• Debit Cash..ETB468,500
• Credit Interest income..ETB234,250
• Credit Accrued interest
  receivableETB233,000
• Credit Foreign Exchange GainETB
  1250

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Exercise
LO 7

• Collection of principal the Notes receivable
  is converted at the spot rate of 0.00937
  1billion KS 0.00937 9,370,000 ETB including
  the foreign exchange gain of ETB 50,000
  1billion KS(0.00937-0.00932) from December
  31, 2013 to July 31, 2014
• Debit Loans receivable.50,000
• Credit Foreign Exchange gain.50,000
• To record receipt of loan KS at the spot rate of
  Debit Cash.9,370,000
• Credit Loans receivable9,370,000

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Summary
LO 7
On December 31, 2013, the Financer must revalue
the KS receivable with an offsetting foreign
exchange gain or loss reported in P/L and must
accrue interest income and interest receivable.
Assume 5 annual interest rate.
Interest is calculated by multiplying the loan
principal in KS by the relevant interest rate.
The amount of interest receivable in KS is then
translated to ETB at the spot rate to record the
accrual journal entry. On July 1, 2014,
differences between the amount of interest
accrued at year-end and the actual ETB amount
that must be received from the accrued interest
are recognized as foreign exchange gains/ losses.
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Disclosures

• The standard requires an entity to disclose some
  important disclosures for the purpose of fair and
  faithful presentation
• Amount of exchange difference recognized in
  profit or loss
• Net exchange differences recognized under other
  comprehensive income
• whether presentation currency is different from
  functional currency and the reason for this
  difference any
• Whether there is any change in functional
  currency and reason for the change

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US GAAP Vs IFRS

• Determination of functional currency
• Under US GAAP there is no hierarchy of indicators
  to determine the functional currency of an
  entity, whereas a hierarchy exists under IFRS.
  Hierarchy
• The currency influencing sales transaction
• The currency that influences labor, material and
  other costs of providing goods and services
• The currency in which funds from financing
  activities are generated.
• The currency in which receipts from operating
  activities are retained.