IAS 21 - Foreign currency

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IAS 21 - Foreign currency
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Executive summary

• IFRS and US GAAP are quite similar in their
  approach to foreign currency translation.
• Both IFRS and US GAAP require the adoption of
  functional currencies for foreign subsidiaries,
  although a somewhat different evaluation approach
  is followed to determine functional currency.
• Both IFRS and US GAAP require that the exchange
  gain or loss from foreign currency transactions
  be reflected in the statement of income.
• Both IFRS and US GAAP require (if necessary)
  remeasurement into the functional currency before
  translation into the reporting currency. The two
  approaches to this remeasurement are generally
  the same, with both requiring that remeasurement
  gains and losses be reported in the statement of
  income.

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Executive summary

• The methods of translating financial statements
  from the functional currency to the reporting
  currency are similar under IFRS and US GAAP. Both
  IFRS and US GAAP use a currency translation
  account (CTA) for translation differences. The
  CTA is included in other comprehensive income
  under both IFRS and US GAAP.
• Consolidation of foreign operations may be
  different under IFRS and US GAAP. IFRS allows
  either the step-by-step approach or the indirect
  approach, whereas US GAAP requires the
  step-by-step approach.

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Progress on convergence

• There are currently no convergence projects
  underway or planned for foreign currency matters.

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Functional currency
IFRS
US GAAP
Functional currency is defined as the currency of
the primary economic environment in which a
company operates and which is normally the
currency in which a company primarily generates
and expends cash.
Similar
Assets, liabilities, and operations of an entity
should be measured using the functional currency
of that entity.
Similar
Subsequent to conversion to a functional currency
and generally subsequent to a multinational
companys consolidation, both US GAAP and IFRS
allow financial statements to be presented in a
currency other than the functional currency.
This is referred to as a reporting currency.
Similar
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Functional currency

• IFRS
• There are primary factors and secondary factors
  to consider. The secondary factors are to be
  used only when the determination of the
  functional currency using the primary factors
  produces mixed results. The primary factors to
  be considered in determining the functional
  currency are
• The currency that influences its sales prices,
  which will often be the currency in which the
  sales prices for its goods and services are
  denominated and settled and the currency of the
  country whose competitive forces or regulations
  determine these sales prices.
• The currency that mainly influences labor,
  material and other costs of providing goods and
  services.

• US GAAP
• The following economic factors, and possibly
  others, should be considered both individually
  and collectively when determining the functional
  currency
• Cash flow currency
• Location of the factors that affect sales prices
• Location of the sales market
• Expenses where goods and services are acquired
• The primary currency in which financing is
  denominated
• Volume of intercompany transactions and
  arrangements

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Functional currency

• IFRS
• The secondary factors, which are to be used only
  when the determination of the functional currency
  using the primary results produces mixed results,
  are
• The currency of financing the currency in which
  operating cash flows are retained.
• Activities carried out as an extension of the
  reporting entity.
• Proportion of foreign operations transactions
  with reporting entity.
• Cash flows directly affect cash flows of
  reporting entity and are readily available for
  remittance to it.
• Cash flows sufficient to service existing and
  normally expected debt obligations without funds
  being made available by the reporting entity.

US GAAP
Despite these varying factors for determining the
functional currency of an entity and the fact
that IFRS requires that primary factors be
considered prior to considering the secondary
factors, it is expected that under both methods
the answer to the functional currency conclusion
will be the same.
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Summary of factors considered in determining
functional currency
US GAAP IFRS primary IFRS secondary
Cash flow currency
Currency that influences sales price Currency that influences sales price
Location of sales market
Where goods and services are acquired Currency that influences labor, material and other costs
Denomination of financing Currency of financing
Volume of intercompany transactions and arrangements Proportion of foreign operations transactions with reporting entity
Activities carried out as an extension of the reporting entity
Cash flows directly affect cash flows of reporting entity and are readily available for remittance to it
Cash flows sufficient to service existing and normally expected debt obligations without funds being made available by the reporting entity
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Determining functional currency example

• Example 1
• A US-based company by the name of Big Blue owns
  100 of Big Blue UK. The functional currency of
  Big Blue is the US Dollar (USD) and the
  functional currency of Big Blue UK is the British
  pound (GBP). The USD is also the reporting
  currency of the consolidated group.

Big Blue UK is a leading provider of Tudor-style
ceramic pottery replicas, which are sold at the
finest tourist shops throughout London. However,
with the interest in Henry VIII rising in the US,
in 2008, Big Blue UK began exporting its products
to the US. Total exports accounted for 10 of
the total sales. The ceramic pottery replicas
are made in Wales using clay from quarries in
northern Scotland.

• Based on the above, what is the functional
  currency of Big Blue UK under US GAAP and IFRS?

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Determining functional currency example

• Example 1 solution
• US GAAP The functional currency of Big Blue UK
  is the GBP. Under US GAAP, an entitys
  functional currency is the currency of the
  primary economic environment in which the entity
  operates normally, that is the currency of the
  environment in which an entity primarily
  generates and expends cash. Based on the six
  criteria found in US GAAP (with none being of
  higher importance), Big Blue UK generates most of
  its cash flows in GBP. In addition, most of its
  sales are transacted in GBP and influenced by
  local forces. Its goods and services are
  acquired in the UK.
• IFRS Based upon the available primary
  indicators, the GBP is the functional currency.
  This is because the GBP mainly influences the
  sales prices of goods, labor, materials, other
  costs of providing goods and the competitive
  forces and regulations that mainly determine the
  sales prices of the goods. Thus, it is not
  necessary to utilize the secondary factors under
  IFRS.
• Even though the factors that an entity must
  consider to determine its functional currency are
  set up differently under IFRS and US GAAP, the
  two sets of standards result in the same
  determination of the functional currency.

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Foreign currency transactions
IFRS
US GAAP
Foreign currency transactions are transactions
denominated in a currency other than the entitys
functional currency.
Similar
Foreign exchange gains or losses generally should
be included in income for the period in which the
exchange rate changes.
Similar
At each balance sheet date and upon settlement,
recorded foreign currency monetary balances
should be adjusted to reflect current exchange
rates.
Similar
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Foreign currency transactions
There are no significant differences in recording
financial currency transactions. The important
point is to determine the proper functional
currency because differences in functional
currencies can cause differences in the exchange
gains or losses recorded.
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Translation of foreign currency financial
statementsTranslation (remeasurement) into
functional currency
IFRS
US GAAP
Requires remeasurement into the functional
currency before translation into the reporting
currency, if necessary. Typically this
translation involves translating a foreign
subsidiarys financial statements into the
parents reporting currency.
Similar
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Translation of foreign currency financial
statementsTranslation (remeasurement) into
functional currency
US GAAP
IFRS

• The method used to remeasure the financial
  statements into the functional currency is
• Monetary assets and all liabilities are
  translated at the period-end rates.
• All other assets are translated at the
  historical rates as of the date of acquisition
  (or the date of the investment of the subsidiary
  if the assets were already owned as of the
  investment date).
• Income statement items that can be specifically
  identified with a date of acquisition
  are translated using the historical rate at
  acquisition (e.g., cost of goods sold since
  inventory can be identified with a date of
  acquisition).
• Other Income statement amounts are generally
  translated at a weighted-average rate for the
  period.

Similar
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Translation of foreign currency financial
statementsTranslation (remeasurement) into
functional currency
US GAAP
IFRS

• Remeasurement method (continued)
• Equity components, other than retained earnings,
  are translated at historic rates (based on the
  date of investment in the subsidiary).
• Retained earnings are translated in layers, as
  follows
• Retained earnings that existed at the date of
  investment are translated at historic rates
  (based on the date of investment in the
  subsidiary).
• Income additions to retained earnings since the
  date of investment are translated using the
  weighted-average rate, as are income items.
• Dividend reductions to retained earnings are
  translated using the historical rates at
  the date of declaration of the dividend.
• The remeasurement gain/loss is included in the
  statement of income for the period.

Similar
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Translation of foreign currency financial
statementsTranslation (remeasurement) into
functional currency
There are some differences between US GAAP and
IFRS in remeasuring the functional currency into
the reporting currency in hyperinflationary
economies.
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Overview of translation (remeasurement) into
functional currency
Remeasurement of foreign currency
Translation of foreign currency
US Parent The functional currency is the US
dollar
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2
Foreign entity The financial records
are maintained in functional currency
Foreign entity The financial records are
not maintained in functional currency
The foreign entitys financial records should be
translated to a functional currency with gains or
losses recognized in income and the functional
currency financial statements (if not in US
dollars) are translated to US dollars and gains
and losses are recognized in OCI (currency
translation account). The foreign entitys
financial records in functional currency are
translated to US dollars and gains and losses are
recognized in OCI (currency translation account).
1
2
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Translation of foreign currency financial
statementsTranslation of a foreign entitys
functional currency into a reporting currency
IFRS
US GAAP

• The following method used to translate financial
  statements from the functional currency to the
  reporting currency
• Assets and liabilities are translated to the
  reporting currency at the period-end rates.
• Statement of income and cash flow amounts are
  generally translated at a weighted-average rate
  for the period.
• Equity components, other than retained earnings,
  are translated at historic rates (based on the
  date of investment in the subsidiary).

Similar, with the exception of the translation of
financial statements in hyperinflationary
economies.
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Translation of foreign currency financial
statementsTranslation of a foreign entitys
functional currency into a reporting currency
IFRS
US GAAP

• Translation method (continued)
• Retained earnings are translated in layers as
  follows
• Retained earnings that existed at the date of
  investment are translated at historic rates
  (based on the date of investment in the
  subsidiary).
• Income additions to retained earnings since the
  date of investment are translated using the
  weighted-average rate, as is done for income
  items.
• Dividend reductions to retained earnings are
  translated using the historical rates at the
  date of declaration of the dividend.

Similar, with the exception of the translation of
financial statements in hyperinflationary
economies.
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Translation of foreign currency financial
statementsTranslation of a foreign entitys
functional currency into a reporting currency
IFRS
US GAAP
The net translation gain/loss is not included in
income, but rather such gains/losses are
accumulated in OCI as a CTA.
Similar
Requires certain foreign exchange effects related
to net investments in foreign operations to be
accumulated in shareholders equity (CTA) instead
of recording them in net income as they arise.
Similar
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Translation of foreign currency financial
statementsTranslation of a foreign entitys
functional currency into a reporting currency
CTA
IFRS
US GAAP
The CTA, presented in OCI, reflects the
translation gains and losses not included in the
determination of net income and any differences
from hedging instruments.
Similar
The CTA in OCI is recorded into income in the
same period as the gain or loss on disposal of
the investment in the foreign operation.
Disposal includes sale of 100 or a portion of
the subsidiary, the repayment of share capital,
or abandonment.
Similar
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Translation of foreign currency financial
statementsTranslation of a foreign entitys
functional currency into a reporting currency
CTA

• IFRS
• Amounts in the CTA are taken into income when two
  other events take place
• (1) A subsidiary pays dividends in excess of
  earnings.
• (2) Long-term advances are repaid.
• No similar requirement, which may result in
  differences in impairment charges.

• US GAAP
• No similar requirement.
• When assessing impairment of a disposal group
  that includes a foreign operation, an entity is
  required to add or deduct the CTA related to that
  foreign operation to or from the carrying amount
  of the investment.

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Disposal of an investment example

• Example 2
• The New Coachworks Company, a US-based company,
  owns 100 of its UK subsidiary, Old Coachworks
  Company. The companies follow a calendar year
  for financial reporting purposes.
• On September 30, 2010, Old Coachworks paid
  dividends of GBP 100,000 (150,000 USD) to New
  Coachworks which was GBP 10,000 in excess of Old
  Coachworks share of earnings retained by Old
  Coachworks. The GBP represents a 10 return of
  investment to New Coachworks and the CTA balance
  at September 30, 2010, is 15,000, which
  represents CTA layers for 2007, 2008 and 2009 of
  4,000 per year and 3,000 through September 30,
  2010.

• On November 1, 2010, New Coachworks decided to
  sell 60 of its investment in Old Coachworks to a
  third party in a cash transaction. At year-end,
  the disposal is considered held for sale, but is
  not expected to close until March 2011. The CTA
  totals 16,000 as of year-end.
• The functional currency of Old Coachworks is the
  GBP and the currency of New Coachworks is the
  USD. Currency translation adjustments (CTAs)
  have been recorded in New Coachworks
  consolidated financial statements with respect to
  Old Coachworks.

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Disposal of an investment example

• Does the payment of dividends of GBP 100,000
  (150,000 USD) by Old Coachworks to New
  Coachworks have any effect on New Coachworks CTA
  at the time of the dividends payment, September
  30, 2010? Describe the treatment under US GAAP
  and IFRS.
• Describe the effect the disposal will have on the
  CTA of New Coachworks under both US GAAP and
  IFRS.
• At December 31, 2010, New Coachworks has
  classified Old Coachworks as held for sale. Does
  this classification affect impairment testing
  that will be done as of year-end? Describe your
  conclusions under US GAAP and IFRS.

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Disposal of an investment example

• Example 2 solutions
• Payment of dividends
• US GAAP
• The translation difference (CTA) in equity is not
  recognized when there is a partial return of the
  investment to the parent. The dividends would be
  recognized in the statement of income at the
  translated amount.
• IFRS
• A return on investment (dividends that exceed the
  retained earnings of Old Coachworks by GBP
  10,000) is treated as a partial disposal of the
  foreign investment, and a proportionate share of
  the translation difference (10 x 15,000
  1,500) is recognized in the statement of income.
  

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Disposal of an investment example

• Example 2 solutions (continued)
• Disposal
• US GAAPThe disposal of Old Coachworks should be
  recorded in March 2011, when it is sold. The
  translation difference in equity (CTA) related to
  the portion sold, 60 (60 x 16,000 9,600),
  would be recognized in the statement of income of
  New Coachworks upon the completion of the sale.
  Thus, in March 2011, New Coachworks would
  transfer 9,600 of the existing related CTA from
  OCI and into the statement of income as a
  gain/loss on disposal.
• IFRS The treatment is the same as under US GAAP.
  However, the amount of CTA recognized will
  differ from US GAAP due to the amount of
  dividends received in September 2010. If there
  is a 10 return of equity at September 30, 2010
  (10 x 15,000 1,500), then the 1,500 would
  be reversed from CTA and recognized in the
  statement of income at that time. Thus the
  remaining translation difference in equity (CTA)
  related to the portion sold, 60 (60 x 14,500
  8,700), would be recognized in income of New
  Coachworks upon the completion of the sale. In
  March 2011, New Coachworks would transfer 8,700
  of the existing related CTA from OCI and into the
  income statement as a gain/loss on disposal.

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Disclosures
IFRS
US GAAP

• Requires the disclosure of
• Aggregate translation gains or losses included
  in income.
• Analysis of changes in the CTA for the period,
  including the effects of income taxes.

Similar
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Consolidation of foreign operations

• IFRS
• Requires that when the presentation currency is
  different from the functional currency, that fact
  and the reasons for using a different
  presentation currency shall be disclosed .
• Requires that when there is a change in the
  functional currency of either the reporting
  entity or a significant operation, that fact
  shall be disclosed.

• US GAAP
• Does not have this requirement.
• Does not have this requirement.