Rajesh Dhawan
IAS-21,IAS-29 & SIC-11
Functional Currency:
IASs have no explicit concept of functional currency. Whatever currency the accounts are presented in is simply known as the ‘reporting currency’ (all other currencies are foreign currencies) and its role in the translation processes is similar to that of the US and UK functional currency. There are no rules governing the selection of the reporting currency although the standard observes that it would usually be the currency of the country in which the company is domiciled. So in most cases this reporting currency will probably be the same as the US and UK functional currency. In cases where the company intends to present accounts in a currency that has no relevance for its operations it may be necessary to take the view that its operations are in effect a foreign entity so far as that reporting currency is concerned. Thus the apparent free choice of the underlying functional like currency may not exist in practice. The SIC purposes clarify this issue along the lines set out above.
Foreign Currency Transactions:
Each foreign currency transaction, i.e. the assets, liabilities, gains or loss arising there from, is recorded in the reporting currency at the rate of exchange at the date of the transaction. At each balance sheet date the monetary assets and liabilities (i.e. those to be received or paid in fixed ore determinable amounts of money) are translated at the exchange rate at the balance sheet date. In general the resulting exchange gains and losses are dealt within the income statement.
Where an asset has been purchased in the last year, it was invoiced in a foreign currency, a liability arising on its acquisition cannot yet be settled and there is a severe devaluation of the currency of that liability against which there is no means of hedging then an Allowed Alternative Treatment is available. The devaluation exchange losses on that liability may be capitalized into the related asset (provided that it does not exceed its recoverable amount, or replacement cost if lower). These circumstances are expected to be rare.
Equity investments in foreign entities (subsidiaries, associates, joint venture or branches) are not monetary assets and so are not retranslated. However, monetary items that in substance forms part of the net investment in the foreign entity, i.e. receivables and payables (other than trade items) for which settlement is neither planned nor likely for the foreseeable future, are retranslated but with the exchange differences taken directly to equity.
SFAS-52, F-60
Functional Currency:
A company’s functional currency is defined as the currency of the primarily economic environment in which the company operates. Normally this is the currency of the environment in which the company generates and expects cash. The functional currency of a foreign operation is, in most cases, a matter of fact. In some situations, however, the facts may not identify clearly the functional currency, and management’s judgment is required to determine the functional currency that best achieves the objectives of translation.
Foreign Currency Transactions:
Foreign currency transactions are transactions denominated in a currency other than the company’s functional currency. At the date the transaction is recognised, each asset, liability, revenue, expense, gain or loss arising from the transaction is measured and recorded in the functional currency of the reporting company using the exchange rate in effect at that date. At each balance sheet date, monetary items that are denominated in a currency other than the functional currency of the reporting company are adjusted to reflect the current exchange rate. Resulting gains and losses (except for those items which qualify for hedge accounting), are included in the determination of net income for that period.
Gains and losses in intra-group foreign currency transactions that are of a long-term investment nature (that is, settlement is not planned or anticipated in the foreseeable future, and this is re-assessed at every year end) are included in OCI, provided that the transacting entities are consolidated, combined or accounted for by the equity method in the reporting company’s financial statements.
Translation of foreign currency financial statements
Where a foreign operation is an integral part of the operations of the reporting company, its financial statements should be translated as if its transactions were those of the reporting company.
However, in the most practical cases the operations are not integral, and are termed ‘foreign entities’. In these cases the assets and liabilities are translated at the rate on the balance sheet date; items in the income statement are translated at rates as at the dates of the relevant transactions, although an appropriate average rate may be used; exchange differences so arising are taken directly to equity. The cumulative amount of this translation adjustment must disclose.
In performing this last mentioned translation, goodwill and fair value adjustment in respect of the foreign entity concerned may either be included as part of the re-translated assets and liabilities or be excluded (and therefore never translated).
If a foreign entity reports in a currency that has no relevance for its operations it may be necessary to take the view that the accounts must first be translated into a currency of relevance to the operation, as if that currency were its reporting currency (i.e. like the US re-measurement process). The SIC is currently considered this point.
SFAS-52, F-60
Translation of foreign currency financial statements
The functional currency of a foreign entity will not always be the currency of the country in which it is located or the currency in which its records are maintained. Such a situation will occur, for example, when the entity is merely an extension of the parent company. In that case, the functional currency would be the reporting currency of the parent company.
For subsidiaries for which the local currency is the functional currency, the exchange rate at the balance sheet date is used to convert the assets and liabilities at the balance sheet date from the functional currency to the reporting currency. Revenues, expenses, gains and losses are translated at the exchange rate in effect when these items were recognised. In practice, an appropriately weighted average rate may be used.
Translation adjustments arising from the process of translating an entity’s financial statements from the functional currency into the reporting currency are included in OCI, rather than in net income, and are accumulated and disclosed as a separate component of consolidated stockholder’s equity.
If an investor accounts for an investment in a foreign currency using the equity method, the investor’s financial statements should report a translation adjustment in OCI; that is, the investor’s share of the adjustment resulting from the translation of the investee’s financial statements.
Goodwill and other fair value purchase-accounting adjustments of an acquired foreign entity represent assets of the acquired foreign entity. Accordingly, goodwill and other fair value purchase adjustments and the related accretion and amortised should be translated at current exchange rates in a similar manner to the other assets and liabilities of the foreign entity.
If the accounting records of an entity are maintained in a currency other than its functional currency, they must be converted into its functional currency, by a process called re-measurement, before translation into the reporting currency. The re-measurement process is intended to produce the same accounting results as if the entity’s books of record had been maintained in its functional currency. Consequently, historical exchange rates are used for non-monetary items and related revenue & expenses dominated in currency other than the functional currency and current exchange rates are used to measure monetary items. Exchange gains and losses that arise from the re-measurement process are reported in determining net income.
Translation of Foreign Currency Financial Statements- Hyper-Inflation
IASs do not specify an absolute rate of inflation that is considered to be hyper-inflation. However, they consider that a cumulative inflation rate over three years approaching, or exceeding, 100% is an indication of a hyper-inflationary economy. Before the financial statements of a subsidiary reporting in such a hyper-inflationary currency are translated into the reporting currency they are restated in terms of the measuring unit current at the balance sheet date (i.e. current purchasing power concept is used). The SIC is considered whether it is also acceptable for the financial statements of the subsidiary concerned instead to be reported in a non-hyper-inflationary-currency, provided that currency has relevance for the subsidiary’s operations, before being translated in the normal way to the group’s reporting currency.
Sale or liquidation of a foreign entity:
The cumulative exchange differences, relating to a foreign entity, that have previously been included directly in equity, should be recognised in the income statement when the foreign entity is disposed (or proportionately so if it is partly disposed of). The standard does not specify whereabouts in the income statement this item is included, in practice it is included as part of the gain or loss on the disposal.
SFAS-52, F-60
Translation of Foreign Currency Financial Statements- Hyper-Inflation
Highly inflationary economics include those with cumulative inflation of 100% or more over a three year period. The financial statements of a foreign entity in such an economy must be remeasured as if the functional currency were the reporting currency.
Sale or liquidation of a foreign entity:
The amount attributable to a foreign entity included in the translation component of stakeholder’s equity should be reported as part of the gain or loss upon sale or upon complete or substantially complete liquidation of that entity. Accordingly, accounting records should be maintained in a manner that will allow the identification of that portion of the separate component of equity that relates to each investment operation.
If a company sells part of its ownership interest in a foreign entity, a pro rata amount of the accumulated translation component of equity attributable to that investment should be recognised in measuring the gain or loss on sale.
(Author can be reached @ sunraj.18@rediffmail.com)
