Chapter 28 Foreign currency translation Currency conversion Required
- Slides: 24
Chapter 28 Foreign currency translation
Currency conversion • Required when a foreign currency transaction is completed within an accounting period • Two events: – the purchase or sale of an asset or the incurring of an expense or item of income – the receipt or payment of monies for these assets, expenses or items of income.
Case in point 1 • Given: • UK company sells goods to a Swiss company on 1 May 20 X 2 for SWFr 750 000. – Exchange rate 1 May 20 X 2: £ 1 = SWFr 3. 5 • Payment on 1 August 20 x 2 – Exchange rate 1 August 20 X 2: £ 1 = SWFr 3. 7 • Year end: 30 September 20 X 2; reporting currency: £ Required: • Record this transaction in the UK entity’s books?
Feedback 01. 05. 20 X 2: 750 000 / 3. 5 = 214 286 Dr. Accounts receivable Cr. Sales account 01. 08. 20 X 2: 750 000 / 3. 7 = 202 703 Dr. Cash Cr. Accounts receivable 214 286 202 703 Acc. Receivables : £ 11 583 = loss on exchange (IS) In case exchange rate has decreased: profit on exchange
Currency translation • The issue of currency translation in the balance sheet is relevant when foreign currency transactions have not been completed by the year-end
Case in point 2: Follow up of CIP 1 Given Follow up of case in point 1: Now we assume: • Year end 30 June 20 X 2; • exchange rate £ 1= SWFr 3. 6 on 30. 06. 20 X 2: Required: • Record this transaction in the UK entity’s books? Feedback Acc. Receiv. would be £ 208 033 instead of £ 214 286 Difference of £ 6 253 loss of exchange (IS) 01. 08. 20 X 2: Payment of the debt: Further loss of £ 5 330 (so that total loss of £ 11 583 is split over two years) Accounts receivable 1. 5. X 2 sales 214 286 30. 6. X 2 loss 6 253 Balance 208 033 214 286 1. 7. X 2 balance 208 033 1. 8. X 2 cash 202 703 30. 06. X 3 loss 5 330
CIP 2(cont’d) • Loss of exchange on year end in income statement following the idea of prudence • Assume exchange rate on 30 June 20 x 2: £ 1 = 3. 4 • Year end acc. receivable = £ 220 588 • Profit on exchange = £ 6 302 • 1 August 20 X 2: loss of £ 17 885 • Gain of £ 6 302 is unrealized gain so that question arises whether or not to recognize this gain
IAS 21 requirements for entity’s foreign currency transactions • Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition during the period, or in previous financial statements, should be recognized in profit or loss in the period in which they arise • When monetary items arise from a foreign currency transaction and there is a change in the exchange rate between the transaction date and the date of settlement, an exchange difference results. When the transaction is settled within the same accounting period as that in which it occurred, all the exchange difference is recognized in that period. However, when the transaction is settled in a subsequent accounting period, the exchange difference recognized in each period up to the period of settlement is determined by the change in exchange rates during each period • Thus, an unrealized gain to be recognized in the accounts
– 01. 03. X 2: Case in point 3 • Purchase of an asset: € 12. 000 and • exchange rate 1 FC = 2€; • functional currency is FC – 30. 6. X 2: balance sheet date: • exchange rate 1 FC = 1. 50€ Assets in FC 1. 3. X 2 6 000 Accounts payable in FC 30. 6. X 2 8 000 Exc. diff. 2 000 (loss) Sum up: • monetary items (including loans) closing rate and the exchange gain or loss credited or charged to income • non-monetary items carried at HC exchange rate acquisition date • non-monetary items at FV exchange prevalent when FV was determined
IAS 21 requirements for entity’s foreign currency transactions (cont’d) • Functional currency – currency of the primary economic environment in which the entity operates • Primary economic environment: – the one in which the entity primarily generates and expends cash
IAS 21 requirements for entity’s foreign currency transactions (cont’d) • Example: – An entity operating in France owns several buildings in Paris that are rented to foreign companies, mostly US companies. The lease contracts are determined in US dollars and payment can be made in either US dollars or Euros – Functional currency = EURO
IAS 21 requirements for translating foreign operations for consolidation purposes • All individual entities have their own functional currencies • For consolidation purposes they need to be translated in one presentation currency • Presentation currency: – The currency in which the financial statements are presented
IAS 21 requirements for translating foreign operations for consolidation purposes (cont’d) • Translation from functional to presentation currency occurs as follows: 1. assets and liabilities for each statement of financial position presented shall be translated at the closing rate at the date of that statement of financial position 2. income and expenses for each income statement shall be translated at exchange rates at the date of the transactions 3. all resulting exchange differences shall be recognized as a separate component of equity
CIP 4 Zhou Ltd Statement of financial position 31. 12. 20 X 4 FC FC Share capital 300 Retained profits 100 400 Equipment at cost 350 Less Depreciation 50 300 Inventory 80 Net monetary cur. assets 60 140 Long-term loans (40) 400 Statement of income 31. 12. 20 X 4 FC Sales Less cost of sales 600 (400) Gross profit 200 Less depreciation (50) Less other expenses (50) 100
(cont’d) Presentation currency Zhou Ltd is Crowns (Cr) 1 January 20 X 4 Average for the year to 31 December X 4 31 December 20 X 4 Statement of income 31. 12. 20 X 4 Sales Less cost of sales Gross profit Less depreciation Less other expenses Rate 4. 5 4. 2 4. 5 FC to Cr 5 4. 2 Crs 11. 9 11. 1 Crs 133. 3 88. 9 44. 4 23 21. 4
(cont’d) Presentation currency Zhou Ltd is Crowns (Cr) 1 January 20 X 4 Average for the year to 31 December X 4 31 December 20 X 4 Statement of financial position 31. 12. X 4 Share capital Retained profits Exchange difference Equipment at cost Depreciation Inventory Net monetary current assets Long-term loans Rate 5 4. 2 4. 2 FC to Cr 5 4. 2 Crs 60. 0 21. 4 13. 8 95. 2 83. 3 11. 9 71. 4 19. 0 14. 3 (9. 5) 23. 8 95. 2
Alternative translation methods for financial statements of foreign operations • Two basic possible views: – we can use the exchange rate ruling when the item was created (historic rate) – we can use the exchange rate ruling when the item is being reported (current or closing rate) • Different combinations: – Single rate (closing rate) • all assets, liabilities, revenues, expenses: closing rate – Mixed rate (current/non current) • current assets and liabilities: closing rate • fixed assets and non-current liabilities: rate ruling when the item was established
Alternative translation methods for financial statements of foreign operations (cont’d) – Mixed rate (monetary/non monetary) – monetary assets and liabilities: closing rate – all non-monetary assets and liabilities: rate ruling when the item was established – Mixed rate (temporal) – assets recorded at HC: historic rate (rate ruling when the item was established) – assets recorded on a current value: closing rate – revenues and expenses: rate ruling on the date when the amount shown in the accounts was established
Alternative translation methods for financial statements of foreign operations (cont’d) Translation foreign currency into functional currency: TEMPORAL METHOD Item Cost and depreciation of PPE and intangible assets Inventories Monetary items Income and expense items Translation rate Rate at date of acquisition or fair valuation date Rate when cost incurred Closing rate Rate at date of acquisition or average rate for period if rates do not fluctuate significantly Exchange differences Profit or loss
Alternative translation methods for financial statements of foreign operations (cont’d) Translation functional currency into presentation currency: CLOSING RATE METHOD Item All assets and liabilities (whether monetary or non-monetary) Income or expense items Exchange differences Translation rate Closing rate Rate at date of acquisition or average rate for period if rates do not fluctuate significantly Other comprehensive income
CIP. 5 Home established a 100% ownership of Away on 1 January 20 X 8 by subscribing to € 25 000 of shares in cash when the exchange rate was 12 currency units (CU) to the €. Away raised a long-term loan of 100 000 CU locally on 1 January 20 X 8 and immediately purchased equipment costing 350 000 CU, which was expected to last ten years with no residual value. It was to be depreciated under the straight line method. The accounts of Away in the foreign currency for 20 X 8 follow, during which the relevant exchange rates were: CU to € 1 January 20 X 8 12 Average for year 11 Average for period in which closing inventory acquired 10. 5 31 December 20 X 8 10
CIP. 5 (cont’d) Statement of financial position 31. 12. 20 X 8 CU Statement of income 20 X 8 CU Sales Less cost of sales Gross profit Less depreciation Less other expenses Net profit Share capital 450 000 Retained profits (360 000) 300 000 40 000 340 000 90 000 Equipment at cost (35 000) less Depreciation 350 000 (15 000) Inventory 40 000 Net mon. cur. assets 315 000 less long-term loans (100 000) 35 000 105 000 20 000 340 000
CIP. 5 - Feedback Statement of income 20 X 8 Sales Less cost of sales Gross profit Less depreciation Less other expenses Net profit Rate Closing Temporal Rate 11 11 40 909 32 727 8 182 (3 500) (1 364) 3 318 40 909 32 727 8 182 (2 917) (1 364) 3 901 11 11 10 11 12 11
CIP. 5 - Feedback Statement of financial position 31. 12. 20 X 8 Share capital Retained profits Equipment at cost less Depreciation Inventory Net monetary current assets less long-term loans Exchange difference Rate 10 10 10 Closing Temporal 25 000 3 318 28 318 35 000 3 500 31 500 10 500 2 000 (10 000) 34 000 (5 682) 28 318 25 000 3 901 28 901 29 167 2 917 26 250 10 000 2 000 (10 000) 28 250 651 28 901 Rate 12 12 10. 5 10 10
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