CBIZ & MHM Executive Education Series™ IFRS: Accounting for Foreign Currency

Transactions Presented by: Marco Pulido, Shareholder

July 10, 2014

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Today’s Presenters

Marco Pulido, CPA Shareholder 310.268.2746 | mpulido@cbiz.com Marco has 15 years of experience in public accounting working with U.S. GAAP, IFRS and other foreign accounting standards in the U.S., Europe and in Latin America with Big 4 accounting firms. He has experience with SEC filers (foreign and domestic) and private companies. Marco is a CPA certified in California and has IFRS certifications by the Institute of Chartered Accountants in England and Wales (ICAEW) and the American Institute of Certified Public Accountants (AICPA). Technical accounting expertise includes the following industries: Energy (Oil & Gas) - Retail, Distribution & Manufacturing - Transportation - Utilities - Consumer Services - Construction/Real Estate - Health Sciences – Financial Services – Agriculture.

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Today’s Agenda

Principal concepts of IAS 21

Determining the Functional Currency of an entity

Effects of changes in exchange rates on Monetary Items

Use of a Presentation Currency other than the Functional Currency

1

2

3

4

5

6

Other issues

IFRS vs. US GAAP differences

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The standard applies: in accounting for transactions and balances in foreign

currencies, except for those derivative transactions and balances that are within the scope of IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9 Financial Instruments

in translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation or the equity method; and

in translating an entity’s results and financial position into a presentation currency.

<IAS 21.3>

Scope of IAS 21

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DEFINITION: The currency of the primary economic environment in which the entity operates. Primary economic environment:

Is normally the one in which it primarily generates and expends cash.

Functional Currency

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The currency: that mainly influences sales prices for goods and services (this will

often be the currency in which sales prices for its goods and services are denominated and settled); and

of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.

that mainly influences labor, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled).

<IAS 21.9 >

Determining Functional Currency Primary factors

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The following factors may also provide evidence of an entity’s functional currency: the currency in which funds from financing activities (i.e., issuing

debt and equity instruments) are generated. the currency in which receipts from operating activities are usually

retained.

U.S. GAAP difference: U.S. GAAP has a list of factors to consider, all of which are generally given equal importance. Factors are not distinguished by primary and other.

<IAS 21.10 >

Determining Functional Currency Secondary factors

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Additional factors to consider in determining the functional currency of a foreign operation

Does this factor suggest that the

functional currency of the foreign operation

is the same as the reporting entity?

The activities of the foreign operation are carried out as an extension of the reporting entity. Yes or No?

The activities of the foreign operation are autonomous. Yes or No?

Transactions with the reporting entity represent a large proportion of the business activities of the foreign operation. Yes or No?

Cash flows of the foreign operation are readily remittable to the reporting entity. Yes or No?

Cash flows of the foreign operation are sufficient to service existing and normally expected debt obligations without funds being made available by the reporting entity.

Yes or No?

<IAS 21.11>

Determining Functional Currency Functional currency of a foreign operation vs. reporting entity

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Additional factors to consider in determining the functional currency of a foreign operation

Does this factor suggest that the

functional currency of the foreign operation

is the same as the reporting entity?

The activities of the foreign operation are carried out as an extension of the reporting entity. Yes

The activities of the foreign operation are autonomous. No

Transactions with the reporting entity represent a large proportion of the business activities of the foreign operation. Yes

Cash flows of the foreign operation are readily remittable to the reporting entity. Yes

Cash flows of the foreign operation are sufficient to service existing and normally expected debt obligations without funds being made available by the reporting entity.

Yes

<IAS 21.11>

Determining Functional Currency Functional currency of a foreign operation vs. reporting entity

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When the indicators are mixed and the functional currency is not obvious, management uses its judgment to determine the functional currency giving priority to the primary indicators.

Once determined, the functional currency is not changed unless there is a change in the underlying transactions, events and conditions. A change in functional currency can only be applied

prospectively. The exchange rate of the new functional currency is applied on

the date of the change.

< IAS 21.12, 13 and 35 >

Determining Functional Currency

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A monetary item is a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency.

E.g., Receivable or payable in a foreign currency

Monetary items denominated in a foreign currency must be converted to the functional currency of the reporting entity using the spot exchange rate. At reporting dates and until the monetary item is settled, gains or losses due to

changes in the exchange rate are recorded in the P&L as “exchange gain (loss)” Conversely, the essential feature of a non-monetary item is the absence of a

right to receive or (an obligation to deliver) a fixed amount of units of currency. Similarly, items are converted to functional currency at date of purchase. However,

no subsequent recognition of an “exchange gain (loss)” for changes in exchange rates.

This includes items such: Prepayments for goods or services PP&E purchased in foreign currency (converted at exchange rate at date of purchase to functional

currency of the reporting entity with no subsequent adjustment to the cost basis)

<IAS 21.16 and 21>

Monetary vs. Non-monetary Items

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Question: Yes or No — A corporation in the U.S. purchases inventory from a supplier in

China in Chinese Yuan. Upon receipt of the inventory, the U.S. corporation records a payable.

Is the payable a monetary item?

Example – Purchase of Inventory in Foreign Currency

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Question: Yes or No — A corporation in the U.S. purchases inventory from a supplier in

China in Chinese Yuan. Upon receipt of the inventory, the U.S. corporation records a payable.

Is the payable a monetary item? Response: Yes. The payable represents an obligation to deliver a fixed amount of units of

currency. Hence, this monetary item should be translated to the functional currency of the U.S. corporation (dollar) at the date that the payable is recognized, with periodic adjustments to the payable to reflect changes in the exchange rate until settlement date.

Changes in the payable due to changes in the exchange rate are recorded as an “exchange gain (loss)” on the income statement.

Example – Purchase of Inventory in Foreign Currency

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Financial statements must be maintained in the “functional currency” of each entity.

If maintained in a different currency, i.e. “reporting currency,” the financial statements

must be translated to the functional currency. This entails recognizing all transactions

at their original exchange rate, which will result in a gain (loss) at closing dates.

U.S. GAAP calls this a “remeasurement gain (loss)”.

An entity may then have to convert their financials to a “presentation currency”, e.g. for purposes of consolidating with the reporting entity.

This process requires a translation of the financial statements.

<IAS 21.38 >

Use of a Presentation Currency other than the Functional Currency

Reporting Currency

Functional Currency

Presentation Currency

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Translation of financial statements from functional currency to presentation currency The results and financial position of an entity whose functional currency is not

the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

Assets and liabilities for each balance sheet presented shall be translated at the closing rate at the date of the balance sheet, equity at historical exchange rates;

Income and expenses for each income statement shall be translated at exchange rates at the dates of the transactions, i.e. historical (avg. ex. rate for year is often used); and

All resulting exchange differences are recognized in other comprehensive income (OCI).

Accumulated effect in OCI carries over to future periods and is recognized in P&L once foreign operation is disposed of.

<IAS 21.39 and 48 >

Use of a Presentation Currency other than the Functional Currency

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Question: Yes or No — A foreign subsidiary of a U.S. corporation (whose functional

currency is the US dollar) has determined that the Euro is its functional currency. However, the foreign subsidiary maintains its financial statements, i.e., reporting currency, in US dollars. Must the foreign subsidiary convert its financial statements to its functional currency as required by IAS 21.38?

Example – Use of a Presentation Currency other than the Functional Currency

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Question: Yes or No — A foreign subsidiary of a U.S. corporation (whose functional

currency is the US dollar) has determined that the Euro is its functional currency. However, the foreign subsidiary maintains its financial statements, i.e., reporting currency, in US dollars. Must the foreign subsidiary convert its financial statements to its functional currency as required by IAS 21.38?

Response: Yes. IAS 21 requires that all entities maintain their financial statements in their

functional currency. In this case, the foreign subsidiary must convert their financial statements to its functional currency, which is the Euro. In order to consolidate its financial information with the U.S. corporation, it will then need to translate its financial statements from its functional currency to the presentation currency using the procedures noted in IAS 21.39.

Conversion process = US dollar – Euro – US dollar

Example – Use of a Presentation Currency other than the Functional Currency

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IAS 29 Financial Reporting in Hyperinflationary Economies is applied when the functional currency is the currency of a hyperinflationary economy. The cumulative inflation rate over three years is approaching, or

exceeds, 100%. The results and financial position of an entity whose functional

currency is the currency of a hyperinflationary economy shall be translated into a different presentation currency (IAS 29) using the following procedures: Assets, liabilities, equity – Closing exchange rate Income and expenses – Closing exchange rate

U.S. GAAP – Functional currency changes from hyperinflationary currency to US dollar or currency of reporting entity, if different. IFRS maintains the functional currency.

<IAS 21.42 and 43>

Functional Currency is Currency of a Hyperinflationary Economy

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The method of consolidation is not specified, either the “direct” or “step-by-step” method of consolidation is used Direct method – Each entity within the consolidated group is

directly translated into the functional currency of the ultimate parent and then consolidated into the ultimate parent (i.e., the reporting entity) without regard to any intermediate parent.

Step-by-Step method – Each entity should be consolidated by the enterprise that controls the entity. Hence, each entity is consolidated into its immediate parent until the ultimate parent has consolidated the financial statements of all the entities below it.

The choice of consolidation method used could affect the cumulative translation adjustments in OCI at intermediate levels, and exchange rate differences upon disposal of an intermediate foreign operation.

U.S. GAAP – Step-by-Step is the only allowable method.

Consolidation of Foreign Operations

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Background Canada Mining is a diamond mining company and is jointly controlled as follows:

50% Diamond Mining USA (whose functional currency is the dollar) 50% British Mining (company in the UK whose functional currency is the pound).

Canada Mining is autonomous and the president previously worked for British Mining. International diamond trade follows U.S. regulations and all sales are denominated in

dollars. In 2009, Diamond Mining USA sold its participation in Canada Mining to British Mining.

Question 1 What was the functional currency of Canada Mining in 2008? a) Canadian dollars b) US dollars c) British pounds

Case Study – Determination of the Functional Currency

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Response- 2008 Answer is B, US dollars. It is considered that the dollar is the

functional currency of Canada Mining in 2008, since it is the currency: that mainly influences sales prices for goods and services, and whose competitive forces and regulations mainly determine the

sales prices of its goods and services. The primary indicators at IAS 21.9 (primary factors) precede

those that are noted at IAS 21.10 and 11 (secondary factors).

Case Study – Determination of the Functional Currency

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Question 2 What was the functional currency of Canada Mining in 2009? a) Canadian dollars b) US dollars c) British pounds

Case Study – Determination of the Functional Currency

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Response- 2009 Answer B, US dollars. No change from 2008 since there were

no changes in transactions, facts and underlying conditions that would justify a change in the functional currency.

The functional currency could have changed had Canada Mining become less autonomous, due to an increased dependence on British Mining, and a possible change in the currency which influences pricing.

Case Study – Determination of the Functional Currency

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Questions?

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Join us for these upcoming IFRS courses: September 4: Business Combinations Under IFRS October 23: Consolidated Financial Statements Using

IFRS November 20: The Impact of IFRS on Income Taxes

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