Category: Financial Accounting

Overview

Companies often enter into transactions in a foreign currency. Groups often contain overseas entities. A parent company might own a foreign subsidiary or associate. This foreign entity will normally maintain its accounting records and prepare its financial statements in a currency that is different from the currency of the parent company. These IAS 21 notes are prepared by mindmaplab team and covering IAS 21 foreign currency summary, the effects of changes in foreign exchange rates, monetary items and functional currency determination with examples. This is IAS 21 full text we have also prepared the IAS 21 pdf version download.

IAS Standards

IAS 2 Inventories       

IAS 7 Statements of cash flows

IAS 7 Statement of cash flows  – Revisited

IAS 8 Accounting policies, changes in accounting estimates, and errors

IAS 10 Events after the reporting period       

IAS 12 Income taxes 

IAS 16 Property, plant and equipment          

IAS 17 Leases

IAS 19 Employee benefits     

IAS 20 Accounting for government grants and disclosure of government assistance          

IAS 21 The effects of changes in foreign exchange rates     

IAS 23 Borrowing costs        

IAS 24 Related party disclosures

IAS 27 Consolidated and separate financial statements        

IAS 28 Investments in associates and joint ventures 

IAS 32 Financial instruments: presentation  

IAS 33 Earnings per share

IAS 33 Earnings per share – Revisited          

IAS 36 Impairment of assets 

IAS 37 Provisions, contingent liabilities and contingent assets        

IAS 38 Intangible assets

IAS 40 Investment property

IFRS Standards

IFRS 3 Business combinations    

IFRS 5 Non-current assets held for sale and discontinued operations    

IFRS 7 Financial instruments: disclosures          

IFRS 8 Operating segments         

IFRS 9 Financial instruments      

IFRS 10 Consolidated financial statements        

IFRS 11 Joint arrangements         

IFRS 12 Disclosure of interests in other entities 

IFRS 13 Fair value measurement 

IFRS 15 Revenues from contracts with customers          

IFRS 16 Leases

IAS 17 VS IFRS 16 Lease – Differences

Ratio Analysis

Companies often enter into transactions in a foreign currency. Groups often contain overseas entities. A parent company might own a foreign subsidiary or associate. This foreign entity will normally maintain its accounting records and prepare its financial statements in a currency that is different from the currency of the parent company.

These transactions need to be translated into the company’s/parent company’s own currency in order to record them in its ledger accounts/group’s consolidated accounts.

Scope of IAS Foreign currency

IAS 21 shall be applied:

1. in accounting for transactions and balances in foreign currencies, except for those derivative transactions and balances that are within the scope of IFRS 9 Financial Instruments;
2. 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
3. in translating an entity’s results and financial position into a presentation currency.

IAS 21 Definitions

1. Presentation currency – The currency in which the financial statements of an entity are presented
2. Functional currency – The currency of the primary economic environment in which an entity operates.
   • IAS 21 describes the functional currency as – The currency that mainly influences:
     1. sales prices for goods and services.
     2. labour, material and other costs of providing goods or services.
     3. The currency in which funds from financing activities are generated by issuing debt and equity.
     4. The currency in which receipts from operating activities are usually retained.
   • The functional currency is not necessarily the currency of the country in which the entity operates or is based
   • When a reporting entity records transaction in its financial records, it MUST identify its functional currency and make entries in that currency.
3. Foreign currency – A currency other than the functional currency of the entity.
4. Exchange rate – The rate of exchange between two currencies
5. Spot rate – The exchange rate at the date of the transaction
6. Closing rate – The spot exchange rate at the end of the reporting period

The two main accounting issues

The process of translation would be quite simple if exchange rates between currencies remained fixed. However, exchange rates are continually changing. The translated valuation of foreign currency assets or liabilities in the statement of financial position might therefore change if they are translated at different times.

The two main accounting issues when accounting for foreign currency items are:

1. What exchange rate(s) should be used for translation?
2. How to account for the gains or losses that arise when exchange rates change?

IAS 21 The individual entity – Accounting rules

An individual company may have transactions that are denominated in a foreign currency. These transactions may have to be translated on several occasions. When a transaction or asset or liability is translated on more than one occasion, it is:

• translated at the time that it is originally recognised; and
• re-translated at each subsequent occasion.

Re-translation may be required, after the transaction has been recognised initially:

1. at the end of a financial year (end of a reporting period);
2. when the transaction is settled (which may be either before, or after the end of the financial year).

On each subsequent re-translation, an exchange difference will occur. This gives rise to a gain or loss on translation from the exchange difference.

• The gain or loss is the difference between the original and re-translated value of the item.
• There is an exchange gain when an asset increases in value on re-translation, or when a liability falls in value.

Initial recognition: translation of transactions

On initial recognition, a transaction in a foreign currency must be translated at the spot rate on the date of the transaction.

If the entity buys items in frequently, it may be able to use an average spot rate for a period, for all transactions during that period.

IAS 21 therefore allows entities to use an average rate for a time period, provided that the exchange rate does not fluctuate significantly over the period.

Reporting at the end of each reporting period and gain or loss arising on translation

The rules in IAS 21 for reporting assets and liabilities at the end of a subsequent reporting period make a distinction between:

1. Monetary items, such as trade payables and trade receivables, and
2. Non-monetary items, such as non-current assets and inventory.

Revaluations of non-current assets

A non-current asset in a foreign currency might be re-valued during a financial period.

Any gain or loss arising on retranslation of this property is recognised in the same place as the gain or loss arising on the revaluation that led to the retranslation.

1. If a revaluation gain had been recognised in other comprehensive income in accordance with IAS 16, the exchange difference would also be recognised in other comprehensive income.
2. If a revaluation gain had been recognised in profit or loss in accordance with IAS 40, the exchange difference would also be recognised in profit or loss.

Reporting at the settlement of a transaction

The settlement of a foreign currency transaction involves a receipt or payment in foreign currency.

There will be exchange difference when the exchange rate at the date of settlement is different to that at the date of initial recognition of the receivable or payable in question. This is recognised in the statement of profit or loss.

IAS 21 The Foreign operation – Accounting rules

If a company has a foreign operation (such as a foreign subsidiary) that prepares its accounts in a functional currency that is different from the group’s presentation currency, there are three stages in the accounting process, for the purpose of preparing consolidated financial statements:

1. Adjust and update
   • Ensure that the individual financial statements of the foreign entity are correct and up-to-date.
2. Translate
   • The assets and liabilities of the foreign entity should be translated into the presentation currency of the parent company.
3. Consolidate
   • After translation, all the financial statements are now in the same currency.
   • Normal group accounting principles are now used to prepare the consolidated accounts of the group.

Adjust and update stage

This deals with any adjustments to the accounts of the subsidiary and parent, e.g. intercompany trading transactions and inter-company loans. Apply the normal rules for dealing with these.

The translation stage

This apply where the functional currency of the foreign entity is not a currency suffering from hyperinflation. When there is hyperinflation, IAS 29 provides special accounting rules.

The normal rules for translation, contained in IAS 21, are:

The statement of financial position

• The assets and liabilities of the foreign operation are translated at the closing rate for inclusion in the consolidated statement of financial position.
• This rule also applies to purchased goodwill arising on the acquisition of a foreign subsidiary.

The statement of profit or loss

• Income and expenses are translated at the rates ruling at the date of the transaction (spot rates) for inclusion in the consolidated statement of profit or loss.
• Average rates are widely used in practice.

Exchange differences

All resulting exchange differences are recognised in other comprehensive income for the period and are credited (gain) or debited (loss) to a separate reserve within the equity section of the consolidated statement of financial position, and this reserve is maintained within equity until the foreign operation is eventually disposed of:

• The total Exchange gain/loss amount is recognised in other comprehensive income.
• The amount attributable to the parent is recognised in a currency translation reserve.
• The amount attributable to the non-controlling interest is recognised in the non-controlling interest balance.

The consolidation stage

After the translation stage, the financial statements of the overseas entity are in the presentation currency of the parent company. Consolidation can proceed as normal. However, there are several issues to be aware of:

1. Goodwill must be retranslated at each reporting date; and
2. A foreign exchange reserve must be included in the consolidated statement of financial position for the cumulative exchange differences.

IAS 21 requires that:

Goodwill arising on the purchase of the foreign subsidiary (and also any fair value adjustments to the value of assets of the subsidiary) should be stated in the functional currency of the foreign subsidiary.

The goodwill and fair value adjustments will therefore be translated each year at the closing exchange rate.

*The Exchange gain/loss amount on goodwill is fully attributable to the parent as it only relates to the parent’s investment in the subsidiary.

* Remember that share capital and reserves of subsidiary include Exchange differences.

Disposal of a foreign subsidiary

Most of the accounting rules for the disposal of a foreign subsidiary, or for the partial disposal of a foreign subsidiary, are set out in IFRS 10.

IFRS 10 does not deal with the accounting treatment of the balance on the separate equity reserve account when a foreign subsidiary is disposed of. This matter is dealt with by IAS 21.

*Keep it simple – The gain/loss on disposal of foreign subsidiary (Consideration received from sale of shares – Carrying value of net assets of subsidiary) along with Exchange gain/loss are recognized in profit or loss.

IFRIC 22: Foreign Currency Transactions and Advance Consideration

IFRIC 22 applies to a foreign currency transaction (or part of it) when an entity recognises a nonmonetary asset or non-monetary liability arising from the payment or receipt of advance consideration before the entity recognises the related asset, expense or income (or part of it).

IFRIC 22 addresses how to determine the date of the transaction for the purpose of determining the exchange rate to use on initial recognition of the related asset, expense or income (or part of it) on the derecognition of a non-monetary asset or non-monetary liability arising from the payment or receipt of advance consideration in a foreign currency.  In this respect the date of the transaction for the purpose of determining the exchange rate to use on initial recognition of the related asset, expense or income (or part of it) is the date on which an entity initially recognises the non-monetary asset or non-monetary liability arising from the payment or receipt of advance consideration. If there are multiple payments or receipts in advance, the entity shall determine a date of the transaction for each payment or receipt of advance consideration.

Overview

IAS 19 Employee benefits are all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment. IAS 19 revised provides guidance on accounting for all forms of employee benefits, except for share-based payments. Share-based payments are dealt with by IFRS 2. These IAS 19 notes are prepared by mindmaplab team and covering IAS 19 employee benefits calculation with example, employee benefits IFRS, retirement and pension accounting, projected unit credit method under IAS 19, the termination benefits, IAS 19 defined benefit plan, actuarial gains and losses, IAS 19 short term employee benefits and with all the disclosure requirements with examples and a summary of everything. We have also prepared the IAS 19 pdf version download.

IAS Standards

IAS 2 Inventories       

IAS 7 Statements of cash flows

IAS 7 Statement of cash flows  – Revisited

IAS 8 Accounting policies, changes in accounting estimates, and errors

IAS 10 Events after the reporting period       

IAS 12 Income taxes 

IAS 16 Property, plant and equipment          

IAS 17 Leases

IAS 19 Employee benefits     

IAS 20 Accounting for government grants and disclosure of government assistance          

IAS 21 The effects of changes in foreign exchange rates     

IAS 23 Borrowing costs        

IAS 24 Related party disclosures

IAS 27 Consolidated and separate financial statements        

IAS 28 Investments in associates and joint ventures 

IAS 32 Financial instruments: presentation  

IAS 33 Earnings per share

IAS 33 Earnings per share – Revisited          

IAS 36 Impairment of assets 

IAS 37 Provisions, contingent liabilities and contingent assets        

IAS 38 Intangible assets

IAS 40 Investment property

IFRS Standards

IFRS 3 Business combinations    

IFRS 5 Non-current assets held for sale and discontinued operations    

IFRS 7 Financial instruments: disclosures          

IFRS 8 Operating segments         

IFRS 9 Financial instruments      

IFRS 10 Consolidated financial statements        

IFRS 11 Joint arrangements         

IFRS 12 Disclosure of interests in other entities 

IFRS 13 Fair value measurement 

IFRS 15 Revenues from contracts with customers          

IFRS 16 Leases

IAS 17 VS IFRS 16 Lease – Differences

Ratio Analysis

 

The scope and basic principles of IAS 19

Employee benefits are all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment. IAS 19 provides guidance on accounting for all forms of employee benefits, except for share-based payments. Share-based payments are dealt with by IFRS 2.

IAS 19 sets out rules of accounting and disclosure for:

1. Short term employee benefits;
   1. salaries, wages
   2. paid annual leave and paid sick leave
   3. profit-sharing and bonuses
   4. non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current employees.
2. Post-employment benefits;
   1. retirement benefits
   2. post-employment life insurance and post-employment medical care
3. Other long-term employee benefits;
   1. long-service leave pays
   2. long-term disability benefits
4. Termination benefits

Accounting principle

IAS 19 requires an entity:

• to recognise a liability when an employee has provided a service in exchange for a benefit that will be paid in the future, and
• to recognise an expense when the entity makes use of the service provided by the employee.

The basic double entry may therefore be:

Debit: Employment cost (charged as an expense in the statement of profit or loss)

Credit: Liability for employee benefits

Short-term employee benefits

Short-term employee benefits are employee benefits that are expected to be settled wholly within twelve months. Discounting the liability to a present value is not required, because it is payable within 12 months.

Short-term paid absences

Entitlement to paid absences falls into two categories:

1. Accumulating
   1. Are carried forward for use in future periods if the current period’s entitlement is not used in full
   2. expense and liability is recognised when employees render service that increases their entitlement to future paid absences
   3. measured at the additional amount expected to be paid as a result of the unused entitlement that has accumulated at the end of the reporting period.
2. Non-accumulating:
   1. unused amounts cannot be carried forward
   2. expense and liability is recognised when the absences occur

Profit-sharing and bonus plans

The expected cost of profit-sharing and bonus payments must be recognised when, and only when:

1. the entity has a present legal or constructive obligation to make such payments as a result of past events; and
2. a reliable estimate of the obligation can be made.

A present obligation exists when, and only when, the entity has no realistic alternative but to make the payments.

Termination benefits

An entity must recognise a liability and expense for termination benefits at the earlier of the following dates:

1. when the entity can no longer withdraw the offer of those benefits; and
2. when the entity recognises costs for a restructuring within the scope of IAS 37 that involves the payment of termination benefits.

Termination benefits are measured in accordance with the nature of the employee benefit, that is to say short term benefits, other long- term benefits or postemployment benefits.

Other long-term benefits

1. Other long-term employee benefits are all employee benefits other than short-term employee benefits, post-employment benefits and termination benefits.
2. An entity must recognise a net liability (asset) for any other long-term benefit. This is measured as:
   1. the present value of the obligation for the benefit; less
   2. the fair value of assets set aside to meet the obligation (if any).
3. Movements in the amount from one year to the next are recognised in P&L.

Post-employment benefits

Post-employment benefits are employee benefits that are payable after the completion of employment. The most significant post-employment benefit is a retirement pension.

Post-employment benefit plans – are formal or informal arrangements under which an entity provides post-employment benefits for one or more employees. There are two types:

     Defined contribution plans

• In a defined contribution pension plan, the employer pays an agreed amount of money (‘defined contributions’) at regular intervals into a pension fund for the employee. The amount of money that the employer contributes is usually a fixed percentage of the employee’s wages or salary (e.g. 5% of the employee’s basic salary).
• The contributions to the fund are invested to earn a return and increase the value of the fund.
• The amount of pension received by the employee is not pre-determined, but depends on the size of the employee’s share of the fund at retirement. The entity will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods.

Accounting treatment: contributions to defined contribution schemes

• the contributions payable for the reporting period are charged to profit or loss as an expense (an employee cost) in the statement of profit or loss.
• any unpaid contributions at the end of the year will be shown in the statement of financial position as an accrual/liability and any prepaid contributions will be shown as an asset (a prepayment).

Defined benefit plans (final salary schemes)

Under a defined benefit plan, the employer guarantees the amount of pension that its employees will receive after they retire. A company might save cash into a separate fund (just as for defined contribution plans) in order to build up an asset that can be used to pay the pensions of employees when they retire. This would be known as a funded plan. If an employer does not save up in this way the plan is described as being unfunded.

The amount that an employee will receive is usually linked to the number of years that he or she has worked for the company, and the size of his/her annual salary at retirement date (or on leaving the company).

If there are insufficient funds in the plan to provide employees with the guaranteed pensions then the employer must make up the shortfall.

Role of an actuary

An actuary will advise the company how much to pay in contributions into the pension plan each year, in order to ensure there are sufficient funds to cover the company’s obligation to make the pension payments.

It is very unlikely that the actuary’s estimates will be 100% accurate so whenever the value of the pension fund assets and the employer’s pension obligations are measured, the company may find that there is a deficit or a surplus.

• When the amount of the employer’s future pension obligations is more than the value of the investments in the pension fund, the fund is in deficit.
• When the value of the investments in the pension fund is higher than the value of the employer’s obligations to make future pension payments, the fund is in surplus.

When a surplus or deficit occurs, an employer might take no action. Alternatively, the company might decide to eliminate a deficit (not necessarily immediately) by making additional contributions into the fund.

When the fund is in surplus, the employer might stop making contributions into the fund for a period of time (and ‘take a pension holiday’). Alternatively the company may withdraw the surplus from the fund, for its own benefit.

Accounting for defined benefit plans

Statement of financial position

IAS 19 requires that an entity must recognise a defined benefit item (net liability due to a deficit or net asset due to a surplus) in the statement of financial position.

The net defined benefit liability (asset) is the deficit or surplus and is measured as:

• the present value of the defined benefit obligation; less
• the fair value of plan assets (if any).

A surplus in a defined benefit plan is measured at the lower of:

• the surplus in the defined benefit plan; and
• the asset ceiling (which is the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan).

The present value of a defined benefit obligation is the present value, without deducting any plan assets, of expected future payments required to settle the obligation resulting from employee service in the current and prior periods.

Movement for the period

The movements on the defined benefit item are due to:

1. cash contributions to the plan
2. current service cost (to P&L);
3. past service cost (to P&L);
4. gains or loss on settlement (to P&L);
5. net interest (expense or income) (to P&L); and
6. remeasurement (to OCI);

The benefit paid has no effect as it reduces the plan assets and plan obligations by the same amount.

Movements recognised through OCI:

Remeasurements of the net defined benefit liability (asset) comprise:

• actuarial gains and losses (are changes in the present value of the defined benefit obligation);
• any change in the effect of the asset ceiling, excluding amounts included in net interest on the net defined benefit liability (asset).

Accounting for defined benefit pension plans

Step 4

Calculate the remeasurement as a balancing figure.

IAS 19 requires disclosure of reconciliations of the present value of the defined benefit obligation and the fair value of the defined benefit assets.

Past service cost

Past service cost is the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment.

Past service cost may be either positive (when benefits are introduced or changed so that the present value of the defined benefit obligation increases) or negative (when benefits are withdrawn or changed so that the present value of the defined benefit obligation decreases).

Recognition

Past service cost must be recognised as an expense at the earlier of:

• when the plan amendment or curtailment occurs
• when related restructuring costs are recognized

Asset ceiling test

IAS 19 requires that an entity must recognise a defined benefit item (net liability due to a deficit or net asset due to a surplus) in the statement of financial position.

However, if the net item is a surplus it is subject to a test which puts a ceiling on the amount that can be recognised. This is known as the “asset ceiling” test.

Overview

Statements of cash flows, as their name indicates, report cash flows that have occurred during the period. The only non-cash items included in a statement of cash flows are adjustments to the profit before tax, when the indirect method is used to present cash flows from operating activities. These IAS 7 notes are prepared by mindmaplab team and covering IAS 7 full standard, IAS 7 statement of cash flows with illustrative examples, the definition of cash and cash equivalents, disclosure requirements, IAS 7 format both indirect method and direct method. This summary of IFRS 7 cash flow statement is a full text summary of IAS 07. We have also prepared the IAS 7 pdf version download.

IAS Standards

IAS 2 Inventories       

IAS 7 Statements of cash flows

IAS 7 Statement of cash flows  – Revisited

IAS 8 Accounting policies, changes in accounting estimates, and errors

IAS 10 Events after the reporting period       

IAS 12 Income taxes 

IAS 16 Property, plant and equipment          

IAS 17 Leases

IAS 19 Employee benefits     

IAS 20 Accounting for government grants and disclosure of government assistance          

IAS 21 The effects of changes in foreign exchange rates     

IAS 23 Borrowing costs        

IAS 24 Related party disclosures

IAS 27 Consolidated and separate financial statements        

IAS 28 Investments in associates and joint ventures 

IAS 32 Financial instruments: presentation  

IAS 33 Earnings per share

IAS 33 Earnings per share – Revisited          

IAS 36 Impairment of assets 

IAS 37 Provisions, contingent liabilities and contingent assets        

IAS 38 Intangible assets

IAS 40 Investment property

IFRS Standards

IFRS 3 Business combinations    

IFRS 5 Non-current assets held for sale and discontinued operations    

IFRS 7 Financial instruments: disclosures          

IFRS 8 Operating segments         

IFRS 9 Financial instruments      

IFRS 10 Consolidated financial statements        

IFRS 11 Joint arrangements         

IFRS 12 Disclosure of interests in other entities 

IFRS 13 Fair value measurement 

IFRS 15 Revenues from contracts with customers          

IFRS 16 Leases

IAS 17 VS IFRS 16 Lease – Differences

Ratio Analysis

The purpose of IAS 7 statements of cash flows

IAS 7 Statements of cash flows requires an entity to prepare a statement of cash flows and to present it as a key financial statement.

The statement of cash flows provides information on:

1. Liquidity – Generation of cash and use of cash (and cash equivalents)
2. Viability – Ability to survive
3. Adaptability – Ability to respond to change

Statements of cash flows, as their name indicates, report cash flows that have occurred during the period. The only non-cash items included in a statement of cash flows are adjustments to the profit before tax, when the indirect method is used to present cash flows from operating activities.

IAS 7 Consolidated statements of cash flows

The special features of a consolidated statement of cash flows

The rules for preparing a group statement of cash flows are similar to the rules for a statement of cash flows for an individual entity.

However, there are additional items in a consolidated statement of cash flows that are not found in the statement of cash flows of an individual company. The most significant of these are cash flows (or adjustments to profit before tax) relating to:

• Non-controlling interests (e.g. Dividends paid).
• Associates (or JVs) (e.g. Share of profit, Dividends received).
• Acquiring or disposing of subsidiaries during the year.
• Foreign exchange loss.

Cash flows from operating activities

The following additional items adjustments should be made such as:

• Subtract share of profit of associates and joint ventures
• Add share of loss of associates and joint ventures
• Exchange rate differences
  • A loss arising from exchange rate differences must be added
  • A gain arising from exchange rate differences must be subtracted.

Cash flows from investing activities

Cash flows in this section of the consolidated statement of cash flows include the following additional items:

• Subtract Acquisition of subsidiary, net of cash acquired
• Add Proceeds from disposing of subsidiaries during the year (disposal proceeds minus any cash in the subsidiary at the disposal date)
• Subtract cash paid to acquire shares in an associate (or JV) during the year
• Add cash received from the disposal of shares in an associate (or JV) during the year
• Add Dividends received from associates

*Note that when a subsidiary has been acquired, the working capital brought into the group (receivables plus inventory minus trade payables of the acquired subsidiary) is paid for in the purchase price to acquire the subsidiary. This is treated as a separate item in the investing activities section of the statement of cash flows.

Cash flows from financing activities

The additional items these cash flows include:

• Subtract Dividends paid to non-controlling interests (NCI)
• Subtract cash paid as a new loan to or from an associate (or JV) during the year
• Add cash received as a repayment of a loan to or from an associate (or JV) during the year.

* Note that dividends received from an associate (or JV) are shown as cash flows from investing activities; whereas dividends paid to non-controlling interests in subsidiaries are (usually) shown as cash flows from financing activities.

Non-controlling interests and the group statement of cash flows

*Unless there is an acquisition or a disposal of a subsidiary during the year, the only cash flow relating to non-controlling interests is the amount of dividends paid to the non-controlling interests by subsidiaries.

If there is a gain or loss on translation of a foreign subsidiary, the non-controlling interest has a share of this exchange gain or loss.

To calculate dividend payments to non-controlling interests, we must therefore remove the effect of exchange rate differences during the year.