Foreign transactions and entities: formula sheet

Key formulas

Functional currency

Functional currency = currency of the primary economic environment in which the entity operates

Usually where the entity mainly generates and spends cash.

Primary indicators

Currency that mainly influences (1) sales prices, including the currency of the competitive forces and regulations that determine prices, and (2) labour, material and other costs

IAS 21.9 gives these primary factors. Look at the currency that drives prices and costs, not just the currency of invoices.

Secondary indicators

Currency in which (1) financing is raised, (2) operating receipts are retained

IAS 21.10 gives these as additional factors. Used as supporting evidence when the primary indicators do not give a clear answer.

Foreign operation indicators

Extension of parent? Degree of autonomy, share of transactions with parent, cash flows affecting parent, debt servicing

IAS 21.11 gives these as additional factors for a foreign operation, not primary ones. If the operation is an extension of the parent, its functional currency is likely to be the parent's.

Currency definitions

Foreign currency = any currency other than the functional currency; Presentation currency = currency of the financial statements

Presentation currency can be any currency the entity chooses.

Change of functional currency

Apply translation procedures of the new functional currency prospectively from the date of change

Only when underlying transactions, events and conditions change.

Initial recognition

Functional currency amount = Foreign amount ÷ or × spot rate at transaction date

Check the quote direction. If the rate is 1.60 foreign per 1 functional, you divide the foreign amount by 1.60.

Monetary items at reporting date

Retranslate at closing rate. Exchange difference = closing carrying amount − previous carrying amount (or settlement amount)

Taken to profit or loss in general.

Non-monetary items at historical cost

Not retranslated. Stay at the transaction-date rate

Includes PPE and inventory at cost. Inventory at net realisable value is compared in the same currency, translated at the rate when NRV was measured.

Non-monetary items at fair value

Translate at the rate on the date fair value was determined

Where the fair value gain goes to OCI, the related exchange element goes to OCI. Where it goes to profit or loss, so does the exchange element.

Settlement

Exchange difference = amount settled at settlement-date spot rate − carrying amount

Recognised in profit or loss in the period it arises.

Assets and liabilities

Foreign amount ÷ closing rate

Use direct quotes carefully. If the rate is D2 = $1, divide the dinar amount by 2 to get dollars. This includes goodwill and fair value adjustments arising on acquiring the foreign operation.

Income and expenses

Foreign amount ÷ rate at transaction date (or average rate)

The average rate is an acceptable approximation if rates do not fluctuate significantly. Use the specific date rate for a one-off large item.

Equity at acquisition

Share capital and pre-acquisition reserves ÷ rate at acquisition date

Post-acquisition profits are included at the translated profit for each year.

Dividends

Dividend ÷ rate at date of the dividend

Use the date it is recognised as a distribution, as stated in the question.

Exchange difference for the year

Closing net assets at closing rate − (opening net assets at opening rate + profit at average rate − dividends at their date rate)

A positive figure is an OCI gain. A negative figure is an OCI loss. It is the balancing figure and should equal the sum of the separate effects.

Split of the exchange difference

Parent share = difference × parent %; NCI share = difference × NCI %

Apply the same split to exchange differences on goodwill if goodwill is measured on a full basis. Follow the goodwill method in the question.

Goodwill at acquisition (functional currency)

Goodwill = Consideration + NCI − Fair value of net assets at acquisition

Work it out in the subsidiary's currency. The NCI is either at fair value or at its proportionate share of net assets. The net assets are at fair value, including fair value adjustments.

Translation of goodwill

Goodwill in group currency = Goodwill in foreign currency ÷ closing rate

Rates are quoted as foreign currency per 1 unit of group currency. Divide if so, multiply if the rate is the other way round. Check the quote.

Exchange difference on goodwill

Difference = Closing goodwill at closing rate − (Opening goodwill at opening rate − Impairment at average rate)

Use it as a balancing figure. Write it as a gain or loss in OCI. The impairment reduces goodwill, so it is deducted from the opening figure. The impairment itself is not part of the exchange difference.

Fair value adjustment treatment

FV adjustment at closing rate; extra depreciation at average rate

The same logic applies to the adjustment as to any asset of the foreign operation.

Allocation of the difference

Parent share = difference × parent %; NCI share = difference × NCI % (full goodwill method)

Under the proportionate method, all goodwill differences go to the parent.

Recycling on loss of control

Gain/loss on disposal = Proceeds + FV of any retained interest − Carrying amount of net assets (including goodwill) + Carrying amount of NCI derecognised + Parent's share of cumulative exchange differences (credit balance added, debit balance deducted)

Only the parent's share of the cumulative exchange differences is recycled to profit or loss. The NCI share is derecognised within the NCI carrying amount and is not recycled. Add a cumulative credit balance to the gain. Deduct a cumulative debit balance. Net assets and goodwill are at the closing rate at the disposal date.

Partial disposal, control kept

Amount reattributed to NCI = Cumulative exchange differences × proportion of interest disposed

No recycling to profit or loss. It is a transfer within equity, as no control is lost.

Net investment loan exchange difference (individual books)

Foreign currency loan × (closing rate − opening rate) = exchange difference in profit or loss of the entity

In the consolidated accounts, the difference is taken to OCI and kept in the translation reserve until disposal.

Translation of foreign subsidiary

Exchange difference = Closing net assets at closing rate − Opening net assets at opening rate − Profit at average rate

Add any adjustment for dividends or other equity movements at the rate used. Goodwill is also retranslated at the closing rate.

Net investment hedge: effective portion

OCI (hedge reserve) = the lower, in absolute terms, of the cumulative gain or loss on the instrument and the cumulative change in value of the designated hedged amount of net assets

The hedged amount may be only part of the net assets, so do not compare with the total net assets difference. Any excess gain or loss on the instrument is ineffective and goes to profit or loss.

Foreign loan hedging net assets: exchange difference

Loan exchange difference = Loan in foreign currency × (closing rate − opening rate) using the quoted rate as foreign currency per parent currency unit, so divide, do not multiply

If the rate is quoted as foreign units per $1, the loan in foreign units is divided by the rate. A weaker foreign currency (higher units per $) lowers the dollar value of the loan, giving a gain.

Translation of net assets under IAS 21

Exchange difference in OCI = closing net assets at closing rate − (opening net assets at opening rate + profit at average rate)

This formula applies only to a foreign operation that is not hyperinflationary. For a hyperinflationary subsidiary, translate the restated profit and all other current-year amounts at the closing rate (where the presentation currency is not hyperinflationary). Include goodwill in net assets for a foreign operation. Adjust for dividends at the rate on the date paid.

Disposal reclassification

Reclassify to profit or loss = cumulative translation reserve + cumulative net investment hedge reserve (effective portion)

Reclassification is made on disposal of the foreign operation, as a reclassification adjustment.

IAS 29 restatement of non-monetary items

Restated amount = historical cost × (price index at reporting date ÷ price index at date of acquisition or revaluation)

Monetary items are not restated. Non-monetary items carried at historical cost are restated. Items already at current value at the reporting date are not restated.

IAS 29 net monetary position

Gain or loss on net monetary position goes to profit or loss; net monetary liabilities give a gain and net monetary assets give a loss during inflation

Holding cash loses purchasing power. Owing money gains because the debt is repaid in cheaper units. Income statement items are restated using the index from the date of the transaction, and equity components from the date they were contributed or arose.

Translation of hyperinflationary subsidiary

Restate under IAS 29 first, then translate the current-year restated amounts at the closing rate. Comparatives are the prior-year presented amounts, unchanged (if the presentation currency is not hyperinflationary)

Where the presentation currency is not that of a hyperinflationary economy, comparatives are the amounts presented in the prior year, not restated further and not translated at the current closing rate.

Quick revision

• Functional currency is the currency of the primary economic environment in which the entity operates.
• Presentation currency is the currency in which the financial statements are shown, and it can be a free choice.
• Record a transaction at the spot rate on the transaction date. An average rate is allowed if rates do not fluctuate significantly.
• Monetary items are retranslated at the closing rate, with the difference in profit or loss.
• Non-monetary items at historical cost stay at the transaction date rate. Items at fair value use the rate when fair value was measured.
• Translating a foreign operation: assets and liabilities at the closing rate, income and expenses at the transaction date or average rate.
• Translation differences go to OCI and accumulate in a separate component of equity.
• Goodwill and fair value adjustments on a foreign operation are treated as its assets and retranslated at the closing rate.
• The non-controlling interest is allocated its share of the exchange difference on the subsidiary's net assets, whichever method is used. It also takes a share of the goodwill exchange difference only when goodwill is calculated on the full basis, with NCI measured at fair value.
• On disposal, the cumulative translation difference attributable to the parent is reclassified to profit or loss as part of the gain or loss.
• A net investment hedge puts the effective part of the hedging gain or loss in OCI.
• Under IAS 29, where a foreign operation's functional currency is hyperinflationary and the presentation currency is not, restate its statements using a general price index first. Then translate all amounts, including income and expenses, at the closing rate. Comparatives are not restated and stay as the prior-year amounts previously presented.

Common mistakes

• Treating the presentation currency as the functional currency. Fix: Decide the functional currency from the economic environment. Then say separately which currency the statements are presented in.
• Choosing the currency of the country where the entity is registered. Fix: Use the indicators. An entity registered in one country may price and incur costs mainly in another currency.
• Retranslating inventory or PPE at the closing rate when carried at cost. Fix: Ask: monetary or non-monetary? Non-monetary items at cost stay at the historical rate.
• Multiplying when you should divide (or the reverse). Fix: Write the rate as 'foreign currency per 1 of functional currency'. Divide foreign amounts by it. Do a quick sense check on size.
• Translating all items at the closing rate, including the statement of profit or loss. Fix: Use the average rate (or transaction date rates) for income and expenses. Closing rate is for assets and liabilities only.
• Taking the exchange difference to profit or loss. Fix: For translation of a foreign operation, the difference goes to OCI and the translation reserve. Profit or loss only sees it on disposal.
• Keeping goodwill at the historic acquisition-date rate Fix: IAS 21 treats goodwill as an asset of the foreign operation. Retranslate it at the closing rate at every reporting date.
• Putting the exchange difference on goodwill in profit or loss Fix: Differences on translating a foreign operation go to OCI and the translation reserve. They are reclassified only on disposal.
• Leaving cumulative exchange differences in equity after the sale. Fix: Remember that IAS 21 requires reclassification on disposal. Recycled items go to profit or loss.
• Recycling the whole reserve when the parent still controls the subsidiary after a partial sale. Fix: Check control first. If control is kept, transfer the proportionate share to NCI and do not touch profit or loss.

Exam tips

• Always link each indicator to a fact from the scenario. Statements of the rule alone earn few marks.
• Rank the indicators. Mention that primary indicators take priority and say why the secondary ones only support.
• When a scenario is deliberately mixed, give a reasoned conclusion and acknowledge judgement. Do not leave the answer open.
• Keep functional and presentation currency in separate sentences. Examiners often test whether you confuse them.
• Add a professional skills point where the scenario suggests management may be choosing a currency to flatter results: apply scepticism and explain the rule that the determination is fact-based.
• Always state whether each item is monetary or non-monetary. Markers award marks for the classification and the reasoning.
• Show the rate used on every line. Marks are given for method even if arithmetic slips.
• For fair-valued non-monetary items, say where the fair value change goes. The exchange element follows it.