THE FINANCIAL REPORTING WORKSHOP 25 TH TO 29 TH AUGUST 2014 HILLTON HOTEL, NAIROBI IAS 21 EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES 1

Content 1. Introduction 2. Foreign Currency Denominated transactions 3. Foreign entities 4. Discussions 2

1. Introduction A business can carry out transactions that are denominated in foreign currency/set up a foreign entity in a foreign country where currency is different from that of the business. 3

1. Introduction IAS 21 requires that transactions that are stated in foreign currency be translated into local currency for purpose of preparing and presenting financial statements to local currency. 4

1. Introduction In addition, where we have foreign entities, (branch, associate, jointly controlled entity and a subsidiary), then the financial statements of the foreign entity should be translated into local currency before applying the recommended accounting treatment and presentation. 5

2. FCDT The transactions involve: 1. Acquisition and disposal of PPE, Intangibles, Financial assets and inventory where receipts/payments are denominated in foreign currency 6

1. FCDT 2. Sale or purchase of goods on credit and the resulting outstanding balances denominated in foreign currency. 3. Borrowing and lending in foreign currencies. 4. Maintaining bank balances quoted in foreign currencies to be used to make payments and receive in foreign currency 7

1. FCDT - Translation 8 Income statement Items Exchange Rate Sales/incomesActual Rate (Also called Historical rate) Purchases and most expenses Actual Rate (I.e. Historical Rate) DepreciationRate when asset was purchased Interest accruedUse rate at the SFP date (Closing Rate) Revaluation gains/lossesRate when the revaluation is done

1. FCDT - Translation 9 SFP ItemsExchange Rate Non Monetary assets (PPE, Intangibles and Inventory) Use actual/Historical rate Monetary assets (Receivables, Financial assets and Cash) Rate at SFP date (Closing Rate) Monetary Liabilities (Payables, Financial Liabilities and Bank overdraft) Rate at SFP date (Closing Rate)

2. FCDT For certain monetary assets and liabilities, the date of the translation will require the use of a different exchange rate from that of the closing rate. This may result to translation difference. 10

2. FCDT The translation difference is also called exchange gain/loss. An exchange gain or loss on FCDT should be reported in the income statement. If it relates to a loan then it is part of fin. cost 11

3. Foreign Entity In the case of a foreign entity, the exchange rates to be used in translation and the accounting treatment of the exchange-gain/loss will depend on whether the investor and the foreign entity have the same functional currency. 12

3. Foreign Entity Functional currency – the currency of the primary operating environment. The investor and the foreign entity can either have the same or different functional currency. 13

3. Foreign Entity – Same FC Even though the foreign entity may prepare its financial statement using a different currency from that of the investor, the two are described as having the same functional currency if the foreign entity is an extension of the investor. 14

3. Foreign Entity – Same FC This arises when the volume of transactions between the two is high i.e. the transfer of goods, other assets and cash flows. This is most common where the foreign entity is a branch. 15

3. Foreign Entity – Same FC IAS 21 recommends that the incomes, expenses, assets and liabilities of the foreign entity to be translated the same as foreign currency denominated transactions and any ex-gains/losses arising to be reported in the income statement. 16

3. Foreign Entity – Same FC When we translate the financial statements of the foreign entity to the local currency, then the currency in which the eventual financial statements are presented is called the Presentation currency. Check IAS 21 for a discussion on this 17

3. Foreign Entity – Different FC Where the foreign entity prepares its financial statements in a currency that is different from that of a local investor and the foreign entity operates with a high degree of autonomy/independence from the local investor, the two are described as having a different functional currency (Autonomy is fewer transactions between local investor and FE) 18

3. Foreign Entity – Different FC If the local and foreign entity have a different functional currency, all assets and liabilities of the foreign entity should be translated using the closing rate. 19

3. Foreign Entity – Different FC Incomes and expenses should be translated using the historical rate although an ex-rate can be used. Any ex gain/loss arising on transaction should be reported in a separate reserve referred to as the translation reserve. 20

3. Foreign Entity – Different FC In practice a foreign entity that is an associate or JCE or a subsidiary is normally described as having a different functional currency because there few transactions between the foreign entity and / or the investor. 21

3. Foreign Entity – Different FC The translation procedure of the three companies is the same. But after translation the accounting treatment and the presentation will be as per the requirements of the specific standards. 22

FINALLY..... Questions? 23