Chapter 28

Question 1

When is currency conversion required?

Answer 1

Currency conversion is required when a foreign currency transaction is completed within an accounting period. A transaction, foreign or otherwise,

Question 2

How can currency conversion be regarded as compromising events?

Answer 2

• 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. we need to consider how to deal with foreign transactions that are not completed by the year-end.

Question 3

What does IAS 21 accord?

Answer 3

According to IAS 21, exchange differences in monetary positions following transactions need to be recognized in profit or loss. These can be either realized in the period (when the monetary position is cleared by payment) or unrealized (when the monetary position is still outstanding at the balance sheet date).

Question 4

What does the IAS standard tell us about recognising unrealised gains?

Answer 4

Thus, the IAS Standard is telling us to recognize an unrealized gain in the accounts.

Question 5

How can the IAS 21 standard be justified regarding unrealised gains?

Answer 5

This treatment can be justified on the grounds that:
* where exchange gains arise on short-term monetary items, their ultimate cash realization can normally be assessed with reasonable certainty and they are therefore realized in accordance with realization conventions
* it provides symmetry with losses.

Question 6

What is stated under the requirements of IAS 21, regarding foreign currency?

Answer 6

Under the requirements of IAS 21, only foreign currency monetary items should be reported using the closing rate; non-monetary items, which are carried at historical cost denominated in a foreign currency, should be reported using the exchange rate at the date of acquisition or, if the fair value is used, the exchange rate prevalent when the fair value was determined. Therefore, under historical cost accounting, the book value of the asset is not adapted when exchange rates change.

Question 7

What can transactions also involve?

Answer 7

Transactions can also involve the origination of a loan, which is a monetary item. Thus, a loan will be translated as any other monetary item at the closing rate and the exchange gain or loss credited or charged to income.

Question 8

What concept does IAS 21 use?

Answer 8

IAS 21 uses the concept of functional currency

Question 9

What is functional currency?

Answer 9

The functional currency is the currency of the primary economic environment in which the entity operates. An entity should translate all transactions into its functional currency. All other currencies than the functional currency are foreign currencies.

Question 10

What is important when determining the functional currency?

Answer 10

When determining its functional currency, an entity has to consider the guidance in accordance with IAS 21, Paragraphs 9–14. There is a certain hierarchy in determining the functional currency.

Question 11

What does the primary economic environment entail?

Answer 11

First, the primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash.

Question 12

What factors does an entity consider when determine its functional currency?

Answer 12

(a) The currency:
1. (i) that mainly influences sales prices for goods and services and
2. (ii) of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
(b) The currency that mainly influences labour, material and other costs of providing goods or services.
Second, the following factors may also provide evidence of an entity’s functional currency:
(a) The currency in which funds from financing activities are generated.
(b) The currency in which receipts from operating activities are usually retained

Question 13

Which entities can make use of functional currencies?

Answer 13

Only individual entities can have a functional currency. A group does not have a functional currency. IAS 21 gives some additional factors to consider in determining the functional currency of a foreign operation.

Question 14

What happens in a group when determining its functional currencies?

Answer 14

In a group, each entity has determined its own functional currency. Different foreign operations should all be translated into one currency for consolidation purposes. This currency is the presentation currency. So the presentation currency is the currency in which the financial statements are presented.

Question 15

In what way can translation from functional presentation currency follow?

Answer 15

1. 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. 2 Income and expenses for each statement of comprehensive income shall be translated at exchange rates at the date of the transactions; it is possible to use average rates here.
3. 3 All resulting exchange differences shall be recognized in other comprehensive income (therefore outside profit or loss). This is different from translating transactions into the functional currency, as all the resulting exchange differences are then presented as profit or loss. The cumulative exchange differences presented in other comprehensive income are presented as a separate component of equity.

Question 16

Which two possible views can we take, when translating a particular item?

Answer 16

1 We can use the exchange rate ruling when the item was created (historical rate).
2 We can use the exchange rate ruling when the item is being reported (current or closing rate).

Question 17

What is a single rate?

Answer 17

This is based on the idea that the holding entity has a net investment in the foreign operation and that what is at risk from currency fluctuations is this net financial investment. All assets, liabilities, revenues and expenses will be translated at the closing (statement of financial position date) rate.

Question 18

What is a Mixed rate, (current/non-current)?

Answer 18

Here, current assets and liabilities would be translated at the closing rate, whereas fixed assets and non-current liabilities would be translated at the rate ruling when the item was established

Question 19

What is a Mixed rate (monetary/non-monetary)?

Answer 19

This proposal would translate monetary assets and liabilities at the closing rate and all non-monetary assets and liabilities at the rate ruling when the item was established. There is an analogy here with the arguments for current purchasing power accounting. Monetary items are automatically expressed in current monetary units, so use the current rate for them, and non-monetary items are expressed in out-of-date monetary units, so use the out-of-date rate for them.

Question 20

What is a Mixed rate- (temporal)?

Answer 20

This is based on the idea that the foreign operations are simply a part of the group that is the reporting entity. The valuation basis used to value the assets and liabilities determines the appropriate exchange rate.

Question 21

What is important to avoid, with the temporal method?

Answer 21

It is important to avoid the assumption that the temporal method means using historical exchange rates. The words temporal and historical are quite wrongly sometimes used interchangeably in this context.

Question 22

What does IAS 21 state about the temporal method?

Answer 22

The temporal method is in fact prescribed by IAS 21 for translating transactions and events into the functional currency, before translating the functional currency into the presentation currency at closing rate.