COMMON PITFALLS IN IAS 21

What if there is an accounting principle that allows men to account for how much they have spent on ladies as investment? I know a lot of folks who would boast of massive foreign investments, LOL! This is not the objective of this write-up at this time as I obviously do not have such competencies, this article aims at enlightening readers on some grey areas and misconceptions by practitioners, students and IFRS enthusiasts around IAS 21’s principles.

 

The basic objective of IAS 21 is to prescribe to us how to recognize and measure foreign currency transactions and operations into the financial statements of an entity and how to translate financial statement into a presentation currency. The IASB has really helped the lives of Accountants, you know?

 

It is worthy to note that the IAS 21 prescribes what exchange rates should be used and how the exchange gains and losses are reported in the financial statement. The common pitfalls I have identified are in the areas of reporting exchange gains or losses as well as differentiating between functional currency and presentation currency. These would form the crux of this article. Shall we start? Enjoy this piece!

 

So, what then is the difference between Functional and Presentation currency?

 

IAS 21 explains clearly that the Functional currency is the currency of the primary economic environment in which the entity operates while the Presentation currency is the currency in which financial statements are presented. English, yeah? I’ll explain!

 

It is so logical that If I operate a company in Nigeria even when I am from Canada, my sales would be largely influenced in Naira, my costs would be expended in Naira whilst financing(equity or debt as it were) available to me within the Nigerian environment would be driven in Naira; hence Naira becomes my Functional currency. Well, we shouldn’t get carried away by automatically ascribing residence alone as a factor to determine Functional currency, other factors are apt in determining this. On a lighter note, some guys reside here in Nigeria but their investment in babes can make USD their functional currency, should investment in babes qualify as asset; they have spent a lot, I trust my dear Accountants to not belong to this table. LOL!!! My Canada Company may be required by a statutory requirement or regulatory pronouncement to present financials in a particular currency; that’s my Presentation currency, more so the name even implies.

 

Pitfall on Exchange Gain Recognition

 

I know you know that foreign transactions are to be translated using spot exchange rate; meaning translation is done at the rate prevailing when the transaction occurred. It is possible the transaction gives rise to monetary item like cash, then at year end you will need to translate. The standard requires that you translate the monetary items at year end using the closing rates. This is common sense you know? I trust another issue has just prompted up on what monetary items are? Monetary items give their holder right to receive or pay some fixed or determinable units of currency. Clear examples are receivables, payables and cash balances. An item that is not monetary is of course non-monetary. Makes sense?

 

Non-monetary items are never to be retranslated; they are kept at historical cost which would have been translated at spot rate when the item was recognized in the books. Please and please don’t retranslate items of PPE measured at cost at year end. There is however a clause in the standard that requires that non-monetary items measured at fair value be translated using the exchange rate at the date of the fair valuation. I am re-affirming the immensity of IASB’s sense. It is logical that, if I have to fair value a foreign denominated asset, say Equity Investment for example measured at fair value; then I have to determine its new amount in foreign currency, then retranslate to presentation currency. That’s all!

 

It is so fallacious to believe all exchange gains and losses are taken to profit or loss. Esteemed readers, after reading this article I know you would delete that big misconception. Honestly, the default recognition of exchange gains or losses are recognized in profit or loss, however, paragraph 30 of IAS 21 requires that exchange gain and losses on non-monetary items measured through other comprehensive be taken to through OCI as well. Yeah! That your unquoted equity classified as FVTOCI and denominated in foreign currency, when you fair value at year end, the accompanying exchange gain or loss should be taken to OCI where the fair value movement on the non-monetary item is taken.

 

Wow, the story is quite long this time but I hope you enjoyed it. Please don’t despair and recognize exchange gains appropriately.

 

 

Source: Sobur Bello