FOREIGN OPERATIONS

Learning Outcome:

• to understand the principles and practices of accounting for foreign currency operations;

• to understand the requirements of statues and standards on accounting for foreign currency operations;

• to deal with the translation of transactions and financial statements denominated in foreign currencies;

• to deal with the treatment of exchange differences.

MFRS 121 The Effects of Changes in Foreign Exchange Rates

• The objective of MFRS 121 is to deal with two major issues of accounting for the effects of changes in foreign exchange rates:

1) accounting for foreign currency transactions

2) translation of financial statements.

INTRODUCTION

MFRS 121 requires all entities to determine their functional currencies and for financial statements presented in Malaysia, the presentation currency is Ringgit Malaysia (RM).

FUNCTIONAL CURRENCY & PRESENTATION CURRENCY

Functional Currency: the currency of the primary economic

environment in which an entity operates (para 8)

normally, the currency which it primarily generates and expends in cash (para 9).

Presentation Currency:

the currency in which the financial statements are presented (para 8).

FUNCTIONAL CURRENCY • Main factors (para 9):

a) The currency: (i) that mainly influences sales prices for goods and

services (this will often be the currency in which sales prices for its goods and services are denominated and settled); and

(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 (this will often be the currency in which such costs are denominated and settled).

FUNCTIONAL CURRENCY

• If the above factors are mixed, an entity may also consider following additional supporting evidence (para 10):

– The currency in which funds from financing activities (i.e. issuing debt and equity instruments) are generated.

– The currency in which receipts from operating activities are usually retained.

ACCOUNTING FOR FOREIGN CURRENCY TRANSACTION

• Two issues are involved:

1. Which exchange rate should be used to restate the foreign currency into functional currency?

2. How to deal with the exchange difference?

Initial Recognition

• Foreign currency transactions shall be recorded in the functional currency, by translating the foreign currency amount at the spot exchange rate (i.e. exchange rate at the date of transaction).

Initial Recognition

Illustration 1:

On 15 January 2008, F&S Berhad bought equipment on credit from Global Ltd., a Korean company, using US currency amounted to USD50 million. The functional currency is RM and F&S Berhad closes its accounts on 31 December.

The exchange rate on that date was USD1 = RM3.85

Journal entries:15/1/08Dr. Equipment RM192.5 m Cr. Foreign Creditor 192.5 m(USD50 m x RM3.85)

Reporting at subsequent balance sheet dates

Translation at each balance sheet date:• foreign currency monetary items

- the closing rate;

• non-monetary items that are measured in terms of historical cost in a foreign currency - the exchange rate at the date of the

transaction;

• non-monetary items that are measured at fair value in a foreign currency - the exchange rates at the date when the fair

value was determined.

Example:

Assume that the creditor (Global Ltd) in illustration 1 had not been paid as at 31 December 2008, and the exchange rate as at 31 December 2008 was USD1 = RM3.75.

In this case, the creditor(in balance sheet) need to be adjusted to reflected new exchange rate:

Dr Foreign Creditor 5,000,000 Cr Exchange gain

5,000,000 ( to record exchange difference)

[192,500,000 -(USD50m x 3.75)]

Exchange differences

• Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition.

• Shall be recognized in Statement of Comprehensive Income in the period in which they arise.

Illustration 2• XYZ Berhad carried out the following transactions related

to foreign currencies:

(a) Purchased goods from Shane Ltd on 15 May 2005 amounted to USD65,000 when the exchange rate ruling was RM3.95 per unit of USD. The amount was then settled on 15 July 2005, when the exchange rate ruling was RM3.80.

(b) (Purchased machinery from Jariku Ltd amounted to 2 million Japanese Yen on 28 August 2005, when the exchange rate ruling was RM36.50 for every 100 Yen. The settlement was then made on 1 October 2005 when the exchange rate was at RM36.75 per 100 unit of JYen.

• The exchange rate ruling on 31 December 2005 were:RM3.87 for every unit of USDRM36.20 for every 100 units of Jyen

• The exchange difference & journal entries?

SOLUTION:

Date USD Rate (RM) RM

15/5/05 65,000 3.95 256,750

15/7/05 65,000 3.80 247,000

Exchange gain 9,750

15/5/05 Dr Inventory Cr Ac payable

256,750256,750

15/7/05 Dr Ac payable Cr Cash Exchange gain

256,750247,000

9,750

(a)

(b)

Date Yen Rate (RM) RM

28/8/05 2,000,000 36.50 730,000

1/10/05 2,000,000 36.75 735,000

Exchange loss 5,000

28/8/05 Dr Machinery Cr Ac payable

730,000730,000

1/10/05 Dr Ac payableDr Exchange loss Cr Cash

730,0005,000

735,000

TRANSLATION OF FINANCIAL STATEMENTS

• Problem occurs when presentation currency is not the same as its functional currency; or

• presentation currency of the subsidiary is not the same as the parent company.

TRANSLATION OF FINANCIAL STATEMENTS.. (cont)

• Translation rate (MFRS 121): Assets and liabilities - closing rate; Income and expenses items - exchange rates on the

dates of transactions • (for practical reasons, the average rate will be

used)

• All resulting translation differences are to be taken directly to equity in the balance sheet, until the disposal of the net investment.

TRANSLATION OF FINANCIAL STATEMENTS.. (cont)

• The translation difference may be calculated using the following formula:

Illustration 3: (Example 10.12, TLT page 670)

For assets and liabilities:Beginning net asset × (current year’s closing rate – prior year’s closing rate)

For income statements: Retained profit for the year × (current year’s closing rate – current year’s average rate)

Translation of financial statement of foreign subsidiaries and associates

• When the presentation currencies of the subsidiary and the associate are not same with the parent, the parent needs to:– translate the financial statements of the foreign

subsidiary and associate in accordance with MFRS 121; and

– consolidate the financial statements in accordance with MFRS 127 Consolidated and Separate Financial Statement and MFRS 128 Investment in Associates.

Translation of financial statement of foreign subsidiary and associate

• In preparing the consolidated financial statements, two issues need to be considered:1. Share capital and pre-acquisition reserve

Translated using the historical exchange rate prevailing at the date when the parent acquired the shareholdings

goodwill arising from the acquisition-translate using closing rate

2. Post-acquisition reserve

• Illustration 4(Example 10.14, TLT page 675)

DISCLOSURE REQUIREMENT

• Information that needs to be disclosed, please refer to;– Paragraph 52– Paragraph 53– Paragraph 54

SUMMARY • The standard requires that all entities involved in

business transactions with foreign operations should record the transactions in their functional currency.

• However, if the functional currency is not the same as the presentation currency, the financial statements of the foreign operations should be translated into the presentation currency.

End of the Chapter