It focuses on standards dedicated to:
- the presentation of financial statements: How Starter Kits meet IFRS – IAS 1, How Starter Kits meet IFRS – IAS 7
- the consolidation Process: IAS 21, How starter kits meet IFRS – IAS 27 (part 1), How starter kits meet IFRS – IFRS 3, How starter kits meet IFRS – IAS 28 and How starter kits meet IFRS – IAS 31
After a presentation of SAP BusinessObjects Financial Consolidation, Starter Kit for IFRS in the How Starter kits Meet IFRS requirements – Introduction and the two following blogs dedicated to the presentation of financial statements, we will now look into the consolidation process starting with IAS 21.
IAS 21 – The effects of changes in foreign exchange rates
IAS 21 sets out requirements for:
- accounting for transactions and balances in foreign currencies
- translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation, proportionate consolidation or the equity method
- translating an entity’s results and financial position into a presentation currency
This document addresses the question of translating foreign entities’ financial statements as it is a key stage of the consolidation process.
From local currency to functional currency
IAS 21 requires each individual entity to determine its functional currency. This is the currency of the primary economic environment in which it operates and may be different from the currency of the country in which the entity is located (referred to as local currency). For example, oil companies’ functional currency is often US dollar, as crude oil is routinely traded in US dollars around the word.
When accounting books are not maintained in the entity’s functional currency (because functional currency is different from local currency), financial statements must be first translated into the functional currency using the following principles:
- Revenues, expenses, gains and losses are translated using the exchange spot rate at the dates they are recognized; average rates may be used for practical reasons
- Monetary assets and liabilities are translated using the closing rate
- Non-monetary assets and liabilities are translated using the exchange rates at the date of the transaction (historical rate) when they are measured at cost and the exchange rates at the date when the fair value was determined when they are measured at fair value
- Any exchange difference is recognized in profit or loss, except when the underlying operation has been recognized directly in equity (for example, exchange gain or loss on fair value of an AFS financial asset)
In the starter kit
In the starter kit, translation from local currency to functional currency (when need be) must be carried out before data is entered in the package [in SAP BusinessObjects Financial Consolidation, a package is a comprehensive set of data entry schedules that enables consolidated entities to enter their data at local level]. Indeed, the property “currency” of an entity, as declared in the table of entities, corresponds to its functional currency and not to its local currency. Data entered in the packages are those in functional currency.
From functional currency to group currency
IAS 21 sets out the following principles as regards translation from functional currency to presentation currency:
- Assets and liabilities are translated at the closing rate
- Income and expenses are translated using the exchange rates at the dates of the transaction. For practical reasons, a rate that approximates the exchange rates at the dates of the transaction (for example an average rate for the period) is often used
- All resulting exchange differences are recognized as a separate component of equity (“foreign currency translation reserve”)
These exchange differences result from:
- translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate
- translating the opening net assets at a closing rate that differs from the previous closing rate.
The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation. When the exchange differences relate to a foreign operation that is consolidated but not wholly-owned, accumulated exchange differences arising from translation and attributable to non-controlling interests are allocated to, and recognized as part of, non-controlling interests in the consolidated statement of financial position.
Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation should be treated as assets and liabilities of the foreign operation. Thus they should be expressed in the functional currency of the foreign operation and should be translated at the closing rate.
In the starter kit
In the starter kit, the conversion process, which is part of the consolidation process, follows the principles set out by IAS 21 and explained above.
As regards the use of an average rate, two methods are available:
- Year-to-date conversion: amounts are converted on a YTD basis, applying the conversion rate between Jan 1st to the closing date
- Periodic conversion: amounts are converted on a monthly or quarterly basis, applying the exact average rate for each period (month/quarter)
The choice of methods is made when the consolidation parameters (set of rules) are defined.
In the next three blogs, we will focus on IAS 27:
How starter kits meet IFRS – IAS 27 (part 1) : Current consolidation process (elimination of intra-group transactions, calculation of non-controlling interests, …)
How starter kits meet IFRS – IAS 27 (part 2): Changes in the consolidation scope: loss of control
How starter kits meet IFRS – IAS 27 (part 3): Changes in the consolidation scope: equity transactions