This series of blogs describes how SAP Financial Consolidation, Starter Kit for IFRS has been configured to meet International Financial Reporting Standards (IFRS).
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 or the equity method, and
- translating an entity’s results and financial position into a presentation currency.
In this blog we will focus on the second point which is a key part 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 (IAS21.34):
- 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 is recognized in other comprehensive income
In the starter kit, translation from local currency to functional currency (when necessary) must be carried out before data are entered in the package. 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 group 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 in other comprehensive income
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, the conversion process, that is part of the consolidation process, follows the principles set out by IAS 21.
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 average rate between Jan 1st and the closing date
- Periodic conversion: amounts are converted on a monthly or quarterly basis, applying the exact average rate for each period (month/quarter)
This choice is made when the consolidation parameters (set of rules) are defined.
In the next blog we will focus on the consolidation process (IFRS 10, IFRS 11, IAS28 and IFRS3).