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Transition exemptions
Section 35 provides no transition exemptions on adoption of Section 30. Therefore any difference between old GAAP and Section 30 have to be applied retrospectively.
Principal transition adjustments
1) Use of contracted forward rates not permitted under Section 30
SSAP 20 allowed entities a choice to translate year end balances at the average forward contract exchange rate which covers the net foreign exchange exposure on the year end balance sheet. Section 30 does not allow this, instead all monetary assets must be retranslated to the year end rate. Instead these forward contracts are fair valued and brought under the remit of Section 12 – other financial instruments issues. An example of a transition adjustment to bring this in at fair value has been shown in Section 12 of this website. Please refer to that section for further details.
On transition to FRS 102, an entity will have to adjust the monetary assets and liabilities such that they are shown at the year end exchange rate. There will also be a deferred tax impact on this adjustment as previously the adjustment to state year end balances at forward rates would have been taxable/tax deductible.
Example 14: Contracted rate adjustment
The date of transition is 1 January 2014. Company A had forward contracts in place at 1 January 2014. The company makes sales in FC and CU. The functional currency of the company is CU. Under old GAAP as the entity was a non-FRS 26 adopter, the average forward contract rate of CU1=FC0.80 was used to retranslate the 31 December 2013 year end debtor and cash balances and the rate of CU1=FC0.78p at 31 December 2014. The actual year end spot rate at 1 January 2014 was CU1=FC0.75 and 31 December 2014 was CU1=FC0.82. Assume a deferred tax rate of 10%. Details of the value of the cash and debtor balances in FC are:
|
|
31/12/13 |
31/12/14 |
|
Debtors in Foreign Currency |
FC100,000 |
FC50,000 |
|
Cash in Foreign Currency |
FC70,000 |
FC80,000 |
|
Year-end Spot Rate |
CU1=FC0.75p |
CU1=FC0.82p |
|
Average Forward Rate Used |
CU1=FC0.80p |
CU1=FC0.79235 |
|
Debtors as Stated in Balance Sheet |
CU125,000 |
CU63,103 |
|
Cash as Stated in Balance Sheet |
CU87,500 |
CU102,564 |
|
Average Contracted Rate |
CU1=FC0.80p |
CU1=FC0.78p |
The following adjustments would be required:
On 1 January 2014
The carrying amount at 1 January using the year end spot rate as required by FRS 102 should have been:
Debtors – FC100,000/0.75p i.e. year end rate= CU133,333
Cash – FC70,000/0.75p i.e. year end rate= CU93,333
|
|
Debtors |
Cash |
|
Carrying Amount per the Balance Sheet |
CU125,000 |
CU87,500 |
|
Carry Amount at Spot Rate |
CU133,333 |
CU93,333 |
|
Difference – FX Gain |
CU8,333 |
CU5,833 |
Journals required
|
|
CU |
CU |
|
Dr Debtors |
8,333 |
|
|
Dr Cash |
5,833 |
|
|
Cr Profit and Loss Reserves for Foreign Exchange Gain |
|
14,166 |
Being journal to reflect adjustment required to show foreign currency balances at year end spot rate
|
|
CU |
CU |
|
Dr Profit and Loss Reserves for Deferred Tax (CU14,166*10%) |
1,417 |
|
|
Cr Deferred Tax in Balance Sheet |
|
1,417 |
Being journal to reflect deferred tax on the adjustment to reflect tax to be paid on this in the future
Journals required at 31 December 2014 assuming the above journals are posted to balance sheet and P&L reserves
The carrying amount at 31 December 2014 using the year end spot rate should have been:
Debtors – FC50,000/0.82p i.e. year end rate= CU60,975
Cash – FC80,000/0.82p i.e. year end rate= CU97,561
|
|
Debtors |
Cash |
|
Carrying amount per the balance sheet |
CU63,103 |
CU102,564 |
|
Carry amount at spot rate |
CU60,975 |
CU97,561 |
|
Difference – FX loss |
CU2,128 |
CU5,003 |
|
Journals required
|
CU |
CU |
|
Dr Foreign Exchange Loss in P&L |
7,131 |
|
|
Cr Debtors |
|
2,128 |
|
Cr Cash |
|
5,003 |
Being journal to reflect adjustment required to show foreign currency balances at year end spot rate
|
|
CU |
CU |
|
Dr Deferred Tax in Balance Sheet |
713 |
|
|
Cr Deferred Tax in P&L (CU7,131*10%) |
|
713 |
Being journal to reflect deferred tax on the adjustment to reflect the fact that tax was paid on this in the prior year and therefore a tax deduction will be obtained over the next 5 years under the tax transitional arrangements.
The journals posted for the 1 January 2014 will also have to be reversed into the profit and loss account as we have assumed these were posted in 31 December 2014 so as to show the correct opening reserves:
|
|
CU |
CU |
|
Dr Foreign Exchange Gain in P&L |
14,166 |
|
|
Cr Debtors |
|
8,333 |
|
Cr Cash |
|
5,833 |
Being journal to reflect reversal of prior year FX adjustment
|
|
CU |
CU |
|
Dr Deferred Tax in Balance Sheet |
1,417 |
|
|
Cr Deferred Tax in P&L (CU14,166*10%) |
|
1,417 |
Being journal to reflect reversal of prior year deferred tax on the adjustment above
Journals required in the year ended 31 December 2015 year end assuming the above journals are posted to reserves etc
|
|
CU |
CU |
|
Dr Debtors |
2,128 |
|
|
Dr Cash |
5,003 |
|
|
Cr FX gain in P&L |
|
7,131 |
Being journal to reverse the 2014 journals on the forward contract was closed out in the year.
|
|
CU |
CU |
|
Dr Deferred Tax in P&L |
143 |
|
|
(713/5 years) |
|
|
|
Cr Deferred Tax Asset |
|
143 |
Being journals to reflect the 1/5th release of the deferred tax asset recognised in 2014 to reflect the fact that a tax deduction will be claimed for CU1,426 (CU7,131/5 years) in the 2015 tax computation, in line with the tax transition revenue guidelines. The remaining deferred tax will be released over the following four years as the tax deduction is claimed.
2) Long term loans akin to an investment treated as a monetary asset
Under old GAAP no specific guidance was provided in relation to the treatment of long term loans. As a result many entities may have treated long term loans akin to an investment and therefore treated these as non-monetary assets. Under FRS 102, it is clear that such loans are monetary assets and therefore should be retranslated at each year end. As a result, transition adjustments are required to reflect this. It will include deferred tax on the adjustment where this adjustment was be taxed/tax deductible in the past and therefore will be payable/refundable in line with the guidelines issued by the tax authorities.
Example 15: Long term loan adjustment
The date of transition is 1 January 2014. Company A has a 100% investment in Company B. Company A loaned stgFC100,000 to Company B when the rate was CU1=0.80p. The terms of the loan was such that it was long term and it was not likely this loan would ever be repayable in the foreseeable future. Under old GAAP Company A treated this as a non-monetary asset as it was akin to an investment as a result this debtor balance was carried at its historical rate of CU125,000 (CU100,000/0.80). Under Section 30 although this balance would still meet the definition of an investment as it is akin to an investment (net investment in foreign entity) this balance is a non-monetary asset and therefore should be retranslated at the year end spot rate. The spot rate at 1 January 2014 and 31 December 2014 was CU1=FC0.75 and CU1=FC0.82 respectively. Assume the FX adjustment is taxable/tax deductible. Assume deferred tax of 10%. The journals to be posted on transition are:
1 January 2014
The carrying amount of the loan using the spot rate of CU1=FC0.75 under FRS 102 is = CU133,333 (FC100,000/0.75). Therefore the adjustment required is:
|
|
CU |
CU |
|
Dr Amounts Due from Company B (investment) (CU133,333-CU125,000) |
8,333 |
|
|
Cr Profit and Loss Reserves for Foreign Exchange Gain |
|
8,333 |
Being journal to reflect FC loan at the year end spot rate
|
|
CU |
CU |
|
Dr Profit and Loss Reserves for Deferred Tax (CU8,333*10%) |
833 |
|
|
Cr Deferred Tax Liability |
|
833 |
Being journal to reflect deferred tax as tax will be payable on this balance in the future
Journals required at 31 December 2014 assuming the above journals are posted in balance sheet and P&L side to reserves
The carrying amount of the loan using the spot rate of CU1=FC0.82 under FRS 102 is = CU121,951 (FC100,000/0.82). Therefore the adjustment required is:
|
|
CU |
CU |
|
Dr Foreign Exchange Loss in P&L |
3,049 |
|
|
Cr Amounts Due from Company B (investment) (CU121,951-CU125,000) |
|
3,049 |
Being journal to reflect FC loan at the year end spot rate
|
|
CU |
CU |
|
Dr Deferred Tax Asset |
305 |
|
|
Cr Deferred Tax in P&L (CU3,049*10%) |
|
305 |
Being journal to reflect deferred tax as tax will be payable on this balance in the future through adjustment to the tax computation for transition adjustments.
The journals posted for the 1 January 2014 will also have to be reversed into the profit and loss account as we have assumed these were posted in 31 December 2014 so as to show the correct opening reserves:
|
|
CU |
CU |
|
Dr Foreign Exchange Loss in P&L |
8,333 |
|
|
Cr Debtors |
|
8,333 |
Being journal to reflect reversal of prior year FX adjustment
|
|
CU |
CU |
|
Dr Deferred Tax Asset |
833 |
|
|
Cr Deferred Tax in P&L (CU8,333*10%) |
|
833 |
Being journal to reflect reversal of prior year deferred tax.
Journals required at 31 December 2015
The same type of journals will be required as was done in 2014 for 2015 excluding the deferred tax impact as this will be included in the 2015 tax computation. The deferred tax journal required is:
|
|
CU |
CU |
|
Dr Deferred Tax in P&L |
61 |
|
|
Cr Deferred Tax Asset |
|
61 |
|
(CU305/5 years) |
|
|
Being journal to reflect the 1/5th release of deferred tax to reflect the fact that a tax deduction will be claimed for CU610 (CU3,049/5 years) in the 2015 tax computation assuming it is a taxable adjustment in line with the tax transition revenue guidelines.. The remaining deferred tax will be released over the following 4 years as the tax deduction is claimed in the tax computation.
3) Change in functional currency for certain intermediary companies
Given that more detailed guidance is provided in Section 30 as to the determination of an entities functional currency there may be instances where the functional currency will have to be adjusted. This is particular relevant to intermediate holding companies who are not autonomous from the parent company. Under old GAAP it may have been possible that some of these intermediate holding companies had a functional currency of CU under old GAAP however based on the facts and circumstances the functional currency may now change. This change would have to be applied retrospectively which would mean that at the date of transition the historical cost balances for non-monetary items would have to be considered. That said, given that these are merely holding companies there may not be many non-monetary assets on the balance sheet. In this case the opening balance sheet would have to be restated and difference due to exchange posted to profit and loss reserves. See the disclosures section for an example of the notes to be included for disclosure of this error and an explanation as to how it was carried out.
4) Foreign borrowings taken out to fund foreign investment
Under SSAP 20, it was possible in the individual financial statements of the investing company to retranslate a foreign investment where borrowings were taken out to purchase the investment. This resulted in the FX adjustments on the borrowings and the investments somewhat netting against each other. Section 12 of FRS 102 provides a lot more detailed criteria which must be met before this treatment can be adopted and states that it can only be done where a fair value hedge is in operation. Fair value hedges have been looked at in Section 12. Where the criteria for a fair value hedge is not met at the date of transition or at the comparative year end date, then a transition adjustment will be required to reverse the retranslation of the investment from the year end rate back to its historical rate. There will also be a deferred tax adjustment where a tax deduction was obtained or the adjustment was taxed in prior year computations.
Example 16: Foreign borrowings taken out to fund foreign investment
The date of transition is 1 January 2014. Company A (who has a CU functional currency) purchased a 100% UK subsidiary, Company B for FC100,000 retranslated to CU125,000 at 2 January 2014. Company A took out a FC loan of FC100,000 to fund the purchase of Company B. The spot rate of CU to FC at 31 December 2014 was CU1=FC0.75. Assume deferred tax of 10% and the carrying amount of the FC loan at the end of 2014 was FC90,000. Under old GAAP the company was allowed to retranslate the investment of FC100,000 at the year end rate as it met the conditions as it had taken out foreign borrowings specifically to fund this investment. Therefore under old GAAP the FX movement on the investment was set against the FX gain/loss on the FC loan. As a result of this treatment the carrying amount of the investment in old GAAP books at 31/12/14 was CU133,333 (FC100,000/0.75). Assume this adjustment was taxed/tax deductible in the prior year for the purpose of this example.
Section 30 does not allow the treatment adopted under old GAAP as it does not meet the requirements for a fair value hedge under Section 12. As a result the investment cannot be retranslated at the year end rate, instead it must remain at historical cost. The journals required on transition are:
At 31 December 2014
Under old GAAP the journal posted was to Dr investment CU8,333 (CU133,333-CU125,000 being the historic cost) and Cr foreign exchange gain in P&L or OCI for CU8,333. Under FRS 102 this treatment is not allowed so this journal would have to be reversed such that the investment remains to be shown at CU125,000 being the original historic cost. The journal required is:
|
|
CU |
CU |
|
Dr Foreign Exchange Gain/OCI |
8,333 |
|
|
Cr Investment in Company B |
|
8,333 |
Being journal to reverse previous posting under old GAAP.
|
|
CU |
CU |
|
Dr Deferred Tax Asset |
833 |
|
|
Cr Deferred Tax in P&L (CU8,333*10%) |
|
833 |
Being journal to reflect deferred tax for tax paid in 2014 now being repayable assuming it was taxable initially.
This deferred tax will be released over a 5 year period from 2015 in line with the tax transition guidance. The journal required in 2015 is
|
|
CU |
CU |
|
Dr Deferred Tax in P&L |
167 |
|
|
Cr Deferred Tax Asset (CU833/5 years) |
|
167 |
Being journal to reflect the release of deferred tax to reflect the fact that a tax deduction will be claimed for CU1,667 (CU8,333/5 years) in the 2015 tax computation assuming it is a tax deductible amount.
If in the above example this adjustment was not taxed/deducted in the prior year tax computations there would be no deferred tax or current tax implication.
Note a journal would be required to be posted to retained earnings on transition if an entity has treated an investment in the above way under old GAAP. For simplicity in the example above we have assumed an investment was acquired post the transition date.
1) Goodwill on foreign operations
Section 30 requires goodwill and any fair value adjustments to be denominated in the functional currency of the acquired entity and retranslated at the closing rate. Under old GAAP this was not mandated so it may not have been retranslated. As a result a transition adjustment may be required where this has not been completed under old GAAP. There is no deferred tax impact as no deferred tax should be recognised on goodwill recognised in business combinations under Section 29.
Example 17: Goodwill on foreign operations to be retranslated at the closing rate
The transition date to FRS 102 is 1 January 2014. Parent A (who has a CU functional currency) purchased a 100% interest in a US Company, Company B at 1 January 2013 for FC200,000. At that time the fair value of the net assets was FC150,000 which equaled the net assets at the time and goodwill of FC50,000 was recognised on acquisition. Goodwill of CU40,000 (FC50,000/0.80) was recognised at the date of acquisition and was not subsequently retranslated in the consolidated financial statements under old GAAP. The goodwill is amortised over 10 years and the NBV of goodwill under old GAAP at 1 January 2014, 31 December 2014 and 31 December 2015 was CU36,000, CU32,000 and CU28,000 respectively. The year end FX rate at 1 January 2014, 31 December 2014 and 31 December 2015 is FC1=CU0.85, FC1=CU0.87 and FC1=CU0.90.
Under Section 30.23 any goodwill or fair value adjustments recognised in the consolidated financial statements should be retranslated at each year end date. The journal adjustments required on transition are:
On 1 January 2014
Carrying amount of goodwill in FC at 1 January = FC50,000/10yrs*9yrs= FC45,000 retranslated at the year end rate of FC1=CU0.85 = CU38,250
Therefore adjustment required is the difference between the carrying amount under old GAAP of CU36,000 less the carrying amount retranslated at the year end rate of CU38,250. The journals required to be posted in the consolidated accounts is therefore:
|
|
CU |
CU |
|
Dr Goodwill (CU38,250-CU36,000) |
2,250 |
|
|
Cr Profit and Loss Reserves |
|
2,250 |
Being journal to reflect foreign goodwill retranslated at year end rate
Journals required for year ended 31 December 2014 assuming the above journals are posted to reserves etc
Carrying amount of goodwill in FC at 31 December 2014 = FC50,000/10yrs*8yrs= FC40,000 retranslated at the year end rate of FC1=CU0.87 = CU34,800
Therefore adjustment required is the difference between the carrying amount under old GAAP of CU32,000 less the carrying amount retranslated at the year end rate of CU34,800. The journals required to be posted in the consolidated accounts is therefore:
|
|
CU |
CU |
|
Dr Goodwill (CU34,800-CU32,000) |
2,800 |
|
|
Cr Other Comprehensive Income |
|
2,800 |
Being journal to reflect foreign goodwill retranslated at year end rate
A journal is also required to reverse the adjustment posted into the opening balance sheet as this is no longer required such that the true movement in the FX rate is shown in other comprehensive income.
|
|
CU |
CU |
|
Dr other comprehensive income |
2,250 |
|
|
Cr goodwill |
|
2,250 |
Being journal to reflect reversal of prior year goodwill journal
Journals required for year ended 31 December 2015 assuming the above journals are posted to reserves etc
The journals required for 2015 will be similar to the 2014 journals.
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