Section 25 – Foreign Currency Translation

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Section 25 – Overview

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Section 25: Foreign Currency Translation
Summary

 This section applies to foreign currency transactions and foreign operations in the financial statements of an entity.

What is new when compared to previous GAAPs – General?

Section 25 requires that where a forward foreign contract rate exists to match the related foreign currency transaction or where a foreign currency rate is included in the contract, then this contracted rate must be used on initial recognition of the transaction into its functional currency and monetary asset is kept at this rate until settled. In this case the spot rate on the date of the transaction cannot be utilised on initial recognition nor can the spot rate at the period end be used where the transaction is still outstanding.

This contrasts old GAAP (SSAP 20) and FRSSE (Section 13) which gave entities a choice where an entity held forward foreign currency contracts to cover the foreign currency transaction to either recognise:

FRS 105 is contrasted with FRS 102 which requires all foreign currency transactions to be measured at the spot rate at the date of the transaction and the unsettled monetary foreign currency balance at period end at the spot rate. The foreign currency could not use a forward rate or contract rate. Instead any forward foreign currency contracts had to be fair valued on the balance sheet.

Old GAAP/FRSSE allowed long term loans to a subsidiary to be included in the investment value and therefore treated as a non-monetary asset. FRS 102 requires such loans to be retranslated to the year-end spot rate. Section 25 does not deal with such items therefore entities will have a choice as to the method to use while always ensuring they meet the requirements of the concepts and principals in Section 2 of FRS 105.

Section 25 requires minimal disclosures (disclosure of the currency the financial statements are presented in and any commitments, contingencies entered into e.g. unsettled forward foreign exchange contracts, ROI entities require disclosure of the accounting policy) which compares to previous GAAP’s which required more detailed disclosures.

What is different when compared to FRS 102 and entities that adopted FRS 26 under old GAAP?

Under Section 25 forward foreign currency exchange contracts must be carried at cost less impairment and released to the P&L over the life of the contract. They cannot be fair valued. This was the same treatment as was required under FRSSE and for non FRS 26 old GAAP entities.

FRS 102 and FRS 26 of old GAAP on the other hand required that such derivatives be fair valued. Therefore where a company had previously carried these at fair value under FRS 102/FRS 26 they will need to be derecognised under FRS 105.

FRS 102 refers to presentational currency, Section 25 does not address this. However it does require an entity to follow the rules for retransalation of a foreign branch which is determined to have a functional currency which is different from the other elements of the trade in the company which uses the same rules in relation to showing results in the presentational currency, therefore no adjustments are expected where such a foreign branch exists.

FRS 102/old GAAP provides guidance on consolidation of foreign entities, this is not replicated in Section 25 as FRS 105 does not permit consolidated financial statements to be prepared therefore this guidance is not applicable.

What is different when compared to FRSSE/old GAAP?

Section 30 requires the transaction rate/average rate to be used when translating the profit and loss account of a foreign operation which is a foreign branch whereas under old GAAP/FRSSE it allowed either the closing or average rate to be used. Where the closing rate was used a transition adjustment will be required. FRS 102 follows the same guidance as FRS 105 in this area.

The term functional currency is used in FRS 105, whereas old GAAP (SSAP 20)/FRSSE used the term local currency. FRS 102 uses the same wording as FRS 105. Section 25 gives more detailed guidance when determining functional currency which may result in a different functional currency being determined under FRS 105, particularly where an entity is a foreign operation/branch as under Section 25 we need to look to the parent entity if the functional currency cannot be determined from the primary indicators.

Other standards affecting Section 25 where differences arise:

Section 24 – Income tax – Possible need for corporation tax asset/liability to be recognised on transition to FRS 105 e.g. on retranslation of monetary assets from the spot exchange rate to the contracted rate as applicable or the derecognition of derivatives from the balance sheet.

Section 24 – Income tax – Possible need for the derecognition of deferred tax recognised in this area under previous GAAP.

What are the key points?

Functional currency is the currency of the primary economic environment in which an entity operates. Its functional currency is usually the currency that mainly influences its sales prices and costs, although financing activities and the currency in which receipts from operating activities may also be relevant.

On initial recognition, foreign currency transactions are recognised in the functional currency using the spot exchange rate at the date of the transaction unless:

 If at the period end date, the monetary assets have not been settled then the foreign currency amount is retranslated at:

For non-monetary assets at the end of each reporting period:

Where contracted rates exist they must be used.

Forward foreign currency contracts cannot be fair valued instead they must be disclosed.

Forward foreign currency exchange contracts must be carried at cost less impairment and released to the P&L over the life of the contract if applicable.

The balance sheet for foreign operations which are branches should be retranslated at year end spot rate and the profit and loss should be retranslated to the average/transaction date with the exchange difference posted to the profit and loss account.

What do accountants need to do?

Be aware of the differences between Section 25 and old GAAP/FRSSE/FRS 102.

Review the client portfolio to identify companies who have contracted rates/foreign currency exchange contracts of the need to recognise the transaction at the contracted rate initially and subsequently under FRS 105 if not previously done and the impact this will have on the distributable reserves.

Review the client portfolio to identify companies that hold foreign branches to assess whether the new guidance will result in a change in functional currency.

Advise clients of need to derecognise any derivatives (e.g. forward foreign exchange contracts) from the balance sheet.

What do companies need to know?

Be aware of the differences between Section 25 and old GAAP/FRSSE/FRS 102 and assess the impact of these differences on the entity.

Where companies have foreign operations which are branches assess the likely impact of the foreign operations not being allowed to post exchange variances on foreign borrowings to the OCI/STRGL.

Given the new functional guidance in Section 25, assess if the functional currency remains the same.

Assess if long term loans to subsidiaries were previously treated as a non-monetary asset and apply an accounting policy accordingly.

Where forward contracts were/are utilised recognise the need for a transition adjustment to restate comparative figures to the contracted rate to cover the exposure and to derecognise derivatives if applicable to include considering the corporation tax adjustments required.

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