New Venezuelan currency regime - same accounting and reporting considerations

Transcription

1 Applying IFRS New Venezuelan currency regime - same accounting and reporting considerations June 2015

2 Contents Overview Background Looking back at Recent developments and outlook for Cap on profits earned in Venezuela Foreign currency accounting considerations Functional currency Foreign currency transactions Translation of a foreign operation Other accounting and financial reporting considerations Disclosures... 9 What you need to know The new currency exchange system requires companies with operations in Venezuela to reconsider again the exchange rate(s) they use to translate Venezuelan foreign operations and to translate their Venezuelan bolivar-denominated monetary assets and liabilities and related revenues and expenses. Entities will need to consider their specific transactions and their ability to transact through the various exchange mechanisms to determine which exchange rate(s) to use. Economic conditions in Venezuela and changes in the currency exchange mechanisms also raise a number of other financial reporting issues. Entities with significant operations in Venezuela should consider providing additional disclosure about their exposure to Venezuela, including how they are affected by recent developments. 1 June 2015 New Venezuelan currency regime same accounting and reporting considerations

3 Overview Now that Venezuela has revamped its foreign currency exchange system, companies with operations in Venezuela should reconsider the exchange rate(s) they use to translate their bolivar-denominated monetary assets and liabilities and related revenues and expenses. Entities should also consider supplementing their disclosures to reflect their consideration of recent events. In February 2015, the Venezuelan Government (the Government) announced that it merged its two supplementary foreign currency exchange systems (i.e., Sistema Complementario de Administración de Divisas, or SICAD 1, and Sistema Cambiario Alternativo de Divisas, or SICAD 2) into a single mechanism called SICAD. The Government also introduced the Sistema Marginal de Divisas (Marginal Currency System, or SIMADI) to compete with the unofficial parallel currency exchange market (the black market). As a result, companies will need to consider whether to use the new SIMADI rate of approximately 198 bolivars (Bs) per US dollar (USD) as of 4 June 2015, the new SICAD rate of Bs12 per US dollar or the official rate of Bs6.3 per US dollar. To determine which rate(s) to use to translate Venezuelan foreign operations and to translate specific bolivar-denominated monetary assets and liabilities, a company should consider: (1) its legal ability to convert currency or to settle transactions using a specific rate and (2) its intent to use a particular mechanism, including whether the rate available through that mechanism is published or readily determinable. The second criterion is important because entities can use different exchange mechanisms with different rates for many transactions. Determining the appropriate exchange rate(s) for financial reporting purposes will depend on an entity s individual facts and circumstances. Determining the appropriate exchange rate(s) for financial reporting purposes will depend on a company s individual facts and circumstances. Complicating this determination is the increasing lack of exchangeability across all exchange mechanisms. Many questions remain about whether Venezuela s supply of US dollars will be sufficient to meet demand and how exchanges will be handled under the new currency exchange system. This publication addresses the IFRS requirements for translating foreign currency transactions and translation of foreign operations- and some of the factors companies need to consider when determining the appropriate exchange rate or rates to use. Other accounting and disclosure considerations are also discussed. 1. Background The Government has maintained currency controls and a fixed official exchange rate since February Since 2010, the Venezuelan economy has been considered highly inflationary under IAS 29 Financial Reporting in Hyperinflationary Economies. For years, the Government has limited a company s ability to repatriate profits (i.e., pay dividends) and obtain US dollars to pay for imported goods and services. June 2015 New Venezuelan currency regime same accounting and reporting considerations 2

4 1.1 Looking back at 2014 In 2014, the Venezuelan Ministry of Finance reported that the National Foreign Trade Center (CENCOEX) authorised total disbursements of USD20.4 billion for imports, operations and other corporate and individual currency needs, the lowest level of disbursements to the private sector since The amount was 31% lower than in 2013 and 38% lower than in According to Ecoanalítica, a Venezuelan financial advisory and economic research organisation, approximately 31% of Venezuela s domestic demand is met by imports, and 76% of imports are used as inputs for goods produced in the country. 1 As a result, the private sector s ability to obtain US dollars has a significant effect on the Venezuelan economy, especially the supply of goods and services in the domestic market. The problem is that Venezuela s supply of US dollars has shrunk as the price of crude oil, the country s main export and source of US dollars, has fallen. Before the February 2015 announcement, Venezuela had three legal mechanisms to exchange currency, but not all exchange mechanisms and rates were available to all entities. The official rate 2 has been reserved for essential goods, while the SICAD 1 auction rate was used for specific authorised transactions, industries and business activities. All companies incorporated or domiciled in Venezuela were allowed to obtain US dollars through SICAD 2 3 and purportedly for any purpose. We reviewed of the US GAAP financial statements that 82 companies with Venezuelan operations or exposure to bolivar-denominated monetary assets filed with the US Securities and Exchange Commission (SEC). Nearly half of the companies used the SICAD 2 rate of Bs50 per US dollar for remeasurement as of 31 December The breakdown of rates used by these companies illustrates the diversity in practice that exists in the US. Breakdown of rates used by companies as of 31 December 2014 FX rate expressed as Bs per USD Number of companies Official rate SICAD 1 SICAD 2 Multiple Total * NA Percentage * These companies used more than one legally available exchange rate to remeasure their bolivar-denominated monetary assets and liabilities and related revenues and expenses. While entities reporting under IFRS need to make somewhat different judgements compared to US GAAP reporting entities, we expect there is a similar diversity of practice that exists under IFRS. 1 The debacle of CENCOEX: Foreign currency is in few hands, Ecoanalítica, Week III March 2015 Weekly Report. 2 The official exchange rate of 6.3 Bs to the US dollar has remained unchanged since the government formally devalued the currency in February The SICAD 2 rate was intended to be the closest legal rate to a market-based rate, which was obtained through registered financial institutions and exchange houses. 3 June 2015 New Venezuelan currency regime same accounting and reporting considerations

5 2. Recent developments and outlook for 2015 In February 2015, the Venezuelan Government said it merged its SICAD 1 and SICAD 2 foreign currency exchange systems and issued Exchange Agreement No. 33 establishing regulations for foreign exchange transactions conducted through the new SIMADI system. How we see it An entity s decision to use a particular exchange rate or rates should be based on careful consideration of the various exchange mechanisms and entity-specific facts and circumstances. Absent a change in facts and circumstances, a company that previously concluded that it was not eligible to transact at either the official rate or the SICAD 1 rate would generally be expected to use the SIMADI rate, now that the SICAD 2 system no longer exists. SIMADI is intended to compete with the black market by establishing a legal trading system based on supply and demand. It s available to individuals and both public and private companies, except for banks and other financial institutions that are authorised to facilitate exchanges through SIMADI. These financial institutions are prohibited from accessing SIMADI for their own accounts. The Government has said that both the official rate and the new SICAD rate would be available to entities importing essential goods (e.g., certain food, medicine, raw materials), with the majority of such imports being settled at the most favourable rate of Bs6.3 per US dollar. However, the Government has not published any new rules or regulations that clarify exactly which activities, industries or transactions will be eligible to transact at these rates. Allowing certain entities to transact at the two most favourable exchange rates, subject to the country s profit cap laws, is intended to make many necessities affordable for Venezuelan citizens. Since its inception, the SIMADI system reportedly has not been able to meet the demand from the private sector due to a lack of supply of US dollars and complex rules, among other reasons. As a result, the bolivar continues to be devalued. For example, on the first day of operation, the SIMADI exchange rate was approximately Bs172 per US dollar, compared with approximately Bs177 per US dollar on the black market. As of the date of this publication, the SIMADI rate was approximately Bs198 per US dollar, compared with approximately Bs428 4 per USD on the black market. The following exchange mechanisms and rates were legally available, depending on facts and circumstances, as of 31 March 2015: Through CENCOEX at the official rate of 6.3 Through CENCOEX at the new SICAD rate of 12 Through the SIMADI system at the negotiated rate of approximately Dolartoday.com. June 2015 New Venezuelan currency regime same accounting and reporting considerations 4

6 We understand that the new SICAD rate will be established through periodic auctions regulated by the Government in a process similar to the one the Government previously used to set the SICAD 1 rate. However, there have been no public auctions since October 2014, which is why the SICAD rate has remained unchanged at Bs12 per USD. Until auctions resume, any currency exchanged at the SICAD rate will be through CENCOEX. It is unclear which types of transactions and activities will be subject to the new SICAD rate. In January 2014, when use of the SICAD 1 exchange rate was significantly expanded through Exchange Agreement No. 25, the Venezuelan government announced that the published exchange rate resulting from the latest SICAD auction would be used for the following transactions and activities: Foreign investments and payments of royalties; use and exploitation of patents, trademarks, licences and franchises; as well as contracts for technology import and technical assistance International public air transportation service for passengers, cargo and mail duly authorised by the Government Operations inherent in insurance activity Contracts for leasing and services; use and exploitation of patents, trademarks, licences and franchises, as well as import of intangible goods; payment of network rental agreements and installation; repair and maintenance of imported machinery, equipment or software of the telecommunications sector Cash for travelling abroad, including payment of purchases with credit cards while travelling abroad and of electronic commerce transactions with suppliers abroad Remittances to relatives living abroad Payments for operations inherent in national civil aviation It is unclear whether the new SICAD rate will apply to these types of transactions and activities. It is also unclear whether companies that interpreted the term foreign investments in Exchange Agreement No. 25 to mean that future dividend remittances would be transacted at the exchange rate established through the SICAD auction process will be able to continue to make that assertion. Entities may need to change the rate they use to translate their net monetary assets, depending on what the Government says about how the new SICAD rate can be used. 5 June 2015 New Venezuelan currency regime same accounting and reporting considerations

7 How we see it With slumping crude oil prices and significant debt payments coming due later this year, the Government has fewer US dollar reserves available to meet the private sector s demands this year. As a result, entities may have a harder time obtaining US dollars this year than at any time since currency controls were first implemented. In its Week III March 2015 Weekly Report, Ecoanalítica said, the drop in oil prices implies a drop of 48.0% in the country s foreign currency revenues and a deficit of US$25.58 billion, which, given the lack of financing options, will have to be offset by an adjustment in demand and, as always, private sector imports are the first on the list when it comes to implementing cuts. If Ecoanalítica and other analysts are correct, entities doing business in Venezuela may experience less exchangeability in 2015 unless oil prices recover significantly and Venezuela changes its monetary policy. Currency exchanges at either the official or SICAD rate to pay dividends remain unlikely for the foreseeable future. Such capital outflows likely will occur only through the new SIMADI system, assuming liquidity in that market improves and other operational challenges are addressed. According to the Venezuelan Central Bank, during the first six weeks of the new system s operation, only 1.4% of all authorised foreign exchange transactions occurred through SIMADI compared with initial estimates of 5% to 7%. 2.1 Cap on profits earned in Venezuela It is our understanding that an entity s compliance with Venezuela s profit cap law, 5 which was enacted in January 2014, will continue to be a prerequisite to obtain US dollars through any of the exchange mechanisms controlled by the Government. The law limits profit margins by product and service and sets a cap of 30% above the cost structure (as defined) of the good or service. The National Superintendence for Defense of Socioeconomic Rights is in charge of its enforcement and monitors compliance by importers, producers, suppliers and retailers. Some entities have been required to demonstrate their compliance with this law by furnishing performance certificates, which are subject to government audit. 3. Foreign currency accounting considerations 3.1 Functional currency IAS 21 The Effects of Changes in Foreign Exchange Rates defines the functional currency of an entity as the currency of the primary economic environment in which the entity operates. Whilst judgement may sometimes be required to determine the functional currency, it is a matter of fact, not an accounting policy choice. 5 Decree No. 600 with Rank, Value and Force of Master Law of Fair Prices in Official Gazette No. 40,340. June 2015 New Venezuelan currency regime same accounting and reporting considerations 6

8 As the Venezuelan economy is hyperinflationary, IAS 29 must first be applied. IAS 29 requires a restatement approach, whereby financial information recorded in the hyperinflationary currency is adjusted by applying a general price index and expressed in the measuring unit (the hyperinflationary currency) current at the end of the reporting period. The alternative approach whereby an entity selects a stable currency as its unit of accounting is prohibited under IFRS if that currency is not the entity's functional currency as defined under IAS Foreign currency transactions IAS 21 requires each foreign currency transaction to be recorded in the functional currency of the reporting entity at the date it is recognised, using the spot exchange rate in effect at that date. Under IAS 21, when several exchange rates are available, the rate used is that at which the future cash flows represented by the transaction or balance could have been settled, if those cash flows had occurred at the measurement date. If more than one exchange mechanism is legally available, an entity should generally base its decision on its intention to use a particular mechanism to settle the specified transaction and whether the rate available through that mechanism is published or readily determinable at the reporting date. The probability of transacting through a particular mechanism should also be considered (i.e., whether the volume and frequency of exchange activity through a particular mechanism will support the entity s currency needs). If exchangeability is lacking across all exchange mechanisms, an entity should use the published rate for the legally available exchange mechanism that most faithfully reflects the economics of the company s business activity. The exchange rate an entity uses for translation may vary by transaction type, based on the entity s legal ability to convert currency or to settle transactions using the specified rate. Determining which currency exchange mechanisms and rates are legally available to a reporting entity in Venezuela requires careful consideration of Exchange Agreements used. The assistance of legal counsel or Venezuelan regulatory authorities (such as CENCOEX) may be required. 3.3 Translation of a foreign operation Where the results and financial position of a foreign operation are translated into the presentation currency of the reporting entity, IAS 21 requires that the financial statements are first restated in accordance with IAS 29 for hyperinflationary economies. Once restated, IAS 21 requires all current period amounts to be translated at the closing rate at the reporting date. When the presentation currency of the reporting entity is not USD, the entity may also need to determine the USD to presentation currency exchange rate to translate the financial statements of its Venezuelan operations. This is because all three of the exchange rates legally available in Venezuela are based solely on the Bolivar to US dollar conversion. 7 June 2015 New Venezuelan currency regime same accounting and reporting considerations

9 4. Other accounting and financial reporting considerations We do not believe that a lack of exchangeability in itself would result in the deconsolidation of a Venezuelan subsidiary. The Government reported a contraction in gross domestic product (GDP) in 2014 and an inflation rate of 68.5%. Some analysts are projecting a further contraction in GDP this year and an inflation rate of more than double the 2014 rate. Venezuela s deteriorating economy and its currency exchange controls and profit cap law raise a number of financial reporting issues beyond the foreign currency matters discussed above. These accounting and financial reporting considerations include: Consolidation: IFRS 10 Consolidated Financial Statements requires an investor to consolidate an investee that it controls. In determining whether it has control, an entity considers (among other factors) whether it has power over an investee, being existing rights that give it the current ability to direct the relevant activities. In assessing its rights, the investor considers whether those rights are substantive, including whether there are regulatory or legal requirements that prevent the holder from exercising its rights 6 (e.g., where a foreign investor is prohibited from exercising its rights). While entities should consider their individual facts and circumstances in determining whether to deconsolidate a foreign entity, generally, we do not believe that a lack of exchangeability in itself would result in the deconsolidation of a Venezuelan subsidiary. IFRS 12 Disclosure of Interests in Other Entities requires a company to disclose significant restrictions on its ability to access or use the assets and settle the liabilities of the group (e.g., those that restrict the ability of a parent or its subsidiaries to transfer cash or other assets to (or from) other entities within the group 7 ). Cash: IAS 7 Statement of Cash Flows requires an entity to disclose, together with a management commentary, the amount of significant cash and cash equivalent balances held that are not available for use by the group. IAS 7 states that examples include cash and cash equivalent balances held by a subsidiary that operates in a country where exchange controls or other legal restrictions apply when the balances are not available for general use by the parent or other subsidiaries. 8 How we see it The nature of the restriction on the use of cash and cash equivalents must also be assessed to determine if the balance is ineligible for inclusion in cash equivalents because the restriction results in the investment ceasing to be highly liquid or readily convertible. Revenue: Pursuant to IAS 18 Revenue, revenue should be recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. Lack of exchangeability, devaluation of the bolivar and deteriorating economic conditions in Venezuela all raise questions about the collectability of an entity s receivables from customers located in Venezuela. Revenue should only be recognised once the uncertainty about the collectability of the consideration is removed. 6 IFRS 10.B23(a)(vii) 7 IFRS 12.13(a)(i) 8 IAS 7.49 June 2015 New Venezuelan currency regime same accounting and reporting considerations 8

10 Financial assets measured at amortised cost: Paragraph 58 of IAS 39 Financial Instruments: Recognition and Measurement, requires an entity to assess, at each reporting period, whether there is any objective evidence of impairment. Entities with amounts due (e.g., loans, trade receivables) from customers in Venezuela (including the Government) should consider whether there is evidence of impairment and, if so, determine the impairment loss. Investments in equity instruments: Paragraph 61 of IAS 39 explains that, in the following circumstances, there is objective evidence of impairment of an equity investment: Information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the entity operates, and indicates that the cost of investment may not be recovered; or A significant or prolonged decline in the fair value of an investment in such an instrument below its cost. Equity investments in Venezuelan entities are likely to be at high risk of impairment due to the economic conditions. Therefore, entities will need to assess whether there is objective evidence of impairment. Impairment of assets: IAS 36 prescribes the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset. Entities should consider how recent economic and political developments in Venezuela may affect their capital and operating strategies and whether changes to those strategies will affect the recoverability of their assets. Indefinite-lived intangible assets and goodwill are subject to annual impairment tests as well as interim impairment tests if impairment indicators are present. 5. Disclosures Entities with exposure to Venezuela should challenge the disclosures in their financial statements. Where material, disclosures that entities should consider include: A discussion of an entity s operations in Venezuela, including the nature and extent of business activities in that country A discussion that IAS 29 has been applied and the financial statements and the corresponding figures for previous periods that have been restated for changes in the general purchasing power of the functional currency IAS 29 also requires disclosure of whether the financial statements are based on a historical or current cost approach and the identity and level of the price index at the end of the reporting period with disclosure of the movement in the index during the current and previous reporting periods 9 June 2015 New Venezuelan currency regime same accounting and reporting considerations

11 A discussion of exchange rates used to translate bolivar-denominated foreign currency transactions and translation of foreign operations, including a discussion of the entity s ability to actually transact at such rates: Whether items were translated at a different rate than in the previous period (e.g., items translated at the SIMADI rate in the current period that were translated at the SICAD 2 rate in the previous period) Whether multiple exchange rates are used and, if so: (1) the basis for applying different rates; and (2) the limitations and uncertainties of each selected rate (e.g., the amount of currency available at such rates, the entitiy s ability to transact through specified exchange mechanisms and to realise the rates established through those mechanisms (both historically and projected)) The amount of bolivars pending Government approval for settlement at each rate and the length of time pending The effect of exchange restrictions on the company s cash flows available to meet capital and short-term funding requirements, including: possible changes in profitability that may result from any additional expected currency devaluation; change in exchange rates to be used for translation purposes; or the existing law capping profits that can be earned in Venezuela Recognised impairments and debt covenant violations attributed to changes in exchange rates or other factors attributed to the entity s operations in Venezuela In July 2014, the IFRS Interpretations Committee considered a request for guidance on the translation and consolidation of the results and financial position of foreign operations in Venezuela and the question which rate should be used if there was a longer-term lack of exchangeability. The IFRS Interpretations Committee published it s agenda decision on the application of IAS 21 to foreign operations in Venezuela in November 2014, noting that several exisiting disclosure requirements in IFRS would apply when the impact of foreign exchange controls is material: Disclosure of significant accounting policies and significant judgements in applying those policies (paragraphs of IAS 1) Disclosure of sources of estimation uncertainty that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year, which may include a sensitivity analysis (paragraphs of IAS 1) Disclosure about the nature and extent of significant restrictions on an entity s ability to access or use assets and to settle the liabilities of the group, or its joint ventures or associates (paragraphs 10, 13, 20 and 22 of IFRS 12) Next steps The Venezuelan Government may issue more regulations or take other steps that may affect an entity s decision on which exchange rate(s) to use for financial reporting purposes. Entities should continue to closely monitor developments in this area. June 2015 New Venezuelan currency regime same accounting and reporting considerations 10

12 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s International Financial Reporting Standards Group A global set of accounting standards provides the global economy with one measure to assess and compare the performance of companies. For companies applying or transitioning to International Financial Reporting Standards (IFRS), authoritative and timely guidance is essential as the standards continue to change. The impact stretches beyond accounting and reporting, to key business decisions you make. We have developed extensive global resources people and knowledge to support our clients applying IFRS and to help our client teams. Because we understand that you need a tailored service as much as consistent methodologies, we work to give you the benefit of our deep subject matter knowledge, our broad sector experience and the latest insights from our work worldwide EYGM Limited. All Rights Reserved. EYG No. AU3117 ED None In line with EY s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com