Appendix 1: SSAP 20*: Foreign Currency Translation

Transcription

1 Appendix 1: SSAP 20*: Foreign Currency Translation Contents Part 1 - Explanatory Note Part 2 - Definition of Terms Part 3 - Standard Accounting Practice Individual companies Consolidated financial statements Disclosure Date from which effective Part 4- Legal Requirements in UK and Ireland Part 5 - Compliance with International Accounting Standard, no. 21 'Accounting for the Effects of Changes in Foreign Exchange Rates' paragraphs The provisions of this statement of standard accounting practice should be read in conjunction with the explanatory Foreword to accounting standards and need not be applied to immaterial items. The provisions apply to financial statements prepared under either the historical cost convention or the current cost convention. This statement sets out the standard accounting practice for foreign currency translation, but does not deal with the method of calculating profits or losses arising from a company's normal currency dealing operations; neither does it deal specifically with the determination of distributable profits. Statement of standard accounting practice, no. 20, April

2 160 Appendix 1 PART 1 - EXPLANATORY NOTE Background 1 A company may engage in foreign currency operations in two main ways: (a) Firstly, it may enter directly into business transactions which are denominated in foreign currencies; the results of these transactions will need to be translated into the currency in which the company reports. (b) Secondly, foreign operations may be conducted through a foreign enterprise which maintains its accounting records in a currency other than that of the investing company; in order to prepare consolidated financial statements it will be necessary to translate the complete financial statements of the foreign enterprise into the currency used for reporting purposes by the investing company. Objectives of translation 2 The translation of foreign currency transactions and financial statements should produce results which are generally compatible with the effects of rate changes on a company's cash flows and its equity and should ensure that the financial statements present a true and fair view of the results of management actions. Consolidated statements should reflect the financial results and relationships as measured in the foreign currency financial statements prior to translation. Procedures 3 In this statement the procedures which should be adopted when accounting for foreign operations are considered in two stages, namely: (a) the preparation of the financial statements of an individual company; and (b) the preparation of consolidated financial statements.

3 The individual company stage SSAP During an accounting period, a company may enter into transactions which are denominated in a foreign currency. The result of each transaction should normally be translated into the company's local currency using the exchange rate in operation on the date on which the transaction occurred; however, if the rates do not fluctuate significantly, an average rate for a period may be used as an approximation. Where the transaction is to be settled at a contracted rate, that rate should be used; where a trading transaction is covered by a related or matching forward contract, the rate of exchange specified in that contract may be used. 5 Once non-monetary assets, e.g. plant, machinery and equity investments, have been translated and recorded they should be carried in the company's local currency. Subject to the provisions of paragraph 30 concerning the treatment of foreign equity investments financed by foreign currency borrowings, no subsequent translations of these assets will normally need to be made. 6 At the balance sheet date monetary assets and liabilities denominated in a foreign currency, e.g. cash and bank balances, loans and amounts receivable and payable, should be translated by using the rate of exchange ruling at that date, or, where appropriate, the rates of exchange fixed under the terms of the relevant transactions. Where there are related or matching forward contracts in respect of trading transactions, the rates of exchange specified in those contracts may be used. 7 An exchange gain or loss will result during an accounting period if a business transaction is settled at an exchange rate which differs from that used when the transaction was initially recorded, or, where appropriate, that used at the last balance sheet date. An exchange gain or loss will also arise on unsettled transactions if the rate of exchange used at the balance sheet date differs from that used previously. 8 Exchange gains or losses arising on settled transactions in the context of an individual company's operations have already been reflected in cash flows, since a change in the exchange rate increases or decreases the local currency equivalent of amounts paid or received in cash settlement. Similarly, it is reasonably certain that exchange gains or losses on unsettled short-term monetary items

4 162 Appendix 1 will soon be reflected in cash flows. Therefore, it is normally appropriate, because of the cash flow effects, to recognise such gains and losses as part of the profit or loss for the year; they should be included in profit or Joss from ordinary activities unless they arise from events which themselves would fall to be treated as extraordinary items, in which case they should be included as part of such items. 9 When dealing with long-term monetary items, additional considerations apply. Although it is not easy to predict what the exchange rate will be when a long-term liability or asset matures, it is necessary, when stating the liability or the asset in terms of the reporting currency, to make the best estimate possible in the light of the information available at the time; generally speaking translation at the year-end rate will provide the best estimate, particularly when the currency concerned is freely dealt in on the spot and forward exchange markets. 10 In order to give a true and fair view of results, exchange gains and losses on long-term monetary items should normally be reported as part of the profit or loss for the period in accordance with the accruals concept of accounting; treatment of these items on a simple cash movements basis would be inconsistent with that concept. Exchange gains on unsettled transactions can be determined at the balance sheet date no Jess objectively than exchange losses; deferring the gains whilst recognising the losses would not only be illogical by denying in effect that any favourable movement in exchange rates had occurred but would also inhibit fair measurement of the performance of the enterprise in the year. In particular, this symmetry of treatment recognises that there will probably be some interaction between currency movements and interest rates and reflects more accurately in the profit and Joss account the true results of currency involvement. 11 For the special reasons outlined above, both exchange gains and losses on long-term monetary items should be recognised in the profit and loss account. However, it is necessary to consider on the grounds of prudence whether the amount of the gain, or the amount by which exchange gains exceed past exchange losses on the same items, to be recognised in the profit and Joss account should be restricted in the exceptional cases where there are doubts as to the convertibility or marketability of the currency in question.

5 SSAP Gains or losses on exchange arising from transactions between a holding company and its subsidiaries, or from transactions between fellow subsidiaries, should normally be reported in the individual company's financial statements as part of the profit or loss for the year in the same way as gains or losses arising from transactions with third parties. The consolidated financial statements stage 13 The method used to translate financial statements for consolidation purposes should reflect the financial and other operational relationships which exist between an investing company and its foreign enterprises. 14 In most circumstances the closing rate/net investment method, described in paragraphs 15 to 20, should be used and exchange differences accounted for on a net investment basis. However, in certain specified circumstances (see paragraphs 21 to 24) the temporal method should be used. The closing rate/net investment method 15 This method recognises that the investment of a company is in the net worth of its foreign enterprise rather than a direct investment in the individual assets and liabilities of that enterprise. The foreign enterprise will normally have net current assets and fixed assets which may be financed partly by local currency borrowings. In its day-to-day operations the foreign enterprise is not normally dependent on the reporting currency of the investing company. The investing company may look forward to a stream of dividends but the net investment will remain until the business is liquidated or the investment disposed of. 16 Under this method the amounts in the balance sheet of a foreign enterprise should be translated into the reporting currency of the investing company using the rate of exchange ruling at the balance sheet date. Exchange differences will arise if this rate differs from that ruling at the previous balance sheet date or at the date of any subsequent capital injection (or reduction). 17 Amounts in the profit and loss account of a foreign enterprise

6 164 Appendix 1 should be translated at the closing rate or at an average rate for the accounting period. The use of the closing rate is more likely to achieve the objective of translation, stated in paragraph 2, of reflecting the financial results and relationships as measured in the foreign currency financial statements prior to translation. However, it can be argued that an average rate reflects more fairly the profits or losses and cash flows as they arise to the group throughout an accounting period. The use of either method is therefore permitted, provided that the one selected is applied consistently from period to period. 18 No definitive method of calculating the average rate has been prescribed, since the appropriate method may justifiably vary as between individual companies. Factors that will need to be considered include the company's internal accounting procedures and the extent of seasonal trade variations; the use of a weighting procedure will in most cases be desirable. Where the average rate used differs from the closing rate, a difference will arise which should be dealt with in reserves. 19 The results of the operations of a foreign enterprise are best reflected in the group profit and loss account by consolidating the net profit or loss shown in its local currency financial statements without adjustment (other than for normal consolidation adjustments). If exchange differences arising from the retranslation of a company's net investment in its foreign enterprise were introduced into the profit and loss account, the results from trading operations, as shown in the local currency financial statements, would be distorted. Such differences may result from many factors unrelated to the trading performance or financing operations of the foreign enterprise; in particular, they do not represent or measure changes in actual or prospective cash flows. It is therefore inappropriate to regard them as profits or losses and they should be dealt with as adjustments to reserves. 20 Although equity investme tts in foreign enterprises wiii normally be made by the purchast:.: of shares, investments may also be made by means of long-term loans and inter-company deferred trading balances. Where financing by such means is intended to be, for all practical purposes, as permanent as equity, such loans and inter-company balances should be treated as part of the investing company's net investment in the foreign enterprise; hence exchange differences arising on such loans and inter-company balances should be dealt with as adjustments to reserves.

7 SSAP The temporal method 21 For most investing companies in the UK and Ireland foreign operations are normally carried out through foreign enterprises which operate as separate or quasi-independent entities rather than as direct extensions of the trade of the investing company. 22 However, there are some cases in which the affairs of a foreign enterprise are so closely interlinked with those of the investing company that its results may be regarded as being more dependent on the economic environment of the investing company's currency than on that of its own reporting currency. In such a case the financial statements of the foreign enterprise should be included in the consolidated financial statements as if all its transactions had been entered into by the investing company itself in its own currency. For this purpose the temporal method of translation should be used; the mechanics of this method are identical with those used in preparing the accounts of an individual company, as stated in paragraphs 4 to It is not possible to select one factor which of itself will lead a company to conclude that the temporal method should be adopted. All the available evidence should be considered in determining whether the currency of the investing company is the dominant currency in the economic environment in which the foreign enterprise operates. Amongst the factors to be taken into account will be: (a) the extent to which the cash flows of the enterprise have a direct impact upon those of the investing company; (b) the extent to which the functioning of the enterprise is dependent directly upon the investing company; (c) the currency in which the majority of the trading transactions are denominated; (d) the major currency to which the operation is exposed in its financing structure. 24 Examples of situations where the temporal method may be appropriate are where the foreign enterprise: (a) acts as a selling agency receiving stocks of goods from the investing company and remitting the proceeds back to the company; (b) produces a raw material or manufactures part or sub-

8 166 Appendix 1 assemblies which are then shipped to the investing company for inclusion in its own products; (c) is located overseas for tax, exchange control or similar reasons to act as a means of raising finance for other companies in the group. The treatment of foreign branches 25 For the purpose of this statement, foreign operations which are conducted through a foreign branch should be accounted for in accordance with the nature of the business operations concerned. Where such a branch operates as a separate business with local finance, it should be accounted for using the closing rate/net investment method. Where the foreign branch operates as an extension of the company's trade and its cash flows have a direct impact upon those of the company, the temporal method should be used. Areas of hyper-inflation 26 Where a foreign enterprise operates in a country in which a very high rate of inflation exists it may not be possible to present fairly in historical cost accounts the financial position of a foreign enterprise simply by a translation process. In such circumstances the local currency financial statements should be adjusted where possible to reflect current price levels before the translation process is undertaken. The special case of equity in vestment financed by foreign borrowings 27 Under the procedures set out in this statement, exchange gains or losses on foreign currency borrowings taken up by an investing company or foreign enterprise would normally be reported as part of that company's profit or loss from ordinary activities and would flow through into the consolidated profit and loss account. 28 Where an individual company has used borrowings in currencies other than its own to finance foreign equity investments, or where the purpose of such borrowings is to provide a hedge against the exchange risk associated with existing equity investments, the

9 SSAP company may be covered in economic terms against any movement in exchange rates. It would be inappropriate in such cases to record an accounting profit or loss when exchange rates change. 29 Therefore, provided the conditions set out in this paragraph apply, the company may denominate its foreign equity investments in the appropriate foreign currencies and translate the carrying amounts at the end of each accounting period at the closing rates of exchange. Where investments are treated in this way, any resulting exchange differences should be taken direct to reserves and the exchange gains or losses on the borrowings should then be offset, as a reserve movement, against these exchange differences. The conditions which must apply are as follows: (a) in any accounting period, exchange gains or losses arising on the borrowings may be offset only to the extent of exchange differences arising on the equity investments; (b) the foreign currency borrowings, whose exchange gains or losses are used in the offset process, should not exceed, in the aggregate, the total amount of cash that the investments are expected to be able to generate, whether from profits or otherwise; and (c) the accounting treatment adopted should be applied consistently from period to period. 30 Similarly, within a group, foreign borrowings may have been used to finance group investments in foreign enterprises or to provide a hedge against the exchange risk associated with similar existing investments. Any increase or decrease in the amount outstanding on the borrowings arising from exchange movements will probably be covered by corresponding changes in the carrying amount of the net assets underlying the net investments (which would be reflected in reserves). Since in this case the group will be covered in economic terms against any movement in exchange rates, it would be inappropriate to record an accounting profit or loss when exchange rates change. 31 In the consolidated financial statements, therefore, subject to certain conditions, the exchange gains or losses on such foreign currency borrowings, which would otherwise have been taken to the group profit and loss account, may be offset as reserve movements against exchange differences on the retranslation of the net investments. The conditions which must apply are as follows:

10 168 Appendix 1 (a) the relationship between the investing company and the foreign enterprises concerned should be such as to justify the use of the closing rate method for consolidation purposes; (b) in any accounting period, exchange gains or losses arising on foreign currency borrowings may be offset only to the extent of the exchange differences arising on the net investments in foreign enterprises; (c) the foreign currency borrowings, whose exchange gains or losses are used in the offset process, should not exceed, in the aggregate, the total amount of cash that the net investments are expected to be able to generate, whether from profits or otherwise; and (d) the accounting treatment adopted should be applied consistently from period to period. 32 Where the provisions of paragraph 29 have been applied in the investing company's financial statements to a foreign equity investment which is neither a subsidiary nor an associated company, the same offset procedure may be applied in the consolidated financial statements. PART 2 - DEFINITION OF TERMS 33 Financial statements are balance sheets, profit and loss accounts, statements of source and application of funds, notes and other statements, which collectively are intended to give a true and fair view of the financial position and profit or loss. 34 Company includes any enterprise which comes within the scope of statements of standard accounting practice. 35 An exempt company is one which: (a) is registered in Great Britain and does not prepare its accounts in accordance with either Sections 149 and 152 of the Companies Act 1948; or (b) is registered in Northern Ireland and is exempted from full disclosure by Part 3 of Schedule 6A to the Companies Act (Northern Ireland) 1960 as amended by the Companies (Northern Ireland) Order 1982; or

11 SSAP (c) is registered in the Republic of Ireland and is exempted from full disclosure by Part 3 of Schedule 6 to the Companies Act A foreign enterprise is a subsidiary, associated company or branch whose operations are based in a country other than that of the investing company or whose assets and liabilities are denominated mainly in a foreign currency. 37 A foreign branch is either a legally constituted enterprise located overseas or a group of assets and liabilities which are accounted for in foreign currencies. 38 Translation is the process whereby financial data denominated in one currency are expressed in terms of another currency. It includes both the expression of individual transactions in terms of another currency and the expression of a complete set of financial statements prepared in one currency in terms of another currency. 39 A company's local currency is the currency of the primary economic environment in which it operates and generates net cash flows. 40 An exchange rate is a rate at which two currencies may be exchanged for each other at a particular point in time; different rates apply for spot and forward transactions. 41 The closing rate is the exchange rate for spot transactions ruling at the balance sheet date and is the mean of the buying and selling rates at the close of business on the day for which the rate is to be ascertained. 42 A forward contract is an agreement to exchange different currencies at a specified future date and at a specified rate. The difference between the spec~fied rate and the spot rate ruling on the date the contract was entered into is the discount or premium on the forward contract. 43 The net investment which a company has in a foreign enterprise is its effective equity stake and comprises its proportion of such foreign enterprise's net assets; in appropriate circumstances, intragroup loans and other deferred balances may be regarded as part ~f the effective equity stake.

12 170 Appendix 1 44 Monetary items are money held and amounts to be received or paid in money and, where a company is not an exempt company, should be categorised as either short-term or long-term. Short-term monetary items are those which fall due within one year of the balance sheet date. PART 3- STANDARD ACCOUNTING PRACTICE 45 When preparing the financial statements of an individual company the procedures set out in paragraphs 46 to 51 should be followed. When preparing consolidated financial statements, the procedures set out in paragraphs 52 to 58 should be followed. Individual companies 46 Subject to the provisions of paragraphs 48 and 51 each asset, liability, revenue or cost arising from a transaction denominated in a foreign currency should be translated into the local currency at the exchange rate in operation on the date on which the transaction occurred; if the rates do not fluctuate significantly, an average rate for a period may be used as an approximation. Where the transaction is to be settled at a contracted rate, that rate should be used. Where a trading transaction is covered by a related or matching forward contract, the rate of exchange specified in that contract may be used. 4 7 Subject to the special provisions of paragraph 51, which relate to the treatment of foreign equity investments financed by foreign currency borrowings, no subsequent translations should normally be made once non-monetary assets have been translated and recorded. 48 At each balance sheet date, monetary assets and liabilities denominated in a foreign currency should be translated by using the closing rate or, where appropriate, the rates of exchange fixed under the terms of the relevant transactions. Where there are related or matching forward contracts in respect of trading transactions, the rates of exchange specified in those contracts may be used.

13 SSAP All exchange gains or losses on settled transactions and unsettled short-term monetary items should be reported as part of the profit or loss for the year from ordinary activities (unless they result from transactions which themselves would fall to be treated as extraordinary items, in which case the exchange gains or losses should be included as part of such items). 50 Exchange gains and losses on long-term monetary items should also be recognised in the profit and loss account; however, it is necessary to consider on the grounds of prudence whether, in the exceptional cases outlined in paragraph 11, the amount of the gain, or the amount by which exchange gains exceed past exchange losses on the same items to be recognised in the profit and loss account, should be restricted. 51 Where a company has used foreign currency borrowings to finance, or provide a hedge against, its foreign equity investments and the conditions set out in this paragraph apply, the equity investments may be denominated in the appropriate foreign currencies and the carrying amounts translated at the end of each accounting period at closing rates for inclusion in the investing company's financial statements. Where investments are treated in this way, any exchange differences arising should be taken to reserves and the exchange gains or losses on the foreign currency borrowings should then be offset, as a reserve movement, against these exchange differences. The conditions which must apply are as follows: (a) in any accounting period, exchange gains or losses arising on the borrowings may be offset only to the extent of exchange differences arising on the equity investments; (b) the foreign currency borrowings, whose exchange gains or losses are used in the offset process, should not exceed, in the aggregate, the total amount of cash that the investments are expected to be able to generate, whether from profits or otherwise; and (c) the accounting treatment adopted should be applied consistently from period to period. Consolidated financial statements 52 When preparing group accounts for a company and its foreign

14 172 Appendix I enterprises, which includes the incorporation of the results of associated companies or foreign branches into those of an investing company, the closing rate/net investment method of translating the local currency financial statements should normally be used. 53 Exchange differences arising from the retranslation of the opening net investment in a foreign enterprise at the closing rate should be recorded as a movement on reserves. 54 The profit and loss account of a foreign enterprise accounted for under the closing rate/net investment method should be translated at the closing rate or at an average rate for the period. Where an average rate is used, the difference between the profit and loss account translated at an average rate and at the closing rate should be recorded as a movement on reserves. The average rate used should be calculated by the method considered most appropriate for the circumstances of the foreign enterprise. 55 In those circumstances where the trade of the foreign enterprise is more dependent on the economic environment of the investing company's currency than that of its own reporting currency, the temporal method should be used. 56 The method used for translating the financial statements of each foreign enterprise should be applied consistently from period to period unless its financial and other operational relationships with the investing company change. 57 Where foreign currency borrowings have been used to finance, or provide a hedge against, group equity investments in foreign enterprises, exchange gains or losses on the borrowings, which would otherwise have been taken to the profit and loss account, may be offset as reserve movements against exchange differences arising on the retranslation of the net investments provided that: (a) the relationships between the investing company and the foreign enterprises concerned justify the use of the closing rate method for consolidation purposes; (b) in any accounting period, the exchange gains and losses arising on foreign currency borrowings are offset only to the extent of the exchange differences arising on the net investments in foreign enterprises;

15 SSAP (c) the foreign currency borrowings, whose exchange gains or losses are used in the offset process, should not exceed, in the aggregate, the total amount of cash that the net investments are expected to be able to generate, whether from profits or otherwise; and (d) the accounting treatment is applied consistently from period to period. 58 Where the provisions of paragraph 51 have been applied in the investing company's financial statements to a foreign equity investment which is neither a subsidiary nor an associated company, the same offset procedure may be applied in the consolidated financial statements. Disclosure 59 The methods used in the translation of the financial statements of foreign enterprises and the treatment accorded to exchange differences should be disclosed in the financial statements. 60 The following information should also be disclosed in the financial statements: (a) for all companies, or groups of companies, which are not exempt companies, the net amount of exchange gains and losses on foreign currency borrowings less deposits, identifying separately: (i) the amount offset in reserves under the provisions of paragraphs 51, 57 and 58; and (ii) the net amount charged/credited to the profit and loss account; (b) for all companies, or groups of companies, the net movement on reserves arising from exchange differences. Date from which effective 61 The accounting and disclosure requirements set out in this statement should be adopted as soon as possible. They should be regarded as standard in respect of financial statements relating to accounting periods beginning on or after 1 April 1983.

16 174 Appendix I PART 4- LEGAL REQUIREMENTS IN UK AND IRELAND 62. Paragraphs 63 to 69 below apply to companies preparing accounts in compliance with Sections 149 and 152 of the Companies Act 1948 or with Sections 143 and 146 of the Companies Act (Northern Ireland) The references to the Schedule which follow are to Schedule 8 to the Companies Act 1948 (as inserted by Section 1 of the Companies Act 1981). References to the Schedule will also be to Schedule 6 to the Companies Act (Northern Ireland) 1960, as inserted by Article 3 of the Companies (Northern Ireland) Order 1982, when this is brought into operation on 1 July Paragraph 12 of the Schedule requires that the amount of any item shall be determined on a prudent basis and, in particular, that only profits realised at the balance sheet date shall be included in the profit and loss account. (Paragraph 90 of the Schedule defines realised profits in relation to a company's accounts as 'such profits of the company as fall to be treated as realised profits for the purposes of those accounts in accordance with principles generally accepted with respect to the determination for accounting purposes of realised profits at the time when those accounts are prepared'.) 64 Paragraph 15 of the Schedule permits a departure from paragraph 12 of the Schedule if it appears to the directors that there are special reasons for such a departure. Particulars of any departure, the reasons for it and its effect must be given in a note to the accounts. 65 For companies other than exempt companies, all exchange gains taken through the profit and loss account, other than those arising on unsettled long-term monetary items, are realised. For such companies the application of paragraph 50 of this statement may result in unrealised exchange gains on unsettled long-term monetary items being taken to the profit and loss account. In this statement the need to show a true and fair view of results, referred to in paragraph 10 above, is considered to constitute a special reason for departure from the principle under paragraph 15 of the Schedule. 66 This statement is based on the assumption that the process of translation at closing rates for the purposes of this statement does

17 SSAP not constitute a departure from the historical cost rules under Section C of the Schedule nor does it give rise to a diminution in value of an asset under Section B of the Schedule. 67 Paragraph 58 (1) of the Schedule requires that, where sums originally denominated in foreign currencies are brought into the balance sheet or profit and loss account, the basis on which those sums have been translated into sterling shall be stated. 68 Part I of the Schedule lays down the choice of formats permitted for the presentation of accounts. Distinction is drawn between operating and other income and expense. For this reason it is necessary to consider the nature of each foreign exchange gain or loss and to allocate each accordingly. Gains or losses arising from trading transactions should normally be included under 'Other operating income or expense' while those arising from arrangements which may be considered as financing should be disclosed separately as part of 'Other interest receivable/payable and similar income/expense'. Exchange gains or losses which arise from events which themselves fall to be treated as extraordinary items should be included as part of such items. 69 Paragraph 46 of the Schedule requires the following information to be disclosed about movements on any reserve: (a) the amount of the reserve at the date of the beginning of the financial year and as at the balance sheet date respectively; (b) any amounts transferred to or from the reserve during that year; and (c) the source and application respectively of any amounts so transferred. 70 Paragraphs 1 and 2 of Schedule 2 to the Companies Act 1981 permit certain companies to prepare accounts in compliance with Sections 149A and 152A of and Schedule 8A to the Companies Act 1948 instead of Sections 149 and 152 and Schedule 8. Paragraph 11 (9) of Schedule 8A requires disclosure of the basis on which foreign currencies have been converted into sterling. Schedule 2 to the Companies (Northern Ireland) Order 1982 will permit similar companies registered in Northern Ireland to prepare accounts in accordance with Sections 143A and 146A of and Schedule 6A to the Companies Act (Northern Ireland) 1960 which require the same disclosure.

18 176 Appendix 1 71 Similar legal requirements are expected to be enacted in the Republic of Ireland. PART 5- COMPLIANCE WITH INTERNATIONAL ACCOUNTING STANDARD NO. 21 'ACCOUNTING FOR THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES' 72 Compliance with the requirements of Statement of Standard Accounting Practice, No. 20 'Foreign currency translation' will automatically ensure compliance with International Accounting Standard, No. 21 'Accounting for the effects of changes in foreign exchange rates'.

19 Appendix 2: Statement of Financial Accounting Standards No. 52:* Foreign Currency Translation Contents Introduction Standards of Financial Accounting and Reporting: Objectives of translation The functional currency The functional currency in highly inflationary economies Translation of foreign currency statements Foreign currency transactions Forward exchange contracts Transaction gains and losses to be excluded from determination of net income Income tax consequences of rate changes Elimination of intercompany profits Exchange rates Use of averages or other m6thods of approximation Disclosure Effective date and transition paragraph December Copyright by Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut, 06905, USA. Reprinted with permission. Copies of the complete document are available from the FASB. 177

20 178 Appendix 2 Appendix A: Determination of the Functional Currency Appendix B: Remeasurement of the Books of Record into the Functional Currency Appendix C: Basis for Conclusions Appendix D: Background Information Appendix E: Glossary INTRODUCTION FASB Statement No. 8, Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements, was issued in October 1975 and was effective for fiscal years that began on or after 1 January In May 1978, the Board issued an invitation for public comment on Statements 1-12, each of which had been in effect for at least two years. Foreign currency translation* was the subject of most of the comments received. In January 1979, the Board added to its agenda a project to reconsider Statement 8. This Statement is the result of that project. 2 This Statement establishes revised standards of financial accounting and reporting for foreign currency transactions in financial statements of a reporting enterprise (hereinafter, enterprise). It also revises the standards for translating foreign currency financial statements (hereinafter, foreign currency statements) that are incorporated in the financial statements of an enterprise by consolidation, combination, or the equity method of accounting. Translation of financial statements from one currency to another for purposes other than consolidation, combination, or the equity method is beyond the scope of this Statement. For example, this Statement does not cover translation of the financial statements of an enterprise from its reporting currency into another currency for the convenience of readers accustomed to that other currency. 3 This Statement supersedes F ASB Statement No. 8, Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements, t FASB Statement No. 20, Accounting for Terms defined in the glossary (Appendix E) are in boldface type the first time they appear in this Statement. t The following pronouncements, which are superseded or amended by Statement 8, are also superseded or amended by this Statement: paragraphs 7 and of Chapter 12, 'Foreign Operations and Foreign Exchange', of ARB No. 43;

21 FAS Forward Exchange Contracts, FASB Interpretation No. 15, Translation of Unamortized Policy Acquisition Costs by a Stock Life Insurance Company, and FASB Interpretation No. 17, Applying the Lower of Cost or Market Rule in Translated Financial Statements. STANDARDS OF FINANCIAL ACCOUNTING AND REPORTING Objectives of translation 4 Financial statements are intended to present information in financial terms about the performance, financial position, and cash flows of an enterprise. For this purpose, the financial statements of separate entities within an enterprise, which may exist and operate in different economic and currency environments, are consolidated and presented as though they were the financial statements of a single enterprise. Because it is not possible to combine, add, or subtract measurements expressed in different currencies, it is necessary to translate into a single reporting currencyt those assets, liabilities, revenues, expenses, gains, and losses that are measured or denominated in a foreign currency. However, the unity presented by such translation does not paragraph 18 of APB Opinion No.6, Status of Accounting Research Bulletins; and FASB Statement No. 1, Disclosure of Foreign Currency Translation Information. The last sentence of paragraph 5 of ARB 43, Chapter 12, is amended to delete 'and they should be reserved against to the extent that their realization in dollars appears to be doubtful', and paragraph 13 of APB Opinion No. 22, Disclosure of Accounting Policies, is amended to delete 'translation of foreign currencies' as an example of disclosure 'commonly required with respect to accounting policies'. t For convenience, this Statement assumes that the enterprise uses the US dollar (dollar) as its reporting currency. However, a currency other than the dollar may be the reporting currency in financial statements that are prepared in conformity with US generally accepted accounting principles. For example, a foreign enterprise may report in its local currency in conformity with US generally accepted accounting principles. If so, the requirements of this Statement apply. To measure in foreign currency is to quantify an attribute of an item in a unit of currency other than the reporting currency. Assets and liabilities are denominated in a foreign currency if their amounts are fixed in terms of that foreign currency regardless of exchange rate changes. An asset or liability may be both measured and denominated in one currency, or it may be measured in one currency and denominated in another. To illustrate: two foreign branches of a US company, one Swiss and one German, purchase identical assets on credit from a Swiss vendor at identical prices stated in Swiss francs. The German branch measures the cost (an attribute) of that asset in German marks. Although the corresponding liability is also measured in marks, it remains denominated in Swiss francs since the liability must be settled in a specified number of Swiss francs. The Swiss branch measures the asset and liability in Swiss francs. Its liability is both measured and denominated in Swiss

22 180 Appendix 2 alter the underlying significance of the results and relationships of the constituent parts of the enterprise. It is only through the effective operation of its constituent parts that the enterprise as a whole is able to achieve its purpose. Accordingly, the translation of the financial statements of each component entity of an enterprise should accomplish the following objectives: (a) Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise's cash flows and equity. (b) Reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with US generally accepted accounting principles. The functional currency 5 The assets, liabilities, and operations of a foreign entity shall be measured using the functional currency of that entity. An entity's functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment in which an entity primarily generates and expends cash. Appendix A provides guidance for determination of the functional currency. The economic factors cited in Appendix A, and possibly others, should be considered both individually and collectively when determining the functional currency. 6 For an entity with operations that are relatively self-contained and integrated within a particular country, the functional currency generally would be the currency of that country. However, a foreign entity's functional currency might not be the currency of the country in which the entity is located. For example, the parent's currency generally would be the functional currency for foreign operations that are a direct and integral component or extension of the parent company's operations. 7 An entity might have more than one distinct and separable operation, such as a division or branch, in which case each operation may be considered a separate entity. If those operations are conducted in different economic environments, they might have different functional currencies. francs. Although assets and liabilities can be measured in various currencies, rights to receive or obligations to pay fixed amounts of a currency are, by definition, denominated in that currency.

23 FAS The functional currency (or currencies) of an entity is basically a matter of fact, but in some instances the observable facts will not clearly identify a single functional currency. For example, if a foreign entity conducts significant amounts of business in two or more currencies, the functional currency might not be clearly identifiable. In those instances, the economic facts and circumstances pertaining to a particular foreign operation shall be assessed in relation to the Board's stated objectives for foreign currency translatiof! (paragraph 4). Management's judgement will be required to determine the functional currency in which financial results and relationships are measured with the greatest degree of relevance and reliability. 9 Once the functional currency for a foreign entity is determined, that determination shall be used consistently unless significant changes in economic facts and circumstances indicate clearly that the functional currency has changed. Previously issued financial statements shall not be restated for any change in the functional currency. 10 If an entity's books of record are not maintained in its functional currency, remeasurement into the functional currency is required. That remeasurement is required before translation into the reporting currency. If a foreign entity's functional currency is the reporting currency, remeasurement into the reporting currency obviates translation. The remeasurement process is intended to produce the same result as if the entity's books of record had been maintained in the functional currency. The remeasurement of and subsequent accounting for transactions denominated in a currency other than the functional currency shall be in accordance with the requirements of this Statement (paragraphs 15 and 16}. Appendix B provides guidance for remeasurement into the functional currency. The functional currency in highly indationary economies 11 The financial statements of a foreign entity in a highly inflationary economy shall be remeasured as if the functional currency were the reporting currency. Accordingly, the financial statements of those entities shall be remeasured into the reporting currency according to the requirements of paragraph 10. For the purposes of this requirement, a highly inflationary economy is one that has cumulative inflation of approximately 100 per cent or more over a 3-year period. Translation of foreign currency statements 12 All elements of financial statements shall be translated by using a current exchange rate. For assets and liabilities, the exchange rate at

24 182 Appendix 2 the balance sheet date shall be used. For revenues, expenses, gains, and losses, the exchange rate at the dates on which those elements are recognised shall be used. Because translation at the exchange rates at the dates the numerous revenues, expenses, gains, and losses are recognised is generally impractical, an appropriately weighted average exchange rate for the period may be used to translate those elements. 13 If an entity's functional currency is a foreign currency, translation adjustments result from the process of translating that entity's financial statements into the reporting currency. Translation adjustments shall not be included in determining net income but shall be reported separately and accumulated in a separate component of equity. 14 Upon sale or upon complete or substantially complete liquidation of an investment in a foreign entity, the amount attributable to that entity and accumulated in the translation adjustment component of equity shall be removed from the separate component of equity and shall be reported as part of the gain or loss on sale or liquidation of the investment for the period during which the sale or liquidation occurs. Foreign currency transactions 15 Foreign currency transactions are transactions denominated in a currency other than the entity's functional currency. Foreign currency transactions may produce receivables or payables that are fixed in terms of the amount of foreign currency that will be received or paid. A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally shall be included in determining net income for the period in which the exchange rate changes. Likewise, a transaction gain or loss (measured from the transaction date or the most recent intervening balance sheet date, whichever is later) realised upon settlement of a foreign currency transaction generally shall be included in determining net income for the period in which the transaction is settled. The exceptions to this requirement for inclusion in net income of transaction gains and losses are set forth in paragraphs 20 and 21 and pertain to certain intercompany transactions and to transactions that are designated as, and effective as, economic hedges of net investments and foreign currency commitments. 16 For other than forward exchange contracts (paragraphs 17-19), the

25 FAS following shall apply to all foreign currency transactions of an enterprise and its investees: (a) At the date the transaction is recognised, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be measured and recorded in the functional currency of the recording entity by use of the exchange rate in effect at that date (paragraphs ). (b) At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of the recording entity shall be adjusted to reflect the current exchange rate. Forward exchange contracts 17 A forward exchange contract (forward contract) is an agreement to exchange different currencies at a specified future date and at a specified rate (the forward rate). A forward contract is a foreign currency transaction. A gain or loss on a forward contract that does not meet the conditions described in paragraph 20 or 21 shall be included in determining net income in accordance with the requirements for other foreign currency transactions (paragraph 15). Agreements that are, in substance, essentially the same as forward contracts, for example, currency swaps, shall be accounted for in a manner similar to the accounting for forward contracts. 18 A gain or loss (whether or not deferred) on a forward contract, except a forward contract of the type discussed in paragraph 19, shall be computed by multiplying the foreign currency amount of the forward contract by the difference between the spot rate at the balance sheet date and the spot rate at the date of inception of the forward contract (or the spot rate last used to measure a gain or loss on that contract for an earlier period). The discount or premium on a forward contract (that is, the foreign currency amount of the contract multiplied by the difference between the contracted forward rate and the spot rate at the date of inception of the contract) shall be accounted for separately from the gain or loss on the contract and shall be included in determining net income over the life ofthe forward contract. However, if a gain or loss is deferred under paragraph 21, the forward contract's discount or premium that relates to the commitment period may be included in the measurement of the basis of the related foreign currency transaction when recorded. If a gain or loss is accounted for as a hedge of a net investment under paragraph 20, the forward contract's discount or premium may be included with translation adjustments in the separate component of equity.