Foreign Currency Translation – IAS 21 & ASPE

Functional vs. Presentation Currency

• Functional currency (IAS 21 definition): currency of the primary economic environment in which the entity operates.

• Presentation currency: currency in which the reporting entity presents its financial statements (assumed Canadian dollar, CAD).

• Objective of translation: present foreign operation’s results in a way that best reflects the parent’s exposure to exchange-rate changes.

Primary Factors for Determining Functional Currency

• Currency influencing sales prices for goods/services.

• Currency of country whose competitive forces & regulations determine sale prices.

• Currency mainly influencing input costs (labour, materials).

Additional / Secondary Factors

• Currency in which funds/receipts are generated from financing activities.

• Currency in which funds/receipts are retained from operating activities.

• If primary factors are inconclusive, consider:
  • Whether the foreign operation acts as an extension of the parent.
  • Proportion of transactions with the parent (high vs. low).
  • Whether cash flows of the foreign operation directly affect or are readily available to the parent.
  • Ability of foreign operation’s cash flows to service its own debt without parent subsidy.

Integrated vs. Self-Sustaining Operations (IAS 21)

• Integrated (temporal) operation: foreign unit functions as extension of parent; exposure primarily through individual monetary items.

• Self-sustaining (current rate) operation: foreign unit operates autonomously; exposure through net investment.

• Translation summary:
  • Revenue & most expenses – Integrated: average rate of period; Self-sustaining: average rate.
  • Depreciation/amortization – Integrated: rate on date of acquisition of related asset; Self-sustaining: average rate.
  • Cost of goods sold – Integrated: calculated (opening inv. at closing translated balance of prior period + purchases at avg. rate – ending inv. at closing rate); Self-sustaining: average rate.
  • Inventory – Integrated: ending inventory at historical rate (often average of last month); Self-sustaining: closing rate at B/S date.
  • Monetary assets & liabilities – Integrated: closing rate; Self-sustaining: closing rate.
  • Non-monetary assets/liabilities (historical cost) – Integrated: historical rate (later of parent’s investment date or transaction date)*; Self-sustaining: closing rate.
  • Non-monetary assets/liabilities (fair value) – Integrated: rate on revaluation date; Self-sustaining: rate on revaluation date.
  • Shares – both: rate on purchase date.
  • Retained earnings – both: calculated.
  • Dividends – both: rate on declaration date.
  • Foreign exchange gain/loss – Integrated: recognised in net income; Self-sustaining: recognised in OCI.

ASPE (Section 1651) Differences

• Terminology:
  • Integrated foreign operation ⇒ temporal method.
  • Self-sustaining foreign operation ⇒ current rate method.

• No OCI concept:
  • Self-sustaining: FX gains/losses → separate component of shareholders’ equity.
  • Integrated: FX gains/losses → net income.

• Otherwise, measurement bases parallel IFRS.

Example – Determining Functional Currency

Scenario: ‘Foreign Co.’ (Malaysia) manufactures rubber hoses; parent ‘Canadian Co.’ in Canada.

• Sales distribution: (25\%) Australia, (25\%) USA, (50\%) Canada (to parent).

• Input profile: rubber grown in Malaysia; (95\%) labour Malaysian; (5\%) management on Canadian secondment.

• Financing: initial & ongoing advances from parent in CAD.

• Planned cash-flow use: eventual profit repatriation to parent.

Assessment of factors

1. Primary factors
   • Sales-price influence: international – inconclusive.
   • Competitive forces/regulation: (50\%) of sales to parent – points to CAD.
   • Input costs: predominantly Malaysian – points to ringgit (MYR).
   ⇒ No decisive answer.

2. Additional factors
   • Financing currency: CAD.
   • Retention of operating cash: intended repayment to parent (CAD).
   • High proportion of transactions with parent.
   • Cash flows likely to affect parent directly.

Conclusion: Weighing additional factors ⇒ functional currency is CAD (same as parent).

Practical / Ethical / Conceptual Implications

• Proper functional-currency determination ensures faithful representation of risk exposure; misclassification distorts reported performance & could mislead stakeholders.

• Choice affects location of FX gains/losses (net income vs. OCI vs. equity), hence EPS volatility and management incentive structures.

• For multi-currency groups, consistent application across subsidiaries is essential to uphold comparability and transparency.

Quick Reference – Rate Selection Cheatsheet

• Average rate (\bar{R}): use for revenue & expenses in both methods unless specific rule overrides.

• Historical rate (R_{\text{hist}}): non-monetary items (integrated) & share capital.

• Closing rate (R_{\text{cl}}): monetary items & entire balance sheet for self-sustaining ops.

• Revaluation date rate (R_{\text{rev}}): fair-value assets/liabilities.

• Declaration-date rate (R_{\text{div}}): dividends.

Historical rate for integrated subsidiaries equals rate on the later of the parent’s investment date or the original transaction date.