Tuesday, April 26, 2011

Capitalisation of Exchange Differences, permissible or not ?

IAS 21, The Effect of Changes in Foreign Exchange Rates requires recognition of foreign exchange differences as income or expense in the period in which they arise.

Previously, there had been an allowed alternative treatment for certain losses incurred due to effects of exchange rate changes in foreign-denominated obligations associated with asset acquisition. This allowed alternative treatment resulted in capitalization of the loss.

Revised IAS 21 removes the limited option in the previous version of IAS 21 to capitalise exchange differences resulting from a severe devaluation or depreciation of a currency against which there is no means of hedging. Under IAS 21, such exchange differences are now recognised in profit or loss. Consequently, SIC-11, which outlined restricted circumstances in which such exchange differences may be capitalised, has been superseded since capitalisation of such exchange differences is no longer permitted in any circumstances (IAS 21 Paragraph IN10).

Following are further explanation to removed the previously allowed alternative treatment of capitalisation of exchange differences as stated in Basic for Conclusions on IAS 21 :

BC24 - The previous version of IAS 21 allowed a limited choice of accounting for exchange differences that arise ‘from a severe devaluation or depreciation of a currency against which there is no practical means of hedging and that effects liabilities which cannot be settled and which arise directly on the recent acquisition of an asset’. The benchmark treatment was to recognise such exchange differences in profit or loss. The allowed alternative was to recognise them as an asset.

BC25 – The Board noted that the allowed alternative (of recognition as an asset) was not in accordance with the Framework for the Preparation and Presentation of Financial Statements because exchange losses do not meet the definition of an asset. Moreover, recognition of exchange losses as an asset is neither allowed nor required by any liaison standard-setter, so its deletion would improve convergence. Finally, in many cases when the conditions for recognition as an asset are met, the asset would be restated in accordance with IAS 29 Financial Reporting in Hyperinflationary Economies. Thus, to the extent that an exchange loss reflects hyperinflation, this effect is taken into account by IAS 29. For all of these reasons, the Board removed the allowed alternative treatment and the related SIC Interpretation is superseded.


According to IAS 23, Borrowing Costs, an entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. Borrowing costs may include exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

The above image was taken from : Microsoft Office Website

Monday, April 25, 2011

The Concept of Significant Influence

Based on IAS 24 : Related Party Disclosures, entities are considered to be related parties when one of them either :

  1. has the ability to control the other entity
  2. can exercise significant influence over the other entity in making financial and operating decisions
  3. has joint control over the other
  4. is a joint venture in which the other entity is a joint venturer
  5. functions as key management personnel of the other entity
  6. is a close family member of any individual having the ability to control or influence the entity or is a key management member thereof

Significant Influence

The existence of the ability to exercise significant influence is an important concept in relation to this standard. It is one of the two criteria stipulated in the definition of a related party, which when present would, for the purposes of this standard, make one party related to another. In other words, for the purposes of this standard, if one party is considered to have the ability to exercise significant influence over another, then the two parties are considered to be related.

The existence of the ability to exercise significant influence may be evidenced in one or more of the following ways :

  1. By representation on the board of directors of the other entity;
  2. By participation in the policy-making process of the other entity;
  3. By having material intercompany transactions between two entities;
  4. By interchange of managerial personnel between two entities; or
  5. By dependence on another entity for technical information

Significant influence may be gained through agreement, by statute, or by means of share ownership. Under the provisions of IAS 24, similar to the presumption of significant influence under IAS 28, an entity is deemed to possess the ability to exercise significant influence if it directly or indirectly through subsidiaries  holds 20% or more of the voting power of another entity (unless it can be clearly demonstrated that despite holding such voting power the investor does not have the ability to exercise significant influence over the investee).

Conversely, if an entity, directly or indirectly through subsidiaries, owns less than 20% of the voting power of another entity, it is presumed that the investor does not possess the ability to exercise significant influence (unless it can be clearly demonstrated that the investor does have such an ability despite holding less than 20% of the voting power).

Further, while explaining the concept of significant influence, IAS 28 also clarifies that “a substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence” (emphasis added).

Source of this article : WILEY – 2010 Interpretation and Application of International Financial Reporting Standards, by Barry J.Epstein and Eva K.Jermakowicz

Purpose of Related Party Disclosures

IAS 24 : Related Party Disclosures defines a related party as a person or entity that is related to the entity that is preparing its financial statements (reporting entity).

(a) A person or a close member of that person’s family is related to a reporting entity if that person :

  1. has control or joint control over the reporting entity;
  2. has significant influence over the reporting entity; or
  3. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity

(b) An entity is related to a reporting entity if any of the following conditions applies:

  1. The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others)
  2. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member)
  3. Both entities are joint ventures of the same third party
  4. One entity is a joint venture of a third entity and the other entity is an associate of the third entity
  5. The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity
  6. The entity is controlled or jointly controlled by a person identified in (a)
  7. A person identified in (a)(1) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).

Related party relationships are a normal feature of commerce and business. For example, entities frequently carry on parts of their activities through subsidiaries, joint ventures and associates. In those circumstances, the entity has the ability to affect the financial and operating policies of the investee through the presence of control, joint control or significant influence.

A related party relationship could have an effect on the profit or loss and financial position of an entity. Related parties may enter into transactions that unrelated parties would not. For example, an entity that sells goods to its parent at cost might not sell on those terms to another customer. Also, transactions between related parties may not be made at the same amounts as between unrelated parties.

The profit or loss and financial position of an entity may be affected by a related party relationship even if related party transactions do not occur. The mere existence of the relationship may be sufficient to affect the transactions of the entity with other parties. For example, a subsidiary may terminate relations with a trading partner on acquisition by the parent of a fellow subsidiary engaged in the same activity as the former trading partner. Alternatively, one party may refrain from acting because of the significant influence of another – for example, a subsidiary may be instructed by its parent not to engage in research and development.

For these reasons, knowledge of an entity’s transactions, outstanding balances, including commitments, and relationships with related parties may affect assessments of its operations by users of financial statements, including assessments of the risks and opportunities facing the entity (Hrd).

Thursday, April 21, 2011

The latest update of Financial Instruments, Insurance Contracts, Leases and Revenue Recognition discussions

Following is the report from IASB latest meeting on 12 April to 15 April, 2011 which was dropped into my inbox mail on April 20, 2011.

The IASB met in London from Tuesday 12 April to Friday 15 April. The sessions on Tuesday and Wednesday and on Thursday morning were held jointly with the US-based FASB.

The joint discussions focused on four projects: revenue recognition, leases, insurance contracts, and impairment of financial assets. The IASB-only sessions focused on hedge accounting (which the FASB joined by video) and an update of activities of the IFRS Interpretations Committee.

The boards discussed uncertain consideration in relation to revenue recognition and leases. The revenue recognition sessions also focused on allocating the transaction price, licences and rights to use, fulfilment costs, and sale and repurchase agreements. The leases sessions also focused on the definition of a lease and whether there should be one or two accounting approaches for leases.

The session on insurance focused on the use of a 'top-down approach' to determine a discount rate.

The impairment sessions included consideration of feedback from the outreach activities and comment letters on the joint supplementary document Financial Instruments: Impairment, interest income recognition and the definition of amortised cost and whether to discount a loss estimate.

In the sessions on hedge accounting the IASB began its redeliberations on the exposure draft Hedge Accounting and discussed the objective of hedge accounting and accounting for 'funding swaps', designating risk components of financial instruments that bear interest below a benchmark rate (the 'sub-LIBOR' issue), the eligibility of non-derivative financial instruments as hedging instruments (including the interaction with the fair value option) and macro hedge accounting.

During board week Sir David Tweedie, Chairman of the IASB, and Leslie Seidman, Chairman of the FASB, recorded an interview in which they review the achievements of the convergence programme so far and the time line for completing the remaining elements of the programme. To listen to the interview and read a transcript, please click here : Interview with Sir David Tweedie and Leslie Seidman regarding the timeline for completing the convergence programme

The topics discussed at the joint IASB/FASB board meeting were:

  • Financial instruments: impairment
  • Insurance contracts
  • Leases
  • Revenue recognition

The topics discussed at the IASB Board meeting were:

  • Financial instruments: hedge accounting
  • IFRS Interpretations Committee - update from last meeting