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SIC-11, which outlined restricted circumstances in which such exchange differences may be capitalised, has been superseded since capitalisation of such exchange differences is no longer permitted in any circumstances (IAS 21 Paragraph IN10).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.

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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.

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