Section 30: Foreign Currency Translation
Section 30 applies to foreign currency transactions and foreign operations in the financial statements of an entity. It also prescribes the translation of financial statements into a presentation currency.
What is new?
Section 30 does not allow for the use of a contracted rate or forward contract rate when translating monetary assets at the reporting date. Instead a forward contract needs to be fair valued under FRS 102. In contrast old GAAP allowed a forward contract rate to be used and did not require forward contracts to be fair valued.
Section 30 requires the transaction rate/average rate to be used when translating the profit and loss account of a foreign operation whereas under old GAAP it allowed either the closing or average rate to be used. Where the closing rate was used a transition adjustment will be required.
Old GAAP allowed long term loans to a subsidiary to be included in the investment value and therefore treated as a non-monetary asset. This treatment is not permitted under Section 30; instead such loans have to be retranslated to the year-end spot rate. Therefore an adjustment will be required on transition to FRS 102 which may result in deferred tax being recognised for tax which may be payable/refundable as part of transition adjustments in the tax computation going forward.
On consolidation of a foreign operation, goodwill is treated as an asset of the foreign operation and retranslated to the year-end rate whereas under SSAP 20, there was no explicit comment on this.
What is different?
The term functional currency is used in FRS 102, whereas old GAAP (SSAP 20) used the term local currency. Section 30 gives more detailed guidance when determining functional currency which may result in a different functional currency being determined under FRS 102, particularly where an entity is a foreign operation as under Section 30 we need to look to the parent/subsidiary entity if the functional currency cannot be determined from the primary indicators.
There is no concept of presentational currency in old GAAP whereas under Section 30, entities can choose to select its presentational currency.
Under old GAAP, for foreign equity investments which were financed by foreign currency borrowings, there was a special provision allowing an entity to retranslate the equity investment at the closing rate and the exchange difference was posted to the STRGL which was set against the exchange difference on retranslation of the foreign borrowing which was also posted to the STRGL.
No such special provision is contained in Section 30 unless it meets the requirements of a fair value hedge. This will result in volatility in the profit and loss as the loan will be retranslated at the year-end rate and the investment will not be retranslated.
Other standards affecting Section 30 where differences arise:
Section 29 – Income tax – Possible need for deferred tax to be recognised on transition to FRS 102 e.g. on retranslation of long term loans to the spot rate which had previously been carried at the transaction rate.
What are the key points?
Functional currency is the currency of the primary economic environment in which an entity operates (Section 30.3). Its functional currency is usually the currency that mainly influences its sales prices and costs, although financing activities and the currency in which receipts from operating activities may also be relevant.
The presentation currency is a matter of free choice.
On initial recognition, foreign currency transactions are recognised in the functional currency using the spot exchange rate at the date of the transaction.
At the end of each reporting period:
- Non-monetary items carried at historical cost continue to be measured using the exchange rate at the date of the transaction;
- and non-monetary items measured at fair value are measured using the exchange rate on the date when fair value was determined.
In the consolidated financial statements, exchange differences arising on a monetary item that forms part of the net investment in a foreign operation is recognised in other comprehensive income and reported as a component of equity. Such exchange differences are not reclassified to profit or loss on disposal of the net investment.
Use of forward contract rates is not allowed.
The balance sheet for foreign operations should be retranslated at year end spot rate and the profit and loss should be retranslated to the average/transaction date with the exchange difference posted to a separate component in equity.
A change in functional currency is applied prospectively (assuming there was no prior year error) and the rate used is the rate at the date of the change.
What do accountants need to do?
Be aware of the differences between Section 30 and old GAAP.
Review the client portfolio to identify companies who use contracted rates to translate year end balances under old GAAP and advise those companies of the changes and the volatility this may cause to the profit for those companies. It will also require an adjustment on transition to recognise the forward contracts at fair value and the related deferred tax and the recognition of monetary assets at the year-end rate as opposed to the contracted rate (consider deferred tax adjustment also).
Review the client portfolio to identify group companies which hold foreign operations to assess whether the new guidance will result in a change in functional currency.
Advise companies of the transition adjustments where long term loans were previously treated as a non-monetary asset and now have to be treated as monetary and the effect this may have on distributable reserves and any deferred/current tax impact where relevant.
Advise clients of the inability to use the net investment hedge if the conditions for a fair value hedge are not present.
What do companies need to know?
Be aware of the differences between Section 30 and old GAAP and assess the impact of these differences on the entity.
Where companies have foreign operations assess the likely impact of the foreign operations not being allowed to post exchange variance on foreign borrowings to the OCI (assuming there is no fair value hedge).
Given the new functional guidance in Section 30, assess if the functional currency remains the same.
Assess if long term loans to subsidiaries were previously treated as a non-monetary asset and assess the impact so as to determine the transition adjustment.
Where forward contracts were/are utilised, recognise the need for a transition adjustment to restate comparative figures to year end spot rate and consider the related deferred tax implications. Recognise that forward contracts have to be fair valued going forward.