IFRIC has issued a draft interpretation, Foreign Currency Transactions and Advance Consideration, with comments to be received by January 19, 2016
Here’s the background:
- “Paragraphs 21–22 of IAS 21 The Effects of Changes in Foreign Exchange Rates require that a foreign currency transaction must be recorded, on initial recognition in the entity’s functional currency, by applying the spot exchange rate to the foreign currency amount at the date of the transaction. The date of the transaction is the date on which the transaction first qualifies for recognition in accordance with IFRS.
- In circumstances in which an entity pays or receives some or all of the foreign currency consideration in advance of the recognition of the related asset, expense or income, the entity generally recognises a non-monetary asset or liability. This non-monetary asset represents an entity’s right to receive goods or services (a ‘prepayment asset’) and the non-monetary liability represents an entity’s obligation to transfer goods or services (a ‘deferred income liability’).
- The prepayment asset or deferred income liability is subsequently derecognized when the related asset, expense or income is recognized in accordance with the relevant Standards.”
The draft interpretation focuses on how to determine the “date of the transaction” in this circumstance, and on how consequently to determine what exchange rate to use to translate the asset, expense or income on initial recognition, when such a prepayment asset or deferred income liability has been recognized in advance of it. To this point there’s been diversity in practice (which would likely have continued after implementing IFRS 15), between recognizing revenue using the spot exchange rate at the date of receiving the non-refundable advance payment, and using the spot exchange rate at the later date of the transfer of goods or services. This is what IFRIC comes up with:
- The date of the transaction, for the purpose of determining the spot exchange rate used to translate the related asset, expense or income (or part of it) on initial recognition…is the earlier of:
- (a) the date the issuer initially recognizes the non-monetary prepayment asset or the non-monetary deferred income liability; and
- (b) the date the issuer recognizes the asset, expense or income (or part of it) in the financial statements.
- If the issuer recognizes the transaction (including any non-monetary prepayment assets or non-monetary deferred income liabilities) in stages, then it establishes a date of transaction for each stage. This may be the case, for example, if there:
- (a) are multiple payments or receipts in advance;
- (b) are multiple goods to be delivered at different times and/or services rendered over time; or
- (c) is a combination of multiple goods and/or services with some advance payments or receipts and some payments or receipts in arrears.
- When there’s more than one such date of transaction, the issuer applies a spot exchange rate for each date to translate that part of the transaction. When the issuer initially recognizes a non-monetary prepayment asset or a non-monetary deferred income liability, it subsequently uses the same exchange rate on initially recognizing the related part of the asset, expense or income (that is, the part recognized on derecognizing the prepayment or deferred income).
This only applies, as noted, to non-monetary prepayment or deferred income liabilities, not to transactions in which the terms create foreign currency-denominated monetary items (which would be retranslated anyway when settled).
The draft contains a few illustrative examples to clarify how it would work in practice. Apparently the main beneficiaries of this interpretation will be the construction industry, reflecting the prolonged and multi-stage nature of contracts there. But of course it could also affect any one-off situation (a purchase of plant or equipment for instance) where for whatever reason the payment pattern runs ahead of the transaction stream. I suppose the interpretation is basically based on the premise of putting the primary weight on the flow of cash (or non-cash consideration, to which it also applies). With regard to the guidance on multiple payments, for instance, IFRIC “thinks that this treatment reflects that an entity has no foreign exchange risk in respect of the foreign currency amounts already paid or received, but is still exposed to foreign exchange risk in respect of the outstanding consideration.”
The committee currently envisages that the interpretation, if it becomes effective in its current form, might be applied either retrospectively or prospectively, noting that some entities might not have sufficient information for the former approach. Overall, I doubt the previous diversity in practice could very often have had a systematically damaging effect on comparability, given the presumably unsystematic effect of such differences from one entity to the next – sometimes you’d win, sometimes you’d lose. But apart from sighing over whatever work it takes to change the affected systems, one imagines most preparers will basically say: sure, if that’s how we’re meant to do it, then fine with us…
The opinions expressed are solely those of the author