Lack of exchangeability, or: accounting for hell

The IASB has issued the exposure draft Lack of Exchangeability, with comments to be received by September 1, 2021

IAS 21 generally requires using a spot exchange rate when an entity reports foreign currency transactions or a foreign operation’s results and financial position in its financial statements. The standard specifies the exchange rate to use in reporting foreign currency transactions when exchangeability between two currencies is temporarily lacking, but doesn’t address what happens when a lack of exchangeability is not temporary. Taking up the issue a while ago, IFRIC “was informed of diverse views on how to determine whether a currency is exchangeable into another currency and the exchange rate to use when it is not. Although circumstances in which a currency is not exchangeable might arise relatively infrequently, when they do arise economic conditions can deteriorate rapidly. In those circumstances, the diverse views on the application of IAS 21 could lead to material differences in the financial statements of entities affected by a currency that lacks exchangeability.”

The proposed amendments would clarify that “a currency is exchangeable into another currency at a measurement date when an entity is able to exchange that currency for the other currency within a time frame that includes a normal administrative delay and through a market or exchange mechanism in which the exchange transaction would create enforceable rights and obligations.” This would then lead to the following additional requirements:

  • When exchangeability between two currencies is lacking—that is, when a currency is not exchangeable into another currency…at a measurement date—an entity shall estimate the spot exchange rate at that date. The estimated spot exchange rate shall meet the following conditions assessed at the measurement date:
    • (a) a rate at which an entity would have been able to enter into an exchange transaction had the currency been exchangeable into the other currency;
    • (b) a rate that would have applied to an orderly transaction between market participants; and
    • (c) a rate that faithfully reflects the prevailing economic conditions.
  • In estimating the spot exchange rate as required by paragraph 19A, an entity may use an observable exchange rate as the estimated spot exchange rate when that observable exchange rate meets the conditions in paragraph 19A and is either:
    • (a) a spot exchange rate for a purpose other than that for which the entity assesses exchangeability; or
    • (b) the first exchange rate at which an entity is able to obtain the other currency after exchangeability of the currency is restored (first subsequent exchange rate).

The Board took the approach of setting out conditions rather than proposing detailed requirements, because among other things: estimating a spot exchange rate can be complicated and would depend on entity-specific and jurisdiction-specific facts and circumstances; there are many economic models an entity might use to estimate a spot exchange rate, varying in complexity and in the economic factors they use as inputs; and the uncertainties inherent in estimating a spot exchange rate are similar to those that relate to other financial information based on estimates. The proposed approach would be supplemented by disclosures, set out in the exposure draft in the form we discussed here:

  • the entity shall disclose information that enables users of its financial statements to understand how the lack of exchangeability affects, or is expected to affect, the entity’s financial performance, financial position and cash flows. To achieve this objective, an entity shall disclose information about:
    • the nature and financial effects of the lack of exchangeability;
    • the spot exchange rate(s) used;
    • the estimation process; and
    • the risks to which the entity is exposed because of the lack of exchangeability.

It seems that the issue originally arose in relation to Venezuela, and was first discussed by the IFRIC in November 2014, at which time it decided not to add the matter to its agenda. A May 2018 agenda paper noted: “Stakeholders have informed us that recent developments in Venezuela have increased the severity of the matter. Those stakeholders indicated that the official exchange rate of the Venezuelan Bolivar (VEF) does not faithfully represent the economic circumstances prevailing in Venezuela and could not reasonably be used in applying IAS 21 to the financial statements of foreign operations with a functional currency of VEF.” At least at that time, Venezuela was, “to the best of our knowledge, the only jurisdiction for which the matter discussed in this paper arises.” Venezuela, as is always the way of things, hasn’t recently been in the (relative) spotlight as it was for a while – I’m not sure how the exchangeability of its currency is currently being assessed. But either way, if the diversity in practice under current IAS 21 has caused any damage in that regard, the amendments will surely have arrived too late to help much. And I suppose it would be everyone’s wish that once those amendments are in place, the world never provides a reason to look at them again, much less apply them…

The opinions expressed are solely those of the author

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