As we discussed here, IFRIC recently discussed a fact pattern involving an entity that enters into a loan with its subsidiary…

In the fact pattern, the entity and its subsidiary have different functional currencies; the intragroup loan is denominated in the functional currency of either the entity or its subsidiary; and isn’t part of the entity’s net investment in the subsidiary. The entity or the subsidiary applies IAS 21 to translate the loan to its functional currency and recognizes any resulting exchange difference in profit or loss. In preparing its consolidated financial statements the entity eliminates in full the intragroup balances relating to the loan, recognizing the exchange difference on the loan in profit or loss.

IFRS 18 requires an entity to ‘classify foreign exchange differences included in the statement of profit or loss applying IAS 21 in the same category as the income and expenses from the items that gave rise to the foreign exchange differences…’. But how should this be applied when those items have been eliminated on consolidation? One view would be that as the exchange difference arose from the intragroup loan before the elimination of that loan and related income and expenses on consolidation, the entity (usually) classifies the difference using the category in which the income and expenses from the intragroup loan would have been classified before they were eliminated. An alternative view would be that as the income and expenses arising from the intragroup loan have been eliminated on consolidation, there is no ‘same’ category within which the entity can classify the exchange difference, and therefore the entity by default classifies it in the operating category. The discussion resulted in a rare (unprecedented?) split right down the middle: seven Committee members thought the view described in the preceding sentence is the only reasonable reading of IFRS 18; the other seven members thought both views set out above are reasonable. Despite that, the staff recommended that a standard-setting project not be added to the work plan, and the Committee tentatively agreed.

Many respondents took issue with even issuing a tentative agenda decision in the circumstances, such as the Institute of Chartered Accountants in England and Wales:

• …we are concerned that, due to its inconclusive nature, this draft agenda decision risks raising more questions than it answers.
• We believe it will be unhelpful for the Committee to issue an inconclusive agenda decision and recommend that the Committee includes explanatory material alongside its decision to offer greater clarity on what constitute permissible treatments of a foreign exchange difference from an intragroup monetary liability (or asset).

And Chartered Accountants Ireland:

• We feel that it would be very disappointing and unhelpful if the TAD was finalized in its current form…The TAD implies that there are two acceptable views on the designation of such foreign exchange differences, and this means there will be no consistency. Given the disparity in the number of members that found view II to be acceptable compared to the number that found view 1 acceptable, it would appear that the Standard is unclear as to the appropriate approach and should this not be rectified?

One might have imagined that such procedural issues would have been clarified years ago, but there you go, there’s always something new. That matter aside, Grant Thornton raised two interesting points:

• Some concerns were…raised about the way in which consolidation adjustments to eliminate intragroup transactions is conflated with offsetting of assets and liabilities in the financial statements in the staff paper considered at the September IFRIC meeting. In our view this is not appropriate as these are separate concepts. The key concept of consolidation is that the group is considered as one economic entity, therefore in consolidated accounts intragroup transaction have not merely been offset, they are completely eliminated as an economic entity cannot have a transaction with itself.
• We also believe that classification of foreign exchange gains and losses is a topic that contains many more areas of complexity for intragroup transactions than the narrow question addressed by IFRIC in this TAD. For example.. (in) a scenario where the denominated currency was not the functional currency of either party to the transaction, then a potential outcome of applying (a view that the entity classifies the difference using the category in which the income and expenses from the intragroup loan would have been classified before they were eliminated) could result in a gain or loss in both investing and in financing. We do not believe that this would be an appropriate outcome and would not faithfully reflect the group financial performance and an eliminated balance sheet transaction. Similar issues have been discussed in cases such as foreign currency denominated leases which could result in operating or financing expenses. IFRIC should consider whether discussion of wider foreign exchange classification issues is necessary…

Overall, one suspects IFRIC got more feedback on this than they expected (or wanted, given its nature): 51 comment letters. For comparison, the tentative agenda decision on the economic benefits from use of a battery, out for comment over the same period, received just 13!

The opinions expressed are solely those of the author.