What’s the issue?
Under IAS 21 The Effects of Changes in Foreign Exchange Rates a company uses a spot exchange rate when undertaking foreign currency translation. The spot exchange rate is defined as the exchange rate available for immediate delivery. External events – e.g. a pandemic or a geopolitical event – may result in economic uncertainty and cause a lack of exchangeability between two currencies. Therefore, companies may need to assess whether there is a temporary or a long-term lack of exchangeability and determine an appropriate foreign exchange spot rate to use for the purposes of foreign currency translation.
Although the International Accounting Standards Board (the Board) is currently considering feedback on its exposure draft of amendments to IAS 21 that address a lack of exchangeability, the amendments are not yet finalised. The analysis that follows is based on IAS 21 as it stands today.
During times of economic uncertainty, companies may need to assess whether there is a temporary or a long-term lack of exchangeability and determine an appropriate foreign exchange spot rate to use for foreign currency transactions.
Getting into more detail
Assessing lack of exchangeability
Whenever no legal mechanisms exist, the company cannot access one or more of the exchange mechanisms available in practice, or an exchange rate is not available for immediate delivery due to economic uncertainty, judgement may be needed to determine whether the lack of exchangeability is temporary or long-term.
If the lack of exchangeability is temporary, then a company considers the use of the first subsequent rate at which exchanges could be made. [IAS 21.26]
If such a rate does not exist, then this may indicate that the lack of exchangeability is long term. [Insights 22.214.171.124]
If the lack of exchangeability is long term, then the company considers the rate to which it would have access at the measurement date through a legal exchange rate mechanism. This will normally be the official rate. During periods of economic uncertainty, it is particularly important that the company reassess at each reporting date whether the official exchange rate meets the IAS 21 definition of a closing rate and, if applicable, the spot exchange rates at the dates of the foreign currency transactions. However, the use of an unofficial exchange rate (see below) may be more appropriate in very limited circumstances. [Insights 126.96.36.199-30]
Translation of foreign currency financial statements
In some countries there may be dual exchange rates: the official exchange rate and an unofficial parallel exchange rate. In our view, when a foreign operation operates in a dual exchange rate environment (which may be the case when exchangeability is lacking such that multiple unofficial rates exist), its financial statements should be translated using the rate applicable to dividends and capital repatriation because this is how the investment in the foreign operation will be recovered. [Insights 188.8.131.52]
Determining the rate to use when there is a long-term lack of exchangeability
In our view, the determination of which rate to use in these circumstances may be a matter of judgement and the conclusion may change over time. For example, although a company may legally apply to a government agency for foreign currency at the official rate for the purpose of paying dividends, it may also be able to effect dividends or capital repayments through parallel market transactions. We believe that a company should consider all relevant facts and circumstances to determine what is the more appropriate rate to use for the purposes of translation, including:
- practical difficulties, uncertainties or delays associated with applying for foreign currency at the official rate;
- whether a company would plan to remit a dividend or repayment of the net investment through an application for funds at the official rate or through parallel market transactions;
- past and current practice in relation to the remittance of dividends and capital; and
- the ability to source funds for dividend or capital repayments through parallel market transactions. [Insights 184.108.40.206]
A company discloses its significant accounting policies, and the judgements that management makes in applying the company’s accounting policies, that have the most significant effects on the amounts recognised in the financial statements.
This may include the following.
- The judgements made and the reasons for selecting one specific foreign exchange rate rather than another when more than one foreign exchange rate exists.
- Where there are multiple exchange rates, the determination of spot or closing rates may be a source of estimation uncertainty. Therefore, in these cases, the company may be required to disclose information about that source if it has a significant risk of resulting in a material adjustment to carrying amounts of assets or liabilities in the next financial year.
- In our view companies should disclose the reasons for not applying an official exchange rate as well as information about the rate used, if a rate other than the official rate has been used.
The IFRS® Interpretations Committee has drawn attention to the requirement to disclose the nature and extent of significant restrictions on a company’s ability to access or use assets and settle liabilities of the group, or in relation to its joint ventures or associates under specific scenarios . [Insights 220.127.116.11, 40, 50]
Actions for management
- assess whether the lack of exchangeability is temporary or long term;
- determine which rate to use in the presence of multiple exchange rates;
- consider all relevant facts and circumstances in determining a rate to use; and
- disclose significant judgements that were made in selecting a specific spot rate or, under very limited circumstances, reasons for not applying an official exchange rate and information about the rate used.
Follow the project direction of the Lack of exchangeability exposure draft issued in April 2021.
References to ‘Insights’ mean our publication Insights into IFRS®
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