IFRS Conversion Considerations: Foreign Currency

Organizations considering a conversion to the International Financial Reporting Standards (IFRS) from U.S. Generally Accepted Accounting Policies (U.S. GAAP) should note that there are significant differences surrounding the treatment of foreign currency. This article is the part of a series covering considerations for organizations contemplating a conversion from U.S. GAAP to IFRS.

U.S. GAAP covers foreign currency in section ASC 830 of the Codification, while IFRS uses International Accounting Standard (IAS) 21, The Effects of Changes in Foreign Exchange Rates. Both standards require foreign currency transactions to be remeasured at the entity’s functional currency, with changes in exchange rates being recorded into income using average rates. Similarly, both standards require assets and liabilities to be translated at the reporting date currency rates, with translation amounts recorded in other comprehensive income.   Some of the most common issues entities encounter when transitioning to IFRS are discussed below.

While the criteria in determining an entity’s functional currency is different under the two standards, both usually result in the same currency determination. Under IAS 21, the concept of reporting currency has been replaced with two separate notions. Functional currency is the currency of the primary economic environment in which the entity operates, and presentation currency is the currency in which the financial statements are presented. The functional currency can be translated into any presentation currency.

Consolidation of foreign entities under U.S. GAAP utilizes a step-by-step method, where each subsidiary must directly translate its currency into its immediate parent’s currency during the consolidation process. Under IFRS, the step-by-step method is permitted; however, the entity may also elect to use the direct method, where each entity within the consolidated group directly translates into the functional currency of the reporting entity. This method essentially skips converting to the intermediary parent’s currency rate. 

IFRS provides more flexibility for currency derivatives to qualify for hedge accounting. Under IFRS, there is no requirement for an indicated notional value for the hedge to be effective. IFRS also provides additional hedging opportunities for entities within a consolidated group to hedge on behalf of a subsidiary with foreign currency exposure. A parent organization is permitted to bypass an intermediate subsidiary and directly hedge against currency risk at a lower-level subsidiary.

Both standards require an assessment of hyperinflationary economies. While the standards have different criteria for determining hyperinflationary economies, the same economies are generally identified as hyperinflationary. Both standards require restatement as it is deemed that the reporting of the operational results and financial position in the local currency without restatement is not useful as the currency has lost significant purchasing power.

Under U.S. GAAP, an economy is automatically deemed hyperinflationary if the economy reaches a three-year cumulative inflation of 100% or more. Under IFRS, an assessment must made based on judgment factoring in characteristics of the country. These factors include whether the general population holds wealth in another currency, transactions occur in another currency, rates are generally linked to another currency or it is highly probable that three-year cumulative inflation rate will exceed 100%.  The International Monetary Fund publishes reliable inflation rate information for every country each month that can be utilized in this assessment.

Under U.S. GAAP, an entity in a hyperinflationary currency would remeasure its statements as if the functional currency were the parent’s reporting currency, recognizing the difference into income. Monetary items are remeasured at the period-end exchange rate. Nonmonetary items are remeasured into the reporting currency at the historical exchange rate. All remeasurement gains and losses are recognized into profit and loss. When the economy ceases to be hyperinflationary, the reporting amounts would be translated back into the local currency, with those balances becoming the new basis for the nonmonetary assets and liabilities.

IFRS follows a restate-and--then-translate approach for entities in hyperinflationary economies. IFRS requires that local functional currency financials, including comparative information, be maintained but restated to reflect the effect of inflation at the balance sheet date, recognizing the difference into income. For many balance sheet items, restatement should be at a general price index. For nonmonetary items carried at cost, these should be restated to reflect the effect of inflation since they were acquired. All income statement items should also be stated based on the general price index. Once the financial statements are adjusted by applying the general price index, the financial statements are then translated into the reporting currency at the current conversion rate. When an economy ceases to be hyperinflationary, the amounts reported at the end of the previous reporting period become the basis for future statements.

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