ED 86 Application of Foreign Currency Translation to Equity

22 January 1999

The Executive Director
Australian Accounting Research Foundation
211 Hawthorn Road
Caulfield Vic 3162

Dear Sir

ED86 Application of Foreign Currency Translation to Equity

The Group of 100 is pleased to respond to requests for comment on Exposure Draft ED 86 Application of Foreign Currency Translation to Equity. Our comments are as follows :

1 Do you agree that, on issue, each item of equity denominated in a foreign currency should be translated at the spot rate at issue date?

We agree with this proposal.

2(a) Do you agree that equity denominated in a foreign currency should not be retranslated at reporting dates subsequent to the issue date?

We agree with this proposal.

2(b) If you consider that equity denominated in a foreign currency should be retranslated at reporting dates subsequent to the issue date, how do you consider that the consequential exchange differences should be recognised?

Not applicable.

3 Do you agree that returns on equity and returns of equity denominated in a foreign currency should be translated at the spot rate at the date of the transaction?

We agree with this proposal.

4 Do you agree that the above disclosures should be required about equity denominated in a foreign currency?

We agree with the proposed disclosures.

Yours sincerely,

Bryce JH Denison
National President

April 1998

The Executive Director
Australian Accounting Research Foundation
211 Hawthorn Road
CAULFIELD VIC 3162

Dear Sir

ED86 - Foreign Currency Translation

The Group of 100 is pleased to respond to requests for comment on Exposure Draft ED 86 Foreign Currency Translation. Our submission is structured as specific responses to the questions raised in the Invitation to Comment. The comments should be viewed within the overall plan to harmonise the Australian and International accounting standards so that compliance with Australian Accounting Standards ensures compliance with standards issued by the IASC.

Comments on the proposals to:

(a) Deal with foreign currency differences from speculative dealing in the same manner as differences from other foreign currency transactions (paragraph 1.2.4)

The Group of 100 considers that specific reference to speculative dealing within the exposure draft addresses a deficiency in the current Australian Accounting Standards. However, it was noted that no specific guidance is contained within ED86 which addresses valuation and disclosure requirements relating to speculative dealing.

As disclosure has been addressed in AASB 1033 - Presentation and Disclosure of Financial Instruments, The Group of 100 recommends that reference should be made in ED86 to this Accounting Standard.

(b) Require exchange differences relating to foreign currency monetary items forming part of the net investment in a self-sustaining foreign operation to be taken directly to the foreign currency translation reserve by the economic entity (paragraph 4.5)

The Group of 100 agrees with the reclassification of this treatment from commentary status in AASB 1012 - Foreign Currency Translation, paragraph (xxvii), to a black-letter requirement , which formalises the practice already in place under this standard.

(c) Require the restatement of financial reports of self-sustaining foreign operations which report to the parent entity in the currency of a hyperinflationary economy (paragraphs 5.8-5.9)

Paragraphs 5.8 - 5.9 require the restatement of financial reports by applying the proportionate changes in a general price level index. In most instances, the restatement of financial reports will result in an increase in equity.

The Group of 100 is concerned that the application of this requirement will inflate the balance sheet so that the indexed net asset value is not necessarily representative of its recoverable amount. Therefore, the subsequent application of the recoverability test will result in the write-down of overvalued assets to the Profit and Loss Account. This problem is further exacerbated if the recoverability improves in future accounting periods and the gains cannot be offset against the former loss which was recognised in the Profit and Loss Account.

It is interesting to note this requirement is "swaying" accounting treatment towards current cost accounting. Under the concept of current cost accounting, assets may be restated by a different index to the index used to restate liabilities. The differences which result from the application of these two indices are brought to account in the current cost reserve. ED86 is unclear as to whether a different general price level index is to be applied to assets in comparison to liabilities, or whether the same general price level index is to be applied to both. If different indexes are to be used, ED86 needs to clarify how the restated differences are to be brought to account.

The Group of 100 is concerned, on pragmatic grounds given current general price level index information may not be available at the reporting date. We believe that further guidance as to which general price level index should be used and whether this general price level index applied on a monthly basis is required. If the general price level index is not available on a monthly basis, clarification is needed as to how to calculate the proportionate changes.

(d) Require that, on disposal of a current or a former self-sustaining foreign operation, the balance of the foreign currency translation reserve be recognised as a revenue or an expense notwithstanding that this conflicts with existing standards (paragraph 5.10)

The proposed treatment of the Foreign Currency Translation Reserve balance on disposal of a current or former self-sustaining foreign operation appears reasonable. However, it is not clear whether this treatment is also required to be applied to integrated operations which were previously self-sustaining,

We believe that guidance is required (transitional paragraph 9.1) on the treatment of the Foreign Currency Translation Reserve balance which arose from prior disposals. In certain instances, making a retrospective adjustment to these existing balances could have significant, material effects on the consolidated retained earnings. Clarification is also required as to whether these balances should be adjusted through the Profit and Loss Account (extraordinary profit/loss) or transferred directly to the retained profits/accumulated losses.

(e) Retain and clarify the hedging provisions of AASB 1012 and AAS 20 (Section 6)

Conceptually the Group of 100 does not agree with ED 86 stating the difference between current spot and contract rate is a gain or loss that has a value which should be carried forward in the accounts until the contract is delivered. The value of the contract is the difference between current spot, at any given time, and the contract rate as this represents the cash that will be received or paid if the contract is delivered at that time. The comparison between the spot rate at the time of entering the contract and contract rate is only a valid measure of the value of the contract at that time, and it is not a valid measure going forward as it does not accurately measure the value of the contract.

The main problem with the recognition of this deferred gain/loss is that there will never be a cash flow representing this gain/loss, and thus there is some question as to whether it meets the definitions of assets and liabilities under SAC4. (ie Assets – future economic benefits will flow to the entity; Liabilities – future sacrifices of economic benefits) The consequence is a timing issue which arises in relation to the reversal/realisation of this deferred gain/loss. Therefore, clarification is required as to what benefit the additional hedge information regarding the spot rate at deal date provides to the users of the financial reports.

Therefore the practical application of ED 86 poses the question of how to treat the cost/gain recognised and deferred at contract date in the balance sheet, ie:

does it remain in the balance sheet, which appears to lead to double counting in a loss situation; or
should it be reversed out of the balance sheet to avoid the above mentioned double counting: or
does the calculation of the unrealised gain or loss need to be adjusted as the difference between the spot rate on contract date and the month end rate instead of contract rate versus month end rate. This would result in the deferred gain/loss being left in the balance sheet without the problem of double counting in a loss situation.

A practical example illustrating our point of view is attached.

Other Comments

In addition to the Specific Matters for Comment discussed above, The Group of 100 noted the following issues:

ED86 focuses mainly on the treatment of foreign currency translation of self-sustaining operations. As the guidance for integrated operations is substantially less in comparison, ED86 needs to ensure there is sufficient guidance for the treatment of integrated operations.
Paragraph 5.6 briefly touches on the accounting for foreign translation of equity accounting. The Group of 100 does not consider this issue to be adequately addressed, that is, the practical application of ED86 for the translation of equity accounts.
Paragraph 5.3 expands the scope of the recoverable amount test to all non-monetary assets other than inventory. However, the recoverable amount test in AASB 1010 - Accounting for the Revaluation for Non-Current Assets only applies to non-current assets other than inventory and foreign currency monetary assets. Is it intended that ED 86 expand this requirement to include non-monetary current assets within the recoverable amounts test?
Paragraph 5.7 requires financial reports of the foreign operation with a different reporting date to be translated at the rate in effect at the reporting date of the foreign operation and not the controlling entity. This appears not to portray an accurate measurement of the balance sheet at reporting date, especially if there has been a large movement in the foreign currency rate between the two reporting dates. Further, the requirement of Paragraph 5.7 is in conflict with AASB 1024 - Consolidated Accounts, paragraph xxix, which requires appropriate adjustments to be made to the subsidiary’s accounts to prepare them as if the reporting dates were the same as the parent’s.
Paragraph 4.1.2 requires each transaction to be translated at the rate on the transaction date. At present, AASB 1012, Paragraph 50 allows an average or standard exchange rate to be used provided it does not result in a material difference than if the rate at transaction date was used. Further clarification is required as to whether this practice can be continued under the requirements of ED86.
Paragraph 4.2 provides guidance for the measurement of monetary items outstanding at reporting date, that is outstanding items at balance date are to be translated at the spot rate current at that date. The Group of 100 believes further guidance is required in regard to whether spot or spot adjusted for forward points should be used for the valuation on reporting date of non-monetary items, such as sale and purchase hedging transactions and speculative transactions.
The inclusion of paragraph 7.3 under Disclosures seems puzzling and unnecessary. Application of the proposed standard is to the general purpose financial reports of reporting entities (paragraph 1.1) and to financial reports that are held out to be general purpose financial reports by entities (paragraph 1.2). The obligation under paragraph 7.3 is placed on "a self-sustaining foreign operation" (etc), which is unlikely to be subject to paragraphs 1.1 or 1.2. We see no useful purpose in the disclosure envisaged by paragraph 7.3 as such an entity may not be a reporting entity.
An issue was raised in relation to the current economic turmoil in Indonesia, that is, the economy is not hyper-inflationary but does have a rapidly deteriorating currency. When a loan denominated in Australian dollars exists between an Australian parent and a self-sustaining Indonesian operation, the translation of the loan may far exceed the value of the investment in the self-sustaining foreign operation. It was felt that in this instance the exposure draft should provide further clarification as to how the loan and investment should be measured in the parent’s balance sheet to ensure that these items are recorded at values representative of the foreign entity’s ability to repay.
The Group of 100 supports the use of examples as an appendix to ED86, as these are effective in illustrating the requirements of the Standard.

The goal of Australian Standard Setters is to harmonise with International Accounting Standards. The Group of 100 is concerned that what will be adopted in Australia as the preferred accounting treatment is not what will be ultimately adopted for International Standards. We are in effect saying that if we harmonise with one option which is subsequently removed from the International Accounting Standard, we will then have to go through the harmonisation process again.

Therefore, we should ensure the requirements adopted within the International Accounting Standards are developed based on an appropriate framework. This would then form the basis for the development of the Australian Accounting Standards. However, at present this process seems to be working in reverse where we are trying to harmonise Australian Standards to International Standards which are changing.

Yours sincerely,

Bryce JH Denison
National President