04 May 2020
The foreign exchange volatility caused by coronavirus could significantly affect entities’ profit or loss and the way foreign currency transactions are translated.
What does FRS 102 say?
FRS 102 (section 30) prescribes that all foreign currency transactions should be recorded in the functional currency by applying the spot rate between the functional currency and the foreign currency at the date of transaction or a rate that approximates to the spot rate.
Subsequently, the treatment of foreign currency items depends on whether the item is:
- monetary or non-monetary (monetary items are defined as units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency); and
- carried at historical cost or fair value.
Foreign currency monetary items are translated using the closing rate. Non-monetary items are translated using the exchange rate at date of transaction (or if at fair value, date at which fair value was measured).
Exchange gains and losses are recognised in profit or loss (paragraph 30.10). However, there are exceptions to the rule:
- if a monetary item is designated as a hedging instrument in a cash flow hedge, any exchange difference that forms part of the gain or loss on the hedging instrument is recognised in other comprehensive income;
- if a monetary item is designated as a hedge of a net investment in the consolidated financial statements, any exchange difference on the hedging instrument that is considered to be an effective hedge is recognised in other comprehensive income; and
- if a monetary item forms part of the net investment in a foreign operation in the consolidated financial statements then such exchange differences must be recognised in other comprehensive income and accumulated in equity.
Practical impact and interpretation for preparers
Many entities use the average exchange rate method for translating foreign currency transactions at initial recognition on the assumption that the average rate approximates to the spot rate. Entities generally consider the fluctuations in the exchange rates and the volume and size of the transactions when determining whether using average exchange rates is appropriate. Significant changes in the foreign currency exchange rates which may occur during these uncertain times might mean that the use of an average rate is inappropriate and the period over which the average rates are calculated may need to be shorter.
As a result of the fluctuations in exchange rates, many entities may develop hedging strategies to mitigate the profit or loss impact. A number of entities may look to prospectively apply hedge accounting to mitigate the profit or loss volatility resulted by significant exchange rate movements.
There may also be some large gains and losses arising on foreign currency transactions and entities should consider how these are disclosed in the financial statements. It may be necessary to disclose the gains and losses as exceptional items either on the face of the primary statements or in the notes to the accounts.
- Reconsider the period over which the average exchange rates are calculated.
- Consider updating accounting systems and processes to apply appropriate exchange rates.
- Consider the implications of applying hedge accounting prospectively.
- Consider how gains and losses are disclosed in the financial statements.