Chapter 7: Other matters

Tax effects of all exchange differences

Gains and losses on foreign currency transactions and exchange differences arising on the translation of the results and financial position of an entity (including a foreign operation) into a different currency might have tax effects. IAS 12 applies to these tax effects.

Deferred taxes on translation adjustments – example Entity N is a Norwegian corporation (functional currency Norwegian krone) with a wholly-owned subsidiary, Entity S, operating in the Swedish tax jurisdiction. The functional currency of Entity S is the Swedish krona. Historically, no earnings have been repatriated to Entity N because the parent considers its investment to be permanent. IAS 21 provides that any tax effects associated with gains and losses on foreign currency transactions and exchange differences arising from the translation of the financial statements of an entity (including foreign operations) should be accounted for in accordance with IAS 12. Under IAS 12, deferred income tax liabilities may not be accrued by Entity N if both of the following conditions are satisfied: Entity N is able to control the timing of the reversal of the temporary difference; and it is probable that the temporary difference will not reverse in the foreseeable future. Recognition of deferred tax assets, in general, would not be appropriate if Entity N’s intention is to maintain the investment in the long term, such that it is not probable that the deferred tax asset would be recovered.

Cash flow statements

Cash flows arising from transactions in a foreign currency and cash flows of a foreign subsidiary are translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows. IAS 7 applies to foreign currency cash flows.

SIC-7

SIC-7 Introduction of the Euro explains that the requirements of IAS 21 regarding the translation of foreign currency transactions and financial statements of foreign operations should be applied to the fixing of exchange rates when countries join the Economic and Monetary Union (EMU) and change over to the euro, as follows:

(a) foreign currency monetary assets and liabilities resulting from transactions continue to be translated into the functional currency at the closing rate. Any resulting exchange differences are recognized as income or expense immediately, except that an entity continues to apply its existing accounting policy for exchange gains and losses relating to hedges of the currency risk of a forecast transaction;

(b) cumulative exchange differences relating to the translation of financial statements of foreign operations, recognized in other comprehensive income, are accumulated in equity and are reclassified from equity to profit or loss only on the disposal or partial disposal of the net investment in the foreign operation; and

(c) exchange differences resulting from the translation of liabilities denominated in participating currencies should not be included in the carrying amount of related assets.

Introduction of the euro – comparative amounts – example The functional currency of Entity A, based in Slovakia, was previously the Slovak crown. Entity A presented its 31 December 2008 financial statements in that currency. Slovakia adopts the euro as its national currency on 1 January 2009. Consequently, Entity A needs to recognize a change in functional currency as at 1 January 2009. It will present its financial statements at 31 December 2009 in its new functional currency of the euro. The conversion rate from the Slovak crown to the euro (also referred to as the ‘parity’ rate) was fixed in July 2008. Neither SIC-7 nor IAS 21 directly addresses how comparative amounts should be converted when a change in functional currency arises not from a change in entity-specific circumstances, but because the original functional currency has ceased to exist and is officially converted into another currency at a fixed rate. IAS 8 indicates that, in the absence of a specific Standard that applies to the transaction, the requirements in IFRS Standards dealing with similar and related issues should be considered. Therefore, Entity A has an accounting policy choice. There are two acceptable alternatives: it can choose to treat the changeover to the euro as similar to any other change in presentation currency for the comparative period – in which case it would translate the comparative amounts using rates applicable at the dates of the transactions consistent with IAS 21; or in the absence of guidance specific to these circumstances, when the change in functional/presentation currency is not due to entity-specific circumstances, Entity A can choose to maintain the relationship between balances by applying the parity rate established on the changeover to the euro to all the comparative amounts.