How IFRIC’S Take on IAS21 : Handling foreign currency transaction and advance Payments

IFRIC 22, “Foreign Currency Transactions and Advance Consideration,” provides guidance on how to determine the date of the transaction for the purpose of translating foreign currency transactions involving advance payments. This interpretation, which amends IAS 21, “The Effects of Changes in Foreign Exchange Rates,” aims to reduce diversity in practice and enhance consistency in financial reporting.

Scope of IFRIC 22

IFRIC 22 applies to a foreign currency transaction (or part of it) when an entity recognizes a non-monetary asset or non-monetary liability arising from the payment or receipt of advance consideration before the entity recognizes the related asset, expense, or income.

Consensus of IFRIC 22

The key points of the consensus reached by the IFRS Interpretations Committee (IFRIC) are:

1. The date of the transaction for the purpose of determining the exchange rate to use on initial recognition of the related asset, expense or income (or part of it) is the date on which an entity initially recognizes the non-monetary asset or non-monetary liability arising from the advance consideration.
   
2. If there are multiple payments or receipts in advance, the entity shall determine a date of the transaction for each payment or receipt of advance consideration.

Practical Examples

1. Advance Payment for Inventory:
   • Scenario: Company A purchases inventory from a foreign supplier and pays 1 million euros in advance. The functional currency of Company A is the US dollar (USD).
   • Accounting: Company A recognizes a prepaid asset of 1 million euros on the date the advance payment is made. On the date the inventory is delivered and recognized, Company A translates the prepaid asset using the exchange rate at the date of the advance payment, not the current exchange rate.
     
2. Advance Receipt for Service Contract:
   • Scenario: Company B provides consulting services to a foreign customer and receives 500,000 British pounds (GBP) in advance. Company B’s functional currency is the Euro (EUR).
   • Accounting: Company B recognizes deferred revenue of 500,000 GBP on the date the advance payment is received. As Company B provides the consulting services, it recognizes revenue and translates the deferred revenue using the exchange rate at the date of the advance payment.

Effective Date and Transition

IFRIC 22 is effective for annual reporting periods beginning on or after January 1, 2018. Entities can apply the interpretation retrospectively or prospectively to all assets, expenses, and income in the scope of the interpretation that are initially recognized on or after the beginning of the reporting period in which the entity first applies the interpretation.

Impact on Financial Reporting

IFRIC 22 provides clarity on the exchange rate to use when translating foreign currency transactions involving advance payments. This reduces diversity in practice and enhances comparability among entities. However, the interpretation may require changes to an entity’s accounting systems and processes to track the exchange rates at the date of each advance payment or receipt.

How does IFRIC 22 address the recognition of non-monetary assets in foreign currency transactions

IFRIC 22, “Foreign Currency Transactions and Advance Consideration,” provides guidance on how to determine the date of the transaction for the purpose of translating foreign currency transactions involving advance payments. The key points are:

1. The date of the transaction for the purpose of determining the exchange rate to use on initial recognition of the related asset, expense or income (or part of it) is the date on which an entity initially recognises the non-monetary asset or non-monetary liability arising from the advance consideration.
   
2. If there are multiple payments or receipts in advance, the entity shall determine a date of the transaction for each payment or receipt of advance consideration.
   
3. IFRIC 22 applies to a foreign currency transaction when an entity recognises a non-monetary asset or non-monetary liability arising from the payment or receipt of advance consideration before the entity recognises the related asset, expense or income
   
4. For example, if an entity purchases a machine for $1,000 and pays the supplier in advance on April 1, the entity would recognize a non-monetary asset translating $1,000 into its functional currency at the spot exchange rate on April 1. When the machine is delivered on April 15, the entity would derecognize the non-monetary asset and recognize the machine at the same exchange rate used on April 1

What are the key differences between IFRIC 22 and IAS 21 regarding foreign currency transactions

Here are the key differences between IFRIC 22 and IAS 21 regarding foreign currency transactions:

1. Focus on Advance Consideration

IFRIC 22 specifically addresses the accounting treatment of foreign currency transactions when an entity receives or pays consideration in advance. It clarifies how to determine the exchange rate to use when recognizing non-monetary assets or liabilities arising from such transactions.

• Example: If a company pays an advance for inventory in a foreign currency, IFRIC 22 stipulates that the exchange rate to use for recognizing the prepaid asset is the rate at the date of the advance payment.

IAS 21, on the other hand, provides general guidance on how to account for all foreign currency transactions but does not specifically address the nuances of advance payments. IAS 21 primarily focuses on the translation of foreign currency amounts into the functional currency at the date of the transaction.

2. Date of Transaction for Exchange Rate Determination

IFRIC 22 establishes that the date of the transaction for determining the exchange rate is the date on which the non-monetary asset or non-monetary liability is initially recognized. This is particularly relevant when advance consideration is involved.

• Example: A company that receives an advance payment for services must recognize a liability at the exchange rate on the date the advance is received, not at the date the service is performed.

IAS 21 states that the date of the transaction is the date when the transaction first qualifies for recognition in accordance with IFRS standards. However, it does not specifically address how to handle the timing of recognition in the context of advance payments.

3. Multiple Payments or Receipts

IFRIC 22 clarifies that if there are multiple payments or receipts in advance, the entity must determine a date of the transaction for each payment or receipt of advance consideration. This ensures that each transaction is treated appropriately based on its specific timing.

• Example: If a company makes several advance payments for different shipments of goods, it must apply the exchange rate applicable on the date of each individual payment when recognizing the related assets.

IAS 21 does not explicitly provide guidance on how to handle multiple advance payments, which could lead to inconsistencies in practice.

4. Illustrative Examples and Practical Guidance

IFRIC 22 includes illustrative examples that demonstrate the application of its consensus, helping entities understand how to apply the guidance in real-world scenarios. These examples clarify how to recognize non-monetary assets and liabilities when advance payments are made in foreign currencies.

IAS 21 does not provide specific examples related to advance consideration, which may lead to varied interpretations and applications among entities.

Conclusion

IFRIC 22 clarifies the accounting for foreign currency transactions when advance consideration is paid or received. By specifying the exchange rate to use on initial recognition of the related asset, expense, or income, the interpretation promotes consistency in financial reporting. As entities implement IFRIC 22, they should carefully review their existing accounting policies and procedures to ensure compliance with the new requirements.