This article considers three learning outcomes that will be added to the F7 syllabus from September 2016. These are:
- foreign currency transactions
- group disposals, and
- interpretation of consolidated financial statements.
This article highlights the key points of each learning outcome and its impact on the F7 exam.
Foreign currency transactions
The accounting treatment of foreign currency transactions is prescribed by IAS 21, The effects of changes in foreign exchange rates. This standard addresses some key issues and the practicalities of accounting for transactions in foreign currency.
(a) Key terms:
- Functional currency – the currency of the primary economic environment in which the entity operates.
- Presentation currency – the currency in which the financial statements are presented.
The functional currency is the currency in which an entity generates and spends cash. IAS 21 gives guidance, stating that an entity should consider:
- the currency that mainly influences sales prices for goods and services
- the currency that mainly influences labour, material and other costs in producing goods
An F7 candidate would be expected to know the difference between functional and presentational currency. Often, a company’s presentation currency will match its functional currency. If not, the financial statements will need to be translated at the reporting date from the functional currency into the presentation currency. This is very common within group scenarios, where an overseas subsidiary has a functional currency which differs from the presentation currency of the consolidated financial statements. This issue is not examinable at F7, but is examinable in P2.
(b) Mechanics of translation
Often an entity that trades overseas will buy or sell goods in a currency that is not its functional currency. If this is the case, then translation is required to record the transaction into the entity’s functional currency.
This is done at three stages:
Stage 1 – Initial transactions
When an entity enters into a transaction, this should initially be translated using the historic rate (the spot rate) prevailing at that date.
Stage 2 – Settled transactions
When a transaction is settled (when payment or receipt of cash occurs), this is translated at the historic rate prevailing at the date of settlement. Any exchange gain or loss is then recorded in the statement of profit or loss at that date.
Stage 3 – Unsettled transactions
If a transaction is unsettled at the reporting date (meaning the amount is unpaid or a balance in a different currency is outstanding), then the treatment depends on whether the item is a monetary or non-monetary item.
Monetary items are assets or liabilities to paid in a fixed amount, or a unit of currency held. In the F7 exam, monetary items will be trade receivables, trade payables, cash, overdrafts, and loan notes.
If the item is a monetary item, the balance will be retranslated at the closing rate (the exchange rate at the reporting date), with any gain or loss being recorded in the statement of profit or loss.
Non-monetary items (such as inventory or property held under the cost model) are not retranslated. Instead, they are accounted for at the rate that existed at the date of the initial transaction.
Rekon Co acquires goods from two different suppliers in Krone (Kr). Rekon Co acquired goods for Kr 150,000 from supplier A and goods for Kr 200,000 from supplier B. Both purchases were made on 1 October 20X1.
On 1 December 20X1, Rekon Co settles the transaction with supplier A. The transaction with supplier B remains unpaid at 31 December 20X1.
Relevant exchange rates can be found below.
1 October 20X1: $1 = Kr 10
1 November 20X1: $1 = Kr 12
31 December 20X1: $1 = Kr 9
On 1 October, Rekon Co must translate the balances for both purchases into $.
Kr 350,000/10 = $35,000
Dr Purchases $35,000
Cr Payables $35,000 ($15k supplier A, $20k supplier B)
On 1 November 20X1, Reckon Co pays supplier A, and the payment must be retranslated at this date. Kr 150,000/12 = $12,500
Dr Payables $15,000 (original amount)
Cr Cash $12,500 (amount translated at payment date)
Cr P/L gain $2,500
Here, Rekon Co has made a gain, as it has only cost $12,500 to settle the liability, which was estimated at $15,000 initially. This gain is taken to the statement of profit or loss.
On 31 December, Rekon Co must retranslate the outstanding balance to supplier B.
Kr 200,000/9 = $22,222. The original payable was estimated at $20,000, so Rekon Co will make a loss on this transaction of $2,222 to reflect the additional cash that is likely to be required on settlement.
Dr P/L loss $2,222
Cr Payable $2,222
The disposal of subsidiaries is now examinable at F7, however, only full disposals of subsidiaries will be examined at F7, with partial disposals being examinable at P2.
A subsidiary that has been disposed of during the year will not be examined within the preparation of consolidated financial statements in a constructed response question. However, it could be examined within an objective test question, or within an interpretation of consolidated financial statements question (see section 3).
Where a company disposes of a subsidiary in the year, it will have the following impact on its financial statements:
- Consolidated statement of financial position – no assets or liabilities of the subsidiary will be included in the consolidated statement of financial position at the year end, as the group will no longer have control over these. Similarly, there will be no non-controlling interest relating to the subsidiary that has been disposed.
- Consolidated Statement of profit or loss – there are two impacts to consider on the consolidated statement of profit or loss:
(a) The results of the subsidiary must be consolidated in the statement of profit or loss up to the date of disposal.
(b) A gain (or loss) on disposal of the subsidiary must be included in the consolidated statement of profit or loss.
When a company values non-controlling interests at fair value, the formula for calculating the gain or loss on disposal of a subsidiary is shown below.
Less: Carrying amount of goodwill at date of disposal
Less: Net assets at date of disposal
Add back: Non-controlling interest at date of disposal
Gain/loss on disposal
The calculation of goodwill included in the above formula is the same as the calculation of goodwill for inclusion in the statement of financial position less any amounts already written off as impaired.
Net assets at the date of disposal are calculated in the same way as you would calculate net assets at acquisition in a goodwill calculation, but instead it is the net assets at a later date that need to be considered. If a subsidiary is disposed during the year, it may be appropriate to time apportion the subsidiary’s profit in the year in order to calculate the retained earnings at the date of disposal.
Non-controlling interest would be calculated in the same way that it would be in the statement of financial position, but would be calculated at the disposal date rather than the reporting date.
In addition to the gain or loss included in the consolidated financial statements, the parent company would also reflect a gain or loss on disposal in its individual financial statements. The calculation of this would be:
Less: Carrying amount of investment at date of disposal
Gain/loss on disposal
The parent company may be holding the investment at cost, or it may be held at fair value through profit or loss/fair value through other comprehensive income. Regardless, the gain to be reported in the holding company’s individual statement of profit or loss is simply the proceeds less the carrying amount of the investment.
Interpretation of consolidated financial statements
While interpretations and consolidated financial statements have both been on the F7 syllabus for some time, from September 2016, an interpretations question may now combine the two elements. This could be done in a number of ways:
(a) Accounting for group-related issues
This could involve calculating goodwill on a newly acquired subsidiary, or calculating the gain/loss on a subsidiary disposed during the year
(b) Adjustments to financial statements
This could involve adjustments such as fair value adjustments, intra-group balances, unrealised profits, impairments or other adjustments associated with the preparation of consolidated financial statements. Adjustments may then require the calculation of ratios from the adjusted figures.
(c) Interpretation of consolidated financial statements
When producing a discussion on the performance or position of the consolidated financial statements, consideration must be given to the impact of the subsidiary on the financial statements.
(d) A combination of some or all of the above
If a subsidiary has been acquired in the year, the following impacts should be considered:
- The current year’s financial statements will contain an entity which was not included in the previous period, so income, expenses, assets and liabilities are all likely to rise following the consolidation.
- If the subsidiary has been acquired during the year, it is unlikely to have contributed a full year’s results in the statement of profit or loss. This could affect ratios such as return on capital employed or working capital ratios at the year end, as the full assets and liabilities are included in the statement of financial position, but only the post-acquisition income and expenses are included in the statement of profit or loss.
- The new subsidiary is likely to have different margins to the rest of the group which will impact on the interpretation.
- The new subsidiary is likely to have different customers, suppliers and inventory, so the working capital cycle is likely to be different.
- Acquisition-related costs may have been included in the current period which will not be repeated in future periods.
- A new subsidiary may result in shared assets and synergies occurring within the group, for example, departments and properties may be merged.
If a subsidiary has been disposed of during the year, the following impacts should be considered:
- Any prior year statement of profit or loss will involve a full year’s results from the subsidiary, while the current year will not.
- Any prior year statement on financial position will contain the assets and liabilities relating to the subsidiary, whereas the current year will not.
- The statement of profit or loss figures may contain the profit or loss on disposal of the subsidiary, and the subsidiary’s results up to the date of the disposal.
- The statement of profit or loss may also contain some one-off costs relating to the disposal of the subsidiary, such as professional costs or redundancies.
- The group may lose benefits from the subsidiary, such as supplies to the group, or skills held by the senior management of the subsidiary.
For exam purposes, the impact of group-related issues on the interpretation of consolidated financial statements is likely to be extensive and a good working knowledge of consolidations is vital.
Written by a member of the F7 examining team