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Institute of Chartered Accountants of New Zealand Institute of Chartered Accountants of New Zealand

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Institute of Chartered Accountants of New Zealand Institute of Chartered Accountants of New Zealand Powered By Docstoc
					       Institute of Chartered Accountants of New Zealand
                            December 2003




               Request for Comment on
    Discussion Paper, Exposure Draft NZ IAS 21
The Effects of Changes in Foreign Exchange Rates and
      Exposure Draft Interpretation NZ SIC-7
                Introduction of the Euro




            Issued by the Financial Reporting Standards Board
            Institute of Chartered Accountants of New Zealand




                                                                1
Discussion Paper and Exposure Drafts
NZ IAS 21 The Effects of Changes in Foreign Exchange Rates
NZ Interpretation SIC-7 Introduction of the Euro
December 2003

Request for Comments on ED NZ IAS 21 and ED NZ SIC-7

Commenting on these Exposure Drafts
The FRSB is in the process of formulating the New Zealand (NZ) equivalent to IAS
21 The Effects of Changes in Foreign Exchange Rates and Interpretation SIC-7
Introduction of the Euro. It seeks comments from constituents on the proposals set
out in the Discussion Paper and the Exposure Drafts.

Comments should be addressed to:

The Director – Accounting & Professional Standards
Institute of Chartered Accountants of New Zealand
PO Box 11342
WELLINGTON
E-mail: ASD@icanz.co.nz
Fax: (04) 472 6282

The due date for comments to the FRSB is 28 February 2004.



It would be appreciated if respondents include a copy of the comments in
electronic form as that allows for the efficient collation and analysis of
comments. Comments will be made available to the public unless otherwise
requested.


CONTENTS
Discussion Paper
ED NZ IAS 21 The Effects of Changes in Foreign Exchange Rates
ED NZ SIC-7 Introduction of the Euro




                                                                                 2
DISCUSSION PAPER

Introduction
The Financial Reporting Standards Board (FRSB) is implementing the Accounting
Standards Review Board’s (ASRB) decision to adopt International Financial
Reporting Standards (IFRS)1 issued by the International Accounting Standards Board
(IASB). Application of the standards will be to reporting periods beginning on or after
1 January 2007 (or, in the case of entities choosing to adopt early, reporting periods
beginning on or after 1 January 2005).

The ASRB and the FRSB have agreed that New Zealand (NZ) standards should
continue to apply to both profit-oriented and public benefit entities. Standards issued
by the IASB have been developed for application to profit-oriented entities. As a
consequence, the FRSB intends, where necessary, to introduce additional material to
the international standards to ensure that they can be applied in the New Zealand
environment by all reporting entities. The resulting standards will be referred to as NZ
IFRS or NZ IAS, as appropriate.

Constituents are directed to the FRSB’s document on the Process for Adoption of
IFRSs at www.icanz.co.nz for further information.

Objectives
The objectives of the FRSB’s exposure of IFRS are:
 to ensure reasonable steps are taken to obtain submissions from persons or
   organisations or their representatives who will be affected by the adoption of the
   standard and, in particular, by the proposed New Zealand specific changes to the
   IFRS;
 to identify issues in relation to the IFRS that the FRSB should raise with the
   IASB; and
 to alert constituents to changes in financial reporting as a result of adoption of
   international accounting standards.

Differential Reporting
This Exposure Draft does not include differential reporting exemptions. The Ministry
of Economic Development (MED) is currently reviewing the financial reporting
structure in New Zealand. The outcome of the MED’s review will determine which
types of entities are required to apply NZ IFRS2.

The Effects of Changes in Foreign Exchange Rates
International Accounting Standard IAS 21 prescribes the accounting treatment for the
effects of changes in foreign exchange rates. The IASB recently revised IAS 21 as
part of its project on Improvements to International Accounting Standards (IAS 21
(2003)). The current New Zealand equivalents to IAS 21 are Financial Reporting
Standard FRS-21: Accounting for The Effects of Changes in Foreign Currency

1
  Unless otherwise specified, IFRS refer to International Accounting Standards (IAS) (inherited by the
IASB from its predecessor body), IFRSs, and the interpretations of both types of standards.
2
   Refer to the article by Liz Hickey and Tony van Zijl “The proposed new financial reporting
structure”, Chartered Accountants Journal, May 2003, pp 54-55, for a discussion on the proposed
financial reporting structure.


                                                                                                    3
Exchange Rates (FRS-21) and Statement of Standard Accounting Practice SSAP-21:
Accounting for The Effects of Changes in Foreign Currency Exchange Rates (SSAP-
21).

Proposed NZ IAS 21
The FRSB has reviewed IAS 21 (2003) and proposes to adopt all the requirements of
the standard for the New Zealand equivalent (NZ IAS 21) for all reporting entities in
New Zealand, whether profit-oriented or public benefit entities.

ED NZ IAS 21 prescribes the accounting treatment for foreign currency transactions
and the translation of the financial reports of foreign operations. The ED requires
each entity, whether a stand-alone entity, a parent or an operation within a group (e.g.
subsidiary, associate or branch), to determine its functional currency and measure its
results and financial position in that functional currency. ED NZ IAS 21 defines
“functional currency”3 as the currency of the primary economic environment in which
the entity operates (ED NZ IAS 21.8).

A foreign currency transaction should be recorded initially in the functional currency
at the rate of exchange at the date of the transaction (use of averages is permitted if
they are a reasonable approximation of actual). At each subsequent balance date,
foreign currency monetary balances are translated using the closing rate. Differences
arising on the settlement or on the retranslation of foreign currency monetary items at
rates different to those at which they were originally recorded should be dealt with as
an income or expense in the period in which they arise.

Non-monetary items should be reported using the exchange rate at the date of the
transaction (where the item is carried at historical cost) or at the rate that existed when
the values were determined (for non-monetary items carried at fair value). For these
latter items, the treatment of foreign exchange differences on translation follows how
the change in the value of item is accounted for under relevant standards.

The ED requires the determination of the functional currency of each foreign
operation. A foreign operation with the same functional currency as the reporting
entity (e.g. parent) will not need to retranslate its financial reports. Therefore, only
one method of translation is needed for foreign operations (foreign operations with a
different functional currency than the reporting entity). Under this method, assets and
liabilities are translated at the closing rate, and the income and expenses are translated
at the exchange rates at the dates of the transactions (or the average rate for the period
where this is a reasonable approximation). Exchange differences arising on
translating the financial statements of a foreign operation are taken to a separate
component of equity. ED NZ IAS 21 requires that any exchange differences
remaining in equity relating to a foreign operation that is disposed of are to be
recycled to the statement of financial performance at the date of the disposal.

3
  If the functional currency of an entity is a currency of a hyperinflationary economy, ED NZ IAS 21
requires the financial statements to be restated under NZ IAS 29 Financial Reporting in
Hyperiflationary Economies (NZ IAS 29), except for comparative amounts that are translated into a
currency of a non-hyperinflationary economy. IAS 29 requires that these financial statements be
restated in units of the same purchasing power, using the unit current at the balance dates (units of
current purchasing power). For further information consult the discussion paper and exposure draft for
NZ IAS 29. These documents can be obtained from www.icanz.co.nz.


                                                                                                    4
The ED permits an entity (whether a group or a stand-alone entity) to presents its
financial statements in any currency or currencies (defined as the presentation
currency). Translation from an entity’s functional currency to a different presentation
currency is achieved by using the same method as described in the paragraph above
for translating a foreign entity’s financial reports where its functional currency is
different to the functional currency of the reporting entity as discussed above.

Proposed NZ Interpretation SIC-7
The FRSB has reviewed SIC-7 and proposes to adopt all the requirements of the
interpretation for the New Zealand equivalent (NZ SIC-7) for all reporting entities in
New Zealand, whether profit-oriented or public benefit entities. The proposed
interpretation is an interpretation of the application of NZ IAS 21 to the changeover
from the national currencies of participating member states of the European Union to
the Euro. This may be useful for NZ entities with European subsidiaries that may in
the future be adopting the Euro.

New Zealand Additional Material
Additional material applicable to all entities or to public benefit entities is shown with
grey shading and paragraphs denominated with “NZ”. The additional material in ED
NZ IAS 21 and ED NZ SIC-7 relates solely to generic changes. The FRSB considers
that this ED should not contain any additional material for public benefit entities.

Transitional Provisions and Effective Date
The transitional provisions and effective date in ED NZ IAS 21 and ED NZ SIC-7 has
been amended. Entities adopting the proposed NZ IAS 21 for the first time will be
required to comply with the requirements of the proposed NZ IFRS 1 First-time
Adoption of New Zealand International Financial Reporting Standards.

References
The FRSB proposes to change all references to other international standards in the
proposed NZ IAS 21 and SIC-7 to the New Zealand equivalent of those international
standards. For example, references to IAS XX will be changed to NZ IAS XX.

Comparison of ED NZ IAS 21 with FRS-21 and SSAP-21
The table below outlines the significant differences between ED NZ IAS 21 with
FRS-21 and SSAP-21.

ED NZ IAS 21                        FRS-21 and SSAP-21                  Analysis
Scope
ED NZ IAS 21 excludes foreign       FRS-21 deals with the               ED NZ IAS 21 will require that
currency derivatives that are       classification of exchange          foreign currency derivatives that
within the scope of NZ IAS 39       differences arising on a foreign    fall under the scope of NZ IAS
Financial Instruments:              currency liability accounted for    39 be exempted from its
Recognition and Measurement         as a hedge of a net investment in   requirements. This includes the
(NZ IAS 39). An example of          an independent foreign              hedge of a net investment in an
foreign currency derivatives that   operations.                         independent foreign operation
fall under the scope of ED NZ       (FRS-21 3.2, 6.9)                   previously accounted for under
IAS 21 are some foreign                                                 FRS-21 and hedge accounting
currency derivatives that are       SSAP-21 contains requirements       previously accounted for under
embedded in other contracts.        for certain hedges.                 SSAP-21.
(ED NZ IAS 21.3-4)                  (SSAP-21 4.17-5.13)



                                                                                                        5
ED NZ IAS 21                        FRS-21 and SSAP-21                   Analysis
                                    Life insurers that                   Life insurers are not exempted
                                    comprehensively adopt market         from any requirements of ED
                                    value accounting were not            NZ IAS 21. Life insurers were
                                    required to comply with the          previously exempted from
                                    requirement for a foreign            certain requirements of FRS-21.
                                    currency translation reserve for
                                    an independent foreign
                                    operation.
                                    (FRS-21 2.3)

ED NZ IAS 21 does not deal          FRS-21 6.5(d) requires that cash     While ED NZ IAS 21 does not
with the presentation of items in   inflows and outflows shall be        deal with foreign currency
statements of cash flows arising    translated at the spot rate at the   issues to do with the statement
from transactions in a foreign      date of the cash flow or at a rate   of cash flows, it does offer
currency, or with the translation   approximating that rate for the      principles to govern the
of cash flows of a foreign          purposes of translating the          translation of the statement of
operation (See NZ IAS 7 Cash        statement of cash flows of an        cash flows. It does not,
Flow statements (NZ IAS 7)).        independent foreign operation.       however, contain any
(ED NZ IAS 21.7)                    FRS 21.8(f) requires the             disclosures for the statement of
                                    disclosure of the effect of          cash flows. These are found in
                                    translating the opening cash         NZ IAS 7.
                                    balance and the cash flows
                                    during the accounting period at
                                    rates different from the
                                    exchange rate used to translate
                                    the closing cash balance. The
                                    effect shall be reported, in the
                                    statement of cash flows, as part
                                    of the reconciliation of the
                                    change in cash in the period.
Definitions
The following are definitions in    FRS-21 uses the following            ED NZ IAS 21 follows a
ED NZ IAS 21 that are not           terms differently from ED NZ         different approach to FRS-21
found in or are substantially       IAS 21 :                             and SSAP-21. The FRS-21
different from those found in        “foreign currency” is a            notion of a reporting currency is
FRS-21 and SSAP 21 :                    currency other than the          similar to the ED NZ IAS 21
 functional currency is the            reporting currency of the        definition of presentation
     currency of the primary            entity reporting.                currency. However, ED NZ
     economic environment in         “reporting currency” is the        IAS 21 introduces the notion of
     which the entity operates;         currency used in presenting      a functional currency.
 presentation currency is the          the financial report.
     currency in which the                                               ED NZ IAS 21 requires each
     financial statements are     The following are terms defined        entity (whether it be stand-
     presented; and               in FRS-21 but are not defined in       alone, parent subsidiary, joint
 foreign currency is a           ED NZ IAS-21:                          venture or branch) to determine
     currency other than the       entity reporting;                    its “functional currency” and to
     functional currency.          foreign currency monetary            translate all transactions
(ED NZ IAS 21.8)                       liability;                        transacted in other currencies
                                   foreign operation;                   into its functional currency.
                                   monetary items;                      Under ED NZ IAS 21 entities
                                                                         can select one or more
                                   settlement date;
                                                                         presentation currencies.
                                   transaction date; and
                                   translation.
                                  (FRS-21 4.2-4.17)
Determining the entity’s functional currency
Primary indicators of an entity’s FRS-21/SSAP-21 does not                ED NZ IAS 21 follows a
functional currency are:          contain any indicators of an           different approach to FRS-
 the currency that mainly        entity’s functional currency.          21/SSAP-21.



                                                                                                            6
ED NZ IAS 21                         FRS-21 and SSAP-21          Analysis
    influences sales prices for
    goods and services (this                                     ED NZ IAS 21 requires each
    will often be the currency in                                entity (whether it be stand-
    which sales prices for its                                   alone, parent subsidiary, joint
    goods and services are                                       venture or branch) to determine
    denominated and settled);                                    its “functional currency” using
 the currency of the country                                    the primary indicators first and
    whose competitive forces                                     second the additional supporting
    and regulations mainly                                       evidences.
    determine the sales price of
    its goods and services; and                                  NZ entities cannot assume that
 the currency that mainly                                       their functional currency is the
    influences labour, material                                  NZ dollar or, if different, the
    and other costs of providing                                 currency in which their financial
    goods or services (this will                                 reports, before their transition to
    often be the currency in                                     NZ IFRS, are presented in.
    which such costs are
    denominated and settled).                                    Furthermore, if the functional
(ED NZ IAS 21.9)                                                 currency is of a
                                                                 hyperinflationary economy an
Additional supporting evidence                                   entity is required to apply NZ
of an entity’s functional                                        IAS 29. NZ IAS 29 does not
currency:                                                        provide a definition of
 the currency in which funds                                    hyperinflation but provides
     from financing activities (ie                               some guidance on determining
     issuing debt and equity                                     if a currency is of a
     instruments) are generated.                                 hyperinflationary economy.
 the currency in which                                          The NZ dollar is not a currency
     receipts from operating                                     of a hyperinflationary economy.
     activities are usually                                      However, NZ entities may have
     retained.                                                   foreign operations with
(ED NZ IAS 21.10)                                                functional currencies that are of
                                                                 hyperinflationary economies.
If the functional currency is the                                The IFRIC is currently
currency of a hyperinflationary                                  developing an interpretation on
economy, the entity’s financial                                  how entities should apply IAS
reports must be restated under                                   29 in the first year it identifies
NZ IAS 29.                                                       the existence of hyperinflation.
(ED NZ IAS 21.14)                                                The FRSB intend to issue this
                                                                 draft interpretation
                                                                 simultaneously with IFRIC.
Short-term transactions covered by forward exchange contract
                                 For short term transactions     All hedging measurement
                                 covered by forward exchange     requirements are dealt in NZ
                                 contracts, the forward rates    IAS 39.
                                 specified in those contracts
                                 should be used as the basis for
                                 measuring and reporting the
                                 transactions. (SSAP-21 5.3)
Accounting for foreign currency balances where the carrying amounts of some items are
determined by comparing two or more amounts
ED NZ IAS 21 provides            FRS-21 and SSAP-21 do not       ED NZ IAS 21 has more
guidance on selecting the        deal with this issue.           explicit requirements than FRS-
appropriate measurement basis                                    21 on the determination of the
where the carrying amount of an                                  carrying amount of a foreign
asset or liability is determined                                 currency item where another
by comparing two or more                                         standard requires the carrying
amounts. For example, under                                      amount of the item to be
IAS 36 Impairment of Assets,                                     determined by comparing two or



                                                                                                  7
ED NZ IAS 21                      FRS-21 and SSAP-21                  Analysis
the carrying amount of an asset                                       more amounts.
for which there is an indication
of impairment is the lower of its                                     The effect of this comparison
carrying amount before                                                may be that an impairment loss
considering possible impairment                                       is recognised in the functional
losses and its recoverable                                            currency but would not be
amount. When such an asset is                                         recognised in the foreign
non-monetary and is measured                                          currency, or vice versa.
in a foreign currency, the
carrying amount is determined
by comparing:
  (a) the cost or carrying
  amount, as appropriate,
  translated at the exchange rate
  at the date when that amount
  was determined, and
  (b) the net realisable value or
  recoverable amount, as
  appropriate, translated at the
  exchange rate at the date when
  that value was determined.
(ED NZ IAS 21.25)
Classification of foreign operations
Each foreign operation and/or     FRS-21 requires the                 ED NZ IAS 21 will require the
entity in a group will have to    examination of the relationship     determination of the functional
decide its own functional         between foreign operation and       currency of each foreign
currency.                         the reporting entity to determine   operation.
                                  the method of translating the
                                  foreign operation’s financial       If their results must be
                                  information. Foreign operations     consolidated (with a parent),
                                  are classified as either an:        and their functional currency is
                                   independent foreign               different from that of the parent,
                                        operation or                  the general translation
                                   integrated foreign                provisions prescribe the
                                        operation.                    translation process from
                                  (FRS-21 6.1)                        functional to presentation
                                  An integrated foreign operation     currency.
                                  is translated using the temporal
                                  method and an independent           While the approach in ED NZ
                                  foreign operation is translated     IAS 21 differs from FRS-21,
                                  using the current rate method.      their results may be similar.
                                  (FRS-21.6.5-15)
Determining the functional currency of a foreign operation
The following additional factors The factors used to determine        The functional currency of each
to those discussed above under    whether the functional currency     foreign operation must be
Determining the entity’s          of foreign operations is the same   determined using the factors
functional currency are           as the reporting entity have        found in ED NZ IAS 21.
considered in determining         some similarity to those in the
whether the functional currency FRS-21 commentary on the              Despite similarities at face value
of a foreign operation is the     factors that indicate whether the   between the factors in ED NZ
same as that of the reporting     activities of a foreign operation   IAS-21 used to decide if the
entity:                           are an integral part of those of    foreign operation’s functional
 whether the activities of the the entity reporting.                 currency is the same as the
     foreign operation are        (FRS-216.3-6.4)                     reporting entity and those in
     carried out as an extension                                      FRS-21 used to decide if the
     of the reporting entity,                                         activities of a foreign operation
     rather than being carried                                        are integral to reporting entity,
     out with a significant                                           these standards require differing
     degree of autonomy.                                              treatment. Therefore, it cannot


                                                                                                        8
ED NZ IAS 21                       FRS-21 and SSAP-21                  Analysis
 whether transactions with                                            be assumed that the integrated
     the reporting entity are a                                        foreign operation under FRS-21
     high or low proportion of                                         is automatically a foreign
     the foreign operation’s                                           operation with the same
     activities.                                                       functional currency as the
 whether cash flows from                                              reporting entity under ED NZ
     the activities of the foreign                                     IAS 21.
     operation directly affect the
     cash flows of the reporting
     entity and are readily
     available for remittance to
     it.
 whether cash flows from
     the activities of the foreign
     operation are sufficient to
     service existing and
     normally expected debt
     obligations without funds
     being made available by the
     reporting entity.
Goodwill and fair value adjustments resulting from the purchase of a foreign operation
Any goodwill arising on the        FRS-21 requires any goodwill        ED NZ IAS 21 requires one
acquisition of a foreign           arising from the acquisition of     method of measuring goodwill
operation and any fair value       an independent foreign              and any fair value adjustments
adjustments to the carrying        operation and any fair value        to the carrying amounts of
amounts of assets and liabilities adjustments to the carrying          assets and liabilities arising on
arising on the acquisition of that amounts of assets and liabilities the acquisition of the foreign
foreign operation shall be         arising on the acquisition of that operation out of the two allowed
treated as assets and liabilities  foreign operation are treated as    by FRS-21.
of the foreign operation. It       either:
follows that they shall be           (a) assets and liabilities of the
expressed in the functional          independent foreign operation
currency of the foreign              and translated at the closing
operation and shall be translated    rate; or
at the closing rate consistent       (b) assets and liabilities of the
with the requirements of this        entity reporting which either
Standard.                            are already expressed in the
(ED NZ IAS 21.47)                    reporting currency, or are non-
                                     monetary foreign currency
                                     items which are reported using
                                     the exchange rate at the date
                                     of the transaction.
                                   (FRS-21.6-12)
Hedge of an investment in an independent foreign operation
ED NZ IAS 21 excludes this         Where a net investment in an        NZ IAS 39 contains all hedging
from the scope of this standard.   independent foreign operation is requirements and as part of that,
(ED NZ IAS 21.5)                   translated at the closing rate,     the hedge of an investment in an
                                   any exchange difference is          independent foreign operation.
                                   recognised in the foreign
                                   currency translation reserve.
                                   Where a foreign currency
                                   monetary liability is designated
                                   as a hedge of that net
                                   investment, any exchange
                                   difference in translating that
                                   liability should also be
                                   recognised in the foreign
                                   currency translation reserve.
                                   (FRS-21 4.10, 6.9)


                                                                                                       9
ED NZ IAS 21                         FRS-21 and SSAP-21                 Analysis
Disposal of a foreign operation
ED NZ IAS 21 requires on the          FRS-21 does not permit the        ED NZ IAS 21 requires the
disposal of a foreign operation,     accumulated amount of              recycling of foreign exchange
the cumulative amount of the         exchange differences to be taken   differences, previously
exchange differences that have       to income statement or             recognised in equity, though the
been deferred in the separate        recognised in the statement of     statement of financial
component of equity and relate       movements in equity. These         performance on the disposal of a
to that foreign operation shall be   exchange differences are           foreign operation which is
recognised as income or              transferred out of foreign         contrary to FRS-21.
expense when the gain or loss        currency translation reserve to
on disposal is recognised.           another equity account.
(ED NZ IAS 21.38-39)                 (FRS-21 6.18-20)

Disclosures
                                                                        ED NZ IAS 21 and FRS-21
                                                                        have different disclosure
                                                                        requirements. Interested parties
                                                                        should consult ED NZ IAS 21 to
                                                                        understand the required
                                                                        disclosures.

Request for Comments
The FRSB produced ED NZ IAS 21 based on IAS 21 (2003) and ED NZ SIC-7 based
on SIC-7, marked up with the FRSB’s proposed New Zealand specific material. The
FRSB seeks comments on the adoption of ED NZ IAS 21 and ED NZ SIC-7 and
would like respondents to express a clear overall opinion on whether the proposed
adoption, as a whole, is supported. Comments are also invited on the specific matters
raised in this Discussion Paper. The FRSB would prefer that respondents supplement
their opinions by detailed comments, whether supportive or critical, on the major
issues. The FRSB regards both critical and supportive comments as essential to a
balanced review and will consider all submissions, whether they address all specific
matters, additional issues or only one issue.

Specific Matters for Comment
The FRSB would value comments on:

1) Whether the proposed NZ IAS 21 or NZ SIC-7 should contain any additional
   material to allow public benefit entities to comply with the standard and what
   other additional material it should contain;

2) Whether there are any regulatory or other issues arising in the New Zealand
   environment that may affect the implementation of the proposals, particularly any
   issues relating to:
     a)    public benefit entities;
     b) public sector profit-oriented entities; and
     c)    issues relating to the Privacy Act 1993;

3) Whether there are any issues arising from the proposed standard arising from ED
   NZ IAS 21 and ED NZ SIC-7 that you consider the FRSB should raise with the
   IASB; and




                                                                                                     10
4) Whether adoption of the proposed standard arising from ED NZ IAS 21 and ED
   NZ SIC-7 is in the best interests of users of general purpose financial reports in
   New Zealand.




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