Interpretation to clarify translation of advance consideration on foreign currency transactions – Interpretation 22

Interpretation 22 Foreign Currency Transactions and Advance Consideration was issued by the International Accounting Standards Board (IASB) in December 2016 to clarify the ‘date of the transaction’ for the purposes of translating foreign currency transactions where consideration is received or paid in advance under AASB 121 The Effects of Changes in Foreign Exchange Rates.

The interpretation was approved by the Australian Accounting Standards Board (AASB) in February 2017.

This interpretation is likely to impact entities in the construction industry with foreign currency advance receipts or payments.

A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction. AASB 121, paragraph 21 The date of a transaction is the date on which the transaction first qualifies for recognition in accordance with Australian Accounting Standards… Extract of AASB 121, paragraph 22

What exchange rate do we currently use to translate cash received or paid in advance for a foreign currency denominated transaction?

When an entity receives consideration in advance of recognising revenue in the income statement, it recognises both the consideration received, and a non-monetary liability (deferred income or contract liability) in the statement of financial position at the spot rate of exchange on the date that consideration is received.

There is currently diversity in practice when the deferred income is subsequently recognised in the income statement as revenue. This means that revenue is either being recognised:

• Option 1 – For the amount at which the deferred income was originally recognised, i.e. when the consideration was originally received, or
• Option 2 – At the amount of consideration received, translated at the exchange rate applicable on the date the non-monetary item is released to the income statement as revenue. This would result in a foreign exchange gain /loss being recognised in the income statement (for the movement between the spot rate on the date the cash was received, and the spot rate on the date when the revenue in recognised in the income statement).

Similar diversity exists for other types of transactions where consideration is both denominated in a foreign currency and paid or received in advance, for example, purchases and sales of PPE, intangibles and investment property, purchases of inventory or services, entering into lease contracts, and receipt of some government grants.

Interpretation 22 consensus - What exchange rate should we use to recognise revenue, expenses or assets when they first qualify for recognition in accordance with Accounting Standards?

Interpretation 22 specifies that we should use the rate in Option 1 above, i.e. the spot rate on the date when the cash was received or paid in advance, and the non-monetary asset or liability was initially recognised.

This means that the related income, expense or asset is not remeasured for changes in the spot rate occurring between the date of initial recognition of the advance consideration, and the date of recognition of the transaction to which that consideration relates.

Simple example

On 1 January 2016, Entity ABC entered into a contract with a supplier to purchase PPE for USD 5,000. Delivery is expected in Australia on 30 June 2016, but Entity ABC must pay the full purchase price on 1 April 2016. The amount is non-refundable.

Assume exchange rates are as follows:

1 April 2016       AUD 1: USD 0.75

30 June 2016     AUD 1: USD 0.70

Entity ABC’s functional currency is AUD.

The following will be recorded in the books of Entity ABC:

1 April 2016
	AUD	AUD
Dr Prepayment (non-monetary asset)	6,667
Cr Cash		6,667
Being USD 5000 / 0.75
30 June 2016
Dr PPE	6,667
Cr Prepayment		6,667
No further adjustment to non-monetary asset

The Illustrative Examples to Interpretation 22 include more examples of accounting where there are multiple prepayments.

Scope exceptions

Interpretation 22 only applies in cases where the foreign currency advance consideration results in the recognition of a non-monetary asset or liability. However, it does not apply to payments and receipts for income taxes and insurance contracts (including reinsurance contracts) that it issues or reinsurance contracts that it holds.

Interpretation 22 also does not apply when the asset, expense or income:

• Is initially measured at fair value - This exception might be relevant where consideration is paid or received in advance for transactions involving financial assets, financial liabilities, and identifiable assets and liabilities in a business combination, or
• Is required by another IFRS to be measured at the fair value of the consideration paid or received at a date other than the date on which the non-monetary asset or liability was initially recognised - This exception might be relevant to non-cash consideration included in the measurement of revenue in accordance with AASB 15 Revenue from Contracts with Customers.

Effective date

Type of entity	Effective date
For-profit entities	Annual periods beginning on or after 1 January 2018
Not-for-profit entities	Annual periods beginning on or after 1 January 2019

All types of entities can adopt these changes early, but must disclose that fact.

Transition

On initial application, an entity may apply Interpretation 22 either:

1. Retrospectively in accordance with AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, or
2. Prospectively to transactions recognised on or after the beginning of:
   1. The reporting period in which the entity first  applies the interpretation, or
   2. A prior period presented as comparative information in the financial statements of the reporting period in which the entity first applies the Interpretation.

Where the ‘prospective’ method is used, the new requirements are applied to assets, expenses and income recognised on or after the beginning of the reporting periods in (b)(i) and (b)(ii) above for which the entity has recognised non-monetary assets/liabilities arising from advance consideration before that date. For example:

• Method (b)(i) – If 1 January 2018 is used as ‘date of initial application’, all cash advances recognised prior to 1 January 2018 where the asset, expense or income is recognised on or after 1 January 2018 will need to be accounted for using Interpretation 22 (i.e. no adjustment to exchange rate), and
• Method (b)(ii) – If comparatives are adjusted back to 1 January 2017 for a 1 January 2018 ‘date of initial application’, all cash advances recognised prior to 1 January 2017 where the asset, expense or income is recognised on or after 1 January 2017 will need to be accounted for using Interpretation 22 (i.e. no adjustment to exchange rate).