IFRS 18 provides flexibility in classifying foreign exchange differences on intercompany loans

Although IFRS 18 is not yet mandatory, the IFRS Interpretations Committee has already published four new agenda decisions and continues to consider new application questions. This highlights the practical challenges organisations are encountering as they prepare for implementation.

One of the first significant issues considered by the Committee relates to how foreign exchange differences arising from intercompany monetary assets and liabilities should be classified in the statement of profit or loss.

Background

A key implementation question arising from IFRS 18 relates to the classification of foreign exchange differences that remain in consolidated profit or loss after elimination of an intercompany monetary asset or liability. The IFRS Interpretations Committee recently considered the issue and published an agenda decision.

The question arises because IAS 21 The Effects of Changes in Foreign Exchange Rates requires exchange differences on foreign-currency monetary items to be recognised in profit or loss. Where the monetary item is an intercompany loan between entities with different functional currencies, the loan balance is eliminated on consolidation under IFRS 10 Consolidated Financial Statements. However, IAS 21 specifically requires that the resulting foreign exchange difference not be eliminated, because the group remains exposed to currency fluctuations arising from its commitment to convert one currency into another.

Under IFRS 18, foreign exchange differences are generally classified in the same category as the income and expenses that gave rise to them. However, because income and expenses relating to intercompany loans are eliminated on consolidation, uncertainty arises about how the remaining foreign exchange difference should be classified.

Fact pattern considered

The Committee considered a fact pattern involving an intercompany loan between entities with different functional currencies. While the loan itself is eliminated on consolidation, foreign exchange differences recognised under IAS 21 remain in consolidated profit or loss. The issue was how to classify the remaining exchange differences under IFRS 18.

What did the Committee conclude?

The Committee concluded that the exchange difference arises from the intercompany monetary asset or liability itself, rather than from the related cash flows or financing arrangements.

It considered several possible classification approaches, including treating the exchange difference as financing, investing or operating in nature. Ultimately, it determined that two approaches represent reasonable interpretations of IFRS 18.

Entities may therefore either:

1. Classify the exchange difference in the same category that would have applied to the income and expenses from the intercompany loan had they not been eliminated on consolidation, or
2. Classify the exchange difference in the operating category by default.

Practical implications

The agenda decision effectively provides entities with an accounting policy choice. For organisations with significant foreign currency intercompany funding arrangements, that choice could materially affect IFRS 18 profit or loss subtotals and management-defined performance measures (MPMs). Foreign exchange differences on intercompany loans can be material and volatile, particularly for multinational groups with centralised treasury structures.

The agenda decision may also create implementation challenges for entities that choose to classify foreign exchange differences in the same category as the income and expenses from the intercompany loan would have been classified before elimination on consolidation.

To apply this approach consistently, a consolidated group may need systems capable of:

• Identifying the underlying intercompany monetary item
• Determining how related income or expenses would have been classified under IFRS 18
• Tracking differences at a consolidated level, and
• Applying the "undue cost or effort" exemption in paragraph B68 of IFRS 18, where relevant.

As a result, entities adopting IFRS 18 should carefully assess their policy choice, consider its impact on profit or loss subtotals and management-defined performance measures (MPM), and ensure clear disclosure of the approach adopted.

More information

This agenda decision is one of several emerging issues organisations are considering as part of their IFRS 18 implementation projects. Our IFRS 18 resources, webinars and masterclass series explore these challenges in more detail.

Need help

IFRS 18 introduces a range of new judgements and presentation requirements. Our team of experts can help you assess the implications for your organisation, evaluate policy choices and prepare for implementation.