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Topic 1 – What are the major issues addressed by accountants when dealing with international financial transactions? How and why do accountants mitigate risk in such instances?

The major issues addressed by accountants in dealing with international financial transactions include:

  1. Conversion of individual transactions incurred in foreign currency into the functional currency (or the currency of economic environment where the reporting entity operates) and/or presentation currency if difference from functional currency;
  2. Translation of year-end balances denominated in various foreign currencies into a single currency for reporting purpose;
  3. In case of foreign operations whose financial statements are made in a foreign currency, those figures need to be translated into a common currency for the purpose of consolidation of financial statements;
  4. Where financial assets and liabilities are incurred in foreign currencies, the entity is exposed to the risk of fluctuation in assets and liabilities owing to the changes in foreign exchange rates. To minimize this risk entities often enter into hedging arrangements which need to be reporting according to the requirements of hedge accounting.

How these risks are mitigated by accountants and the problems encountered therein are briefly discussed hereunder:

(i) Individual transactions incurred in foreign currency

To determine a single currency into which all international transactions shall be translated, the concept of functional currency is used and several factors are considered in determine what is reporting entity’s functional currency in accordance with paragraph 9 and 10 of AASB 121. These include:

  • Currency that influences the sales price of goods and services sold by the entity,
  • Currency of the country whose competitive demand and supply forces determine the sales price for the entity’s goods and services,
  • Currency that influences the labour costs, material costs and other overhead incurred,
  • Currency in which fundraising activities (issuing shares or bonds) are done,
  • Currency in which profits are retained by the entity.

These factors combinely determine the functional currency of entity and thereafter all foreign currency transactions are recognized in the financial statement of reporting entity by applying the spot exchange rate on the date of transaction. Similarly, the settlement of this transaction in cash or otherwise should be recorded using the spot exchange rate on the settlement date. The resulting exchange differences that arise due to difference in exchange rates are required to be recognized in profit and loss statement in the period in which they are incurred (paragraph 28, AASB 121).

(ii) Translation of year-end balances in foreign currency

Once the functional currency is determined, an issue arises for the translation into functional currency of different line items of financial statements that are measured using different measurement models, such as fixed assets measured using cost or revaluation model of AASB 116 or financial liabilities measured under the requirements of AASB 9 Financial Instruments.

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