IFRIC 22: Foreign Currency Transactions and Advance Consideration
International Financial Reporting Interpretations Committee (IFRIC) 22 provides guidance on how to account for foreign currency transactions and advance consideration. It clarifies the treatment of foreign currency transactions when there is an exchange rate difference between the transaction date and the date of when consideration is paid or received.
Definitions:
Foreign Currency Transaction: A transaction that is denominated in a currency other than an entity’s functional currency.
Advance Consideration: Consideration that is received or paid before the recognition of the related asset, expense, or income.
Explanation:
IFRIC 22 addresses the accounting treatment of foreign currency transactions when there is a time lag between the transaction date and the date of when consideration is paid or received. The standard requires entities to recognize the foreign currency transaction at the spot exchange rate on the transaction date, which is the exchange rate at the date of the initial recognition of the asset, liability, income, or expense. Any difference between the spot exchange rate on the transaction date and the spot exchange rate on the date when the consideration is paid or received is recognized as a gain or loss in the income statement, unless it is deferred in equity as part of a qualifying cash flow hedge.
Examples:
Company A, a US-based entity, enters into a sales contract with Company B, a UK-based entity, to sell goods for £10,000 on December 1, 2022, with payment due on January 31, 2023. The spot exchange rate on December 1, 2022, is $1.30/£, and the spot exchange rate on January 31, 2023, is $1.35/£. Company A recognizes the sales revenue of $13,000 ($1.30/£ × £10,000) on December 1, 2022, and recognizes a foreign exchange gain of $500 (($1.35/£ – $1.30/£) × £10,000) in its income statement on January 31, 2023, when the consideration is received.
Company C, a Canadian-based entity, enters into a purchase contract with Company D, a US-based entity, to buy equipment for $50,000 on January 1, 2023, with payment due on February 28, 2023. The spot exchange rate on January 1, 2023, is CAD 1.40/USD, and the spot exchange rate on February 28, 2023, is CAD 1.45/USD. Company C recognizes the equipment as an asset at CAD 70,000 (CAD 1.40/USD × $50,000) on January 1, 2023, and recognizes a foreign exchange loss of CAD 3,500 (CAD 1.45/USD – CAD 1.40/USD) × $50,000) in its income statement on February 28, 2023, when the consideration is paid.
Case Studies:
Company E, a German-based entity, enters into a lease agreement with Company F, a French-based entity, for a building for €100,000 on October 1, 2022, with payment due on November 30, 2022. The spot exchange rate on October 1, 2022, is €1.20/USD, and the spot exchange rate on November 30, 2022, is €1.18/USD. Company E recognizes the lease liability of $120,000 (€100,000 × €1.20/USD) on October 1, 2022, and recognizes a foreign exchange gain of $2,000 (($1.18/ USD – €1.20/USD) × €100,000) in its income statement on November 30, 2022, when the consideration is paid.
Company G, a Japanese-based entity, enters into a service contract with Company H, a Chinese-based entity, for services worth CNY 1,000,000 on September 1, 2022, with payment due on October 31, 2022. The spot exchange rate on September 1, 2022, is JPY 0.0058/CNY, and the spot exchange rate on October 31, 2022, is JPY 0.0060/CNY. Company G recognizes the service revenue of JPY 172,413,793 (CNY 1,000,000 ÷ JPY 0.0058/CNY) on September 1, 2022, and recognizes a foreign exchange loss of JPY 1,724,138 (JPY 0.0060/CNY – JPY 0.0058/CNY) × CNY 1,000,000) in its income statement on October 31, 2022, when the consideration is received.
In both case studies, the exchange rate difference between the transaction date and the date when consideration is paid or received results in foreign exchange gains or losses, which are recognized in the income statement accordingly.
In conclusion, IFRIC 22 provides guidance on how to account for foreign currency transactions and advance consideration, particularly when there is a time lag between the transaction date and the date of when consideration is paid or received. It requires entities to recognize foreign currency transactions at the spot exchange rate on the transaction date and recognize any exchange rate differences as gains or losses in the income statement, unless they are deferred in equity as part of a qualifying cash flow hedge. Examples and case studies illustrate the application of the standard in various scenarios, helping entities to appropriately account for foreign currency transactions and advance consideration in their financial statements.