SIC-11, which stands for “Foreign Exchange – Capitalisation of Losses Resulting from Severe Currency Devaluations,” is a standard issued by the International Accounting Standards Committee (IASC) that provides guidance on accounting for losses resulting from severe currency devaluations. In this article, we will provide definitions, explanations, examples, and case studies of SIC-11 in 1200 words.
Definitions:
Severe Currency Devaluations: Severe currency devaluations refer to significant and rapid declines in the value of a country’s currency in relation to another currency. These devaluations can result from various factors, such as economic instability, political events, or changes in exchange rate policies, and can have a significant impact on the financial statements of entities operating in that country.
Capitalisation of Losses:
Capitalisation of losses refers to the practice of treating losses resulting from severe currency devaluations as a part of the cost of an asset rather than recognizing them as expenses in the income statement. This allows entities to spread the impact of these losses over a longer period of time, instead of recognizing them immediately as a one-time expense.
Explanations:
SIC-11 provides guidance on how to account for losses resulting from severe currency devaluations. When a severe currency devaluation occurs, the functional currency of an entity, which is the currency of the primary economic environment in which the entity operates, may change. SIC-11 requires entities to determine the functional currency in accordance with the guidance provided in International Accounting Standards (IAS) 21, “The Effects of Changes in Foreign Exchange Rates.”
If an entity’s functional currency changes due to a severe currency devaluation, SIC-11 allows the entity to capitalize the losses resulting from the devaluation as a part of the cost of an asset, provided that certain conditions are met. These conditions include:
The losses are directly attributable to the acquisition, construction, or production of a qualifying asset, which is an asset that requires a substantial period of time to get ready for its intended use or sale.
The losses are incurred after the date at which the entity determines that the functional currency of the entity has changed due to the severe currency devaluation.
The entity is able to demonstrate that it is probable that the losses will be recovered through future operating results or the sale of the qualifying asset.
If these conditions are met, the entity can capitalize the losses resulting from the severe currency devaluation as a part of the cost of the qualifying asset. The capitalized losses are then depreciated or amortized over the useful life of the asset, or recognized as a part of the cost of goods sold when the asset is sold.
Examples:
Example of capitalizing losses resulting from severe currency devaluations:
ABC Company is a manufacturing company based in Country A, and its functional currency is the local currency of Country A. ABC Company acquires a new manufacturing plant in Country B, which has a different functional currency. During the construction of the plant, a severe currency devaluation occurs in Country B, resulting in losses of $1 million for ABC Company. ABC Company determines that the losses are directly attributable to the construction of the qualifying asset, and it is probable that the losses will be recovered through future operating results. Therefore, ABC Company capitalizes the losses as a part of the cost of the qualifying asset, and depreciates the losses over the useful life of the plant.
Example of not capitalizing losses resulting from severe currency devaluations:
XYZ Company is a retail company based in Country C, and its functional currency is the local currency of Country C. XYZ Company has a subsidiary in Country D, which has a different functional currency. During the year, a severe currency devaluation occurs in Country D, resulting in losses of $500,000 for XYZ Company’s subsidiary. However, XYZ Company determines that the losses are not directly attributable to the acquisition, construction, or production of any qualifying asset, and it is not probable that the losses will be recovered through future operating results or the sale of any qualifying asset. Therefore, XYZ Company does not capitalize the losses and recognizes them as an expense in its income statement for the year in which the severe currency devaluation occurred.
Case Studies:
Case study of a company capitalizing losses resulting from severe currency devaluations: Company ABC is a global construction company that operates in various countries. In one of its operations in Country E, a severe currency devaluation occurs due to economic instability. As a result, the company incurs losses of $2 million. However, Company ABC determines that the losses are directly attributable to the construction of a qualifying asset, which is a large infrastructure project that requires a substantial period of time to complete. The company also believes that it is probable that the losses will be recovered through future operating results, as the project is expected to generate significant revenue once completed. Therefore, Company ABC capitalizes the losses as a part of the cost of the qualifying asset and amortizes them over the useful life of the project.
Case study of a company not capitalizing losses resulting from severe currency devaluations: Company XYZ is a multinational retail company with operations in multiple countries. In one of its subsidiaries in Country F, a severe currency devaluation occurs due to political unrest. The subsidiary incurs losses of $1 million as a result. However, Company XYZ determines that the losses are not directly attributable to the acquisition, construction, or production of any qualifying asset, and it is not probable that the losses will be recovered through future operating results or the sale of any qualifying asset. Therefore, Company XYZ does not capitalize the losses and recognizes them as an expense in its income statement for the year in which the severe currency devaluation occurred.
In conclusion, SIC-11 provides guidance on accounting for losses resulting from severe currency devaluations. It allows entities to capitalize such losses as a part of the cost of a qualifying asset, subject to certain conditions being met. This allows entities to spread the impact of these losses over a longer period of time. However, it is important for entities to carefully assess whether the conditions for capitalization are met and to disclose the impact of severe currency devaluations in their financial statements in accordance with the requirements of relevant accounting standards, including IAS 21 and SIC-11. Entities should also consider the specific circumstances and facts of their operations in each country to ensure proper accounting treatment of losses resulting from severe currency devaluations in compliance with the relevant accounting standards.