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Chapter 4

Example 4

X has a foreign subsidiary, whose accounts have been translated for
consolidation purposes. The foreign exchange losses attributable to the parent
shareholders arising on the translation of net assets and goodwill in the year
ended 31 March 20X4 amounted to $28 million.

X financed the investment in the foreign subsidiary by taking out loans in other
currencies to act as a hedge against the foreign exchange risk associated with
the investment in the subsidiary. These loans were translated at 31 March
20X4 and generated foreign exchange gains of $30 million.

The hedge has been formally designated and documented from inception.

Required:

Explain the accounting entries to reflect the above in the consolidated
financial statements of the X Group at 31 March 20X4.

Solution

The hedge is effective, measured at 107% (30/28) or 93% (28/30) (within the
80% – 125% range).

The foreign exchange losses of $28 million on the translation of the subsidiary
(hedged item) will be taken to a foreign exchange reserve in equity and
reported in OCI. This is normal treatment under IAS 21.

The foreign exchange gains on translation of the loans (hedging instrument)
are taken to a foreign exchange reserve in equity and reported in OCI up to
the maximum of $28 million (loss on hedged item) and the remaining
$2 million will be reported in P&L for the year.

The normal treatment under IAS 21 would have been to recognise the entire
gain on the loans in P&L – being translation of a monetary balance. Had this
happened, a mismatch of opposing gains and losses would have occurred.

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