Question

The financial report of Allgreen Ltd, a company incorporated in Singapore, for the year ended 31 December 2018, contained the following disclosure: Foreign currency – Effective 1 January 2019, the Malaysian Ringgit became the functional currency for translating the financial statements of Allgreen’s 59% owned Malaysian subsidiary Allgreen Sendirian Berhad. Economic factors and circumstances related to Allgreen Sendirian Berhad’s operations have changed significantly since the last quarter of 2018. It is deemed that Allgreen Sendirian Berhad is now an independent and relatively self-contained subsidiary. Under these circumstances, these changes require a change in Allgreen Sendirian Berhad’s functional currency from the Singapore dollar to the Malaysian Ringgit. The Malaysian Ringgit has generally depreciated steadily over the past decade with respect to the Singapore dollar. As a result of the change, at 1 January 2019, Allgreen Ltd’s shareholders’ equity and minority interest accounts were reduced by $156 million and $108 million respectively. These amounts were driven principally by a reduction in fixed assets.

(a) Show why the change in functional currency reduced Allgreen Ltd’s fixed assets, shareholders’ equity and minority interest.

(b) Discuss how the change in functional currency affects each of the following, as reported in Allgreen Ltd’s financial statements:

(i) Sales

(ii) Cost of goods sold

(iii) Depreciation expense

Answer 1

Translation exposure is a type of foreign exchange exposure that causes the domestic currency value of foreign subsidiary assets, liabilities, equity, income and expenses to fluctuate due to changes in foreign exchange rate between two reporting dates.

In the parent company's balance sheet, shareholders’ equity and minority interest accounts are listed in Singapore dollars (accounting currency or presentation currency).

When there is a change in an entity’s functional currency, the entity applies the translation procedures applicable to the new functional currency prospectively from the date of the change. In other words, all items are translated into the new functional currency using the exchange rate at the date of the change. The resulting translated amounts for non-monetary items are treated as their historical cost.

To sum it up, when the Malaysian subsidiary Allgreen Sendirian Berhad changed its functional currency to Malaysian Ringgit, it needed to

• Recalculate all monetary assets and liabilities denominated in currencies other than Malaysian Ringgit to Malaysian Ringgit using the closing exchange rate;
• Keep non-monetary items at their historical rate;
• Recalculate all items of income and expenses in currencies other than Malaysian Ringgit to Malaysian Ringgit using the exchange rate at the date of transaction.

Note that monetary assets and liabilities are those that are to be settled in future through receipt or payment of pre-determined units of currency. Monetary items include cash, accounts receivable, notes receivable, investments, accounts payable, salaries payable, taxes payable, etc. Non-monetary items include inventories, fixed assets, etc.