PAS 21 The Effects of Changes in Foreign Exchange Rates

PFRS 2 Share-based Payment

In partial fulfillment of the requirements for Conceptual Framework and Accounting Standards in BS
Accountancy

BSA 1-A

Aragones, Jamie Rose S.

Bautista, Mikki O.

Besana, Rommel

Decena, Rona Mae M.

Gesmundo, Rachel P.

May 6, 2019
 Foreign Exchange

NATURE

The foreign exchange market is the place where money denominated in one currency is bought and
sold with money denominated in another currency. It provides the physical and institutional structure
through which the currency of one country is exchanged for that of another country, the rate of exchange
between currencies is determined, and foreign exchange transactions are physically completed.

The primary purpose of this market is to permit transfer of purchasing power denominated in one
currency to another.

Foreign exchange is the exchange of one currency for another or the conversion of one currency into
another currency. Foreign exchange also refers to the global market where currencies are traded virtually
around the clock.

REOGNITION

If there is a change in the expected exchange rate between the functional currency of the entity and
the currency in which a transaction is denominated, record a gain or loss in earnings in the period when the
exchange rate changes. This can result in the recognition of a series of gains or losses over a number of
accounting periods, if the settlement date of a transaction is sufficiently far in the future. This also means
that the stated balances of the related receivables and payables will reflect the current exchange rate as of
each subsequent balance sheet date.

The two situations in which you should not recognize a gain or loss on a foreign currency transaction
are:

 When a foreign currency transaction is designed to be an economic hedge of a net investment

in a foreign entity, and is effective as such; or
 When there is no expectation of settling a transaction between entities that are to be
consolidated.

Foreign Exchange Accounting Example:

Armadillo Industries sells goods to a company in the United Kingdom, to be paid in pounds having a
value at the booking date of $100,000. Armadillo records this transaction with the following entry:
 Debit Credit

Accounts Receivable 1000

Sales 1000

Later, when the customer pays Armadillo, the exchange rate has changed, resulting in a payment in
pounds that translates to a $95,000 sale. Thus, the foreign exchange rate change related to the transaction has
created a $5,000 loss for Armadillo, which it records with the following entry:

Debit Credit

Cash 95000

Foreign Currency Exchange Loss 5000

Accounts Receivable 100000

The following table shows the impact of transaction exposure on different scenarios.

Risk When Transactions Denominated in Foreign Currency

Import Goods Export Goods

Home Currency weakens Loss Gain

Home Currency strengthens Gain Loss

MEASUREMENT

Measurement of a firm's economic exposure to foreign exchange risk--that is, the sensitivity of the
firm's economic value, or share price, to exchange rate changes--is simplified if one considers separately the
basic components of economic exposure. These are financial exposure and natural exposure. A firm's
financial exposure will depend on the extent to which financial hedges such as debt service on foreign
currency debt and forward foreign exchange contracts reduce foreign exchange exposure; this may be
determined from the data in the financial statements. The natural component of foreign exchange exposure
recognizes that changes in foreign returns and unexpected declines in the value of a foreign currency are
frequently associated with unexpected increases in inflation forecasts, so that dollar returns are naturally
hedged to the extent that these unexpected increases in inflation increase foreign currency returns. The firm's
total natural exposure will depend on the extent to which devaluation is commensurate with foreign relative
inflation and on the extent to which net foreign currency cash flows can be immediately and fully adjusted to
inflation. A firm's total exposure to foreign exchange rate changes is derived by subtracting the proportion of
the firm's value that is naturally hedged from the proportion of the firm's value that is not financially hedged.
When applied to a hypothetical firm operating in several foreign countries, this approach suggests that firms'
economic values are considerably less sensitive to foreign exchange risk than accounting conventions imply.

TRANSACTIONS

Types of Foreign Exchange Transactions

Spot Transaction: The spot transaction is when the buyer and seller of different currencies settle
their payments within the two days of the deal. It is the fastest way to exchange the currencies. Here, the
currencies are exchanged over a two-day period, which means no contract is signed between the countries.
The exchange rate at which the currencies are exchanged is called the Spot Exchange Rate. This rate is often
the prevailing exchange rate. The market in which the spot sale and purchase of currencies is facilitated is
called as a Spot Market.

Forward Transaction: A forward transaction is a future transaction where the buyer and seller enter
into an agreement of sale and purchase of currency after 90 days of the deal at a fixed exchange rate on a
definite date in the future. The rate at which the currency is exchanged is called a Forward Exchange Rate.
The market in which the deals for the sale and purchase of currency at some future date is made is called a
Forward Market.

Future Transaction: The future transactions are also the forward transactions and deals with the
contracts in the same manner as that of normal forward transactions. But however, the transactions made in
a future contract differs from the transaction made in the forward contract on the following grounds:

 The forward contracts can be customized on the client’s request, while the future contracts
are standardized such as the features, date, and the size of the contracts is standardized.
 The future contracts can only be traded on the organized exchanges, while the forward
contracts can be traded anywhere depending on the client’s convenience.
 No margin is required in case of the forward contracts, while the margins are required of all
the participants and an initial margin is kept as collateral so as to establish the future position.

Swap Transactions: The Swap Transactions involve a simultaneous borrowing and lending of two
different currencies between two investors. Here one investor borrows the currency and lends another
currency to the second investor. The obligation to repay the currencies is used as collateral, and the amount
is repaid at a forward rate. The swap contracts allow the investors to utilize the funds in the currency held by
him/her to pay off the obligations denominated in a different currency without suffering a foreign exchange
risk.
 Option Transactions: The foreign exchange option gives an investor the right, but not the obligation
to exchange the currency in one denomination to another at an agreed exchange rate on a pre-defined date.
An option to buy the currency is called as a Call Option, while the option to sell the currency is called as a
Put Option.

Foreign exchange transaction is a type of currency transaction that involves two countries. Generally,
a foreign exchange transaction involves conversion of currency of one country with that of another. The
conversion of currency in a foreign exchange transaction can be performed through :

1. buying or selling of goods and services on credit;

2. borrowing or lending funds.

A foreign exchange transaction is usually carried out in foreign exchange markets. An example of a
foreign exchange transaction is where a person buys dollars and sells pounds.

The following is an example of a federal statute defining foreign exchange transaction:

Pursuant to U.C.C. § 2-103 (i) "Foreign exchange transaction" means a transaction in which one
party agrees to deliver a quantity of a specified money or unit of account in consideration of the other party's
agreement to deliver another quantity of a different money or unit of account either currently or at a future
date, and in which delivery is to be through funds transfer, book entry accounting, or other form of payment
order, or other agreed means to transfer a credit balance. The term includes a transaction of this type
involving two or more moneys and spot, forward, option, or other products derived from underlying moneys
and any combination of these transactions. The term does not include a transaction involving two or more
moneys in which one or both of the parties is obligated to make physical delivery, at the time of contracting
or in the future, of banknotes, coins, or other form of legal tender or specie.

A Foreign currency transactions a should be recorded initially at the rate of exchange at the date of
the transaction (use of averages is permitted if they are a reasonable approximation of actual). [IAS 21.21-
22]

At each subsequent balance sheet date: [IAS 21.23] foreign currency monetary amounts should be
reported using the closing rate non-monetary items carried at historical cost should be reported using the
exchange rate at the date of the transaction non-monetary items carried at fair value should be reported at the
rate that existed when the fair values were determined.

Exchange differences arising when monetary items are settled or when monetary items are translated
at rates different from those at which they were translated when initially recognized or in previous financial
statements are reported in profit or loss in the period, with one exception. [IAS 21.28] The exception is that
exchange differences arising on monetary items that form part of the reporting entity's net investment in a
foreign operation are recognized, in the consolidated financial statements that include the foreign operation,
in other comprehensive income; they will be recognized in profit or loss on disposal of the net investment.
[IAS 21.32]

As regards a monetary item that forms part of an entity's investment in a foreign operation, the
accounting treatment in consolidated financial statements should not be dependent on the currency of the
monetary item. [IAS 21.33] Also, the accounting should not depend on which entity within the group
conducts a transaction with the foreign operation. [IAS 21.15A] If a gain or loss on a non-monetary item is
recognized in other comprehensive income (for example, a property revaluation under IAS 16), any foreign
exchange component of that gain or loss is also recognized in other comprehensive income

PRESENTATION

An entity is required to present its financial statements using its functional currency (i.e., Philippine
pesos). However, whenever needed, the entity may translate its financial statements into any presentation
currency (e.g., Japanese yen, US dollars, etc.), as

Items Translated using

a. Assets and Liabilities  Closing rate at the date of the statement of
(Including comparatives) financial position
b. Income and Expenses  Exchange rates at the dates of transactions (a)
(Including comparatives)
 All resulting exchange differences are recognized in other comprehensive income.

(a)
For expediency reasons, an average rate for the period may be used, except when exchange rates fluctuate
significantly.

DISCLOSURE

The amount of exchange differences recognized in profit or loss (excluding differences arising on
financial instruments measured at fair value through profit or loss in accordance with IAS 39) [IAS
21.52(a)] Net exchange differences recognized in other comprehensive income and accumulated in a
separate component of equity, and a reconciliation of the amount of such exchange differences at the
beginning and end of the period [IAS 21.52(b)] When the presentation currency is different from the
functional currency, disclose that fact together with the functional currency and the reason for using a
different presentation currency [IAS 21.53] A change in the functional currency of either the reporting entity
or a significant foreign operation and the reason therefor [IAS 21.54]
 When an entity presents its financial statements in a currency that is different from its functional
currency, it may describe those financial statements as complying with IFRS only if they comply with all the
requirements of each applicable Standard (including IAS 21) and each applicable Interpretation. [IAS 21.55]

PFRS 2

SHARE BASED PAYMENTS

NATURE

A share-based payment is a transaction in which the entity receives goods or services either as
consideration for its equity instruments or by incurring liabilities for amounts based on the price of the
entity's shares or other equity instruments of the entity. The accounting requirements for the share-based
payment depend on how the transaction will be settled, that is, by the issuance of (a) equity, (b) cash, or (c)
equity or cash.

The concept of share-based payments is broader than employee share options. IFRS 2 encompasses
the issuance of shares, or rights to shares, in return for services and goods. Examples of items included in the
scope of IFRS 2 are share appreciation rights, employee share purchase plans, employee share ownership
plans, share option plans and plans where the issuance of shares (or rights to shares) may depend on market
or non-market related conditions.

IFRS 2 applies to all entities. There is no exemption for private or smaller entities. Furthermore, subsidiaries
using their parent's or fellow subsidiary's equity as consideration for goods or services are within the scope
of the Standard.

There are two exemptions to the general scope principle:

First, the issuance of shares in a business combination should be accounted for under IFRS 3
Business Combinations. However, care should be taken to distinguish share-based payments related to the
acquisition from those related to continuing employee services

Second, IFRS 2 does not address share-based payments within the scope of paragraphs 8-10 of IAS
32 Financial Instruments: Presentation, or paragraphs 5-7 of IAS 39 Financial Instruments: Recognition and
Measurement. Therefore, IAS 32 and IAS 39 should be applied for commodity-based derivative contracts
that may be settled in shares or rights to shares.
IFRS 2 does not apply to share-based payment transactions other than for the acquisition of goods and
services. Share dividends, the purchase of treasury shares, and the issuance of additional shares are therefore
outside its scope.

RECOGNITION

An entity shall recognize the goods and services received or acquired in a share-based payment
transaction when it contains the goods or as the services are received. The entity shall recognize a
corresponding increase in equity if the goods or services were received in a equity-settled share-based
payment transaction, or liability if the goods or services were acquired in a cash-settled share-based payment
transaction.

Goods or services acquired in share-based payment transactions are recognized when the goods are
received or as the services are received. Good or services received that do not qualify as assets are
recognized as expenses.

Illustration – Recognition of employee share option grant

Company grants a total of 100 share options to 10 members of its executive management team (10
options each) on 1 January 20X5. These options vest at the end of a three-year period. The company has
determined that each option has a fair value at the date of grant equal to 15. The company expects that all
100 options will vest and therefore records the following entry at 30 June 20X5 - the end of its first six-
month interim reporting period.

Dr. Share option expense 250

Cr. Equity 250

[(100 × 15) ÷ 6 periods] = 250 per period

If all 100 shares vest, the above entry would be made at the end of each 6-month reporting period.
However, if one member of the executive management team leaves during the second half of 20X6,
therefore forfeiting the entire amount of 10 options, the following entry at 31 December 20X6 would be
made:

Dr. Share option expense 150

Cr. Equity 150

[(90 × 15) ÷ 6 periods = 225 per period. [225 × 4] – [250+250+250] = 150

MEASUREMENT

Depending on the type of share-based payment, fair value may be determined by the value of the shares
or rights to shares given up, or by the value of the goods or services received:

 General fair value measurement principle. In principle, transactions in which goods or services are
received as consideration for equity instruments of the entity should be measured at the fair value of
the goods or services received. Only if the fair value of the goods or services cannot be measured
reliably would the fair value of the equity instruments granted be used.
 Measuring employee share options. For transactions with employees and others providing similar
services, the entity is required to measure the fair value of the equity instruments granted, because it
is typically not possible to estimate reliably the fair value of employee services received.
 When to measure fair value - options. For transactions measured at the fair value of the equity
instruments granted (such as transactions with employees), fair value should be estimated at grant
date.
 When to measure fair value - goods and services. For transactions measured at the fair value of the
goods or services received, fair value should be estimated at the date of receipt of those goods or
services.
 Measurement guidance. For goods or services measured by reference to the fair value of the equity
instruments granted, IFRS 2 specifies that, in general, vesting conditions are not taken into account
when estimating the fair value of the shares or options at the relevant measurement date (as specified
above). Instead, vesting conditions are taken into account by adjusting the number of equity
instruments included in the measurement of the transaction amount so that, ultimately, the amount
recognized for goods or services received as consideration for the equity instruments granted is based
on the number of equity instruments that eventually vest.

Measurement Of Compensation

Employee share option plans are equity-settled share-based payment transactions with employees.
Accordingly, the services received are measured using the following order or priority:

1. Fair Value of equity instruments granted at grant date

2. Intrinsic Value

The compensation expense (salaries expense) on the employee share option plan

Equity-settled share-based payment transaction

Non-employees Employees and Others providing similar services
 Order of priority in measurement: Order of priority in measurement:
1. Fair value of goods or services received 1. Fair value of equity instruments granted
2. Fair value of equity instruments granted 2. Intrinsic value

Note: Annual Improvements to IFRSs 2010–2012 Cycle amends the definitions of 'vesting condition' and
'market condition' and adds definitions for 'performance condition' and 'service condition' (which were
previously part of the definition of 'vesting condition'). The amendments are effective for annual periods
beginning on or after 1 July 2014.

MODIFICATIONS, CANCELLATIONS, AND SETTLEMENTS

The determination of whether a change in terms and conditions has an effect on the amount
recognized depends on whether the fair value of the new instruments is greater than the fair value of the
original instruments (both determined at the modification date).

Modification of the terms on which equity instruments were granted may have an effect on the
expense that will be recorded. IFRS 2 clarifies that the guidance on modifications also applies to instruments
modified after their vesting date. If the fair value of the new instruments is more than the fair value of the
old instruments (e.g. by reduction of the exercise price or issuance of additional instruments), the
incremental amount is recognized over the remaining vesting period in a manner similar to the original
amount. If the modification occurs after the vesting period, the incremental amount is recognized
immediately. If the fair value of the new instruments is less than the fair value of the old instruments, the
original fair value of the equity instruments granted should be expensed as if the modification never
occurred.

The cancellation or settlement of equity instruments is accounted for as an acceleration of the

vesting period and therefore any amount unrecognized that would otherwise have been charged should be
recognized immediately. Any payments made with the cancellation or settlement (up to the fair value of the
equity instruments) should be accounted for as the repurchase of an equity interest. Any payment in excess
of the fair value of the equity instruments granted is recognized as an expense

New equity instruments granted may be identified as a replacement of cancelled equity instruments.
In those cases, the replacement equity instruments are accounted for as a modification. The fair value of the
replacement equity instruments is determined at grant date, while the fair value of the cancelled instruments
is determined at the date of cancellation, less any cash payments on cancellation that is accounted for as a
deduction from equity.

SHARE-BASED COMPENSATION PLANS

 Share-based compensation plan is an arrangement whereby in exchange for services, an employee is
compensated in the form of (or based on) the entity's equity instrument. Examples of share-based
compensation:

a. Employee share options (equity-settled)

b. Employee share appreciation rights (cash-settled)

c. Compensation plans with a choice of settlement between (a) and (b) above.

Share-based compensations are given to key employees as bonuses or additional compensation. The
benefits of a share-based compensation to the employer may include a possible reduction in employee
turnover because employees will have to remain in the entity's employ during the service period in order to
exercise the equity instrument granted. Employees will also be more motivated in contributing to the
achievement of the entity's goals because they are given an opportunity to become owner's of the entity.

Cash-Settled Share-Based Payment Transactions

A cash-settled share-based payment transaction is one whereby an entity acquires goods or services
and incurs an obligation to pay cash at an amount that is based on the fair value of equity instruments.

The goods or services received, and related liability, are measured at fair value of the liability.

At the end of each reporting period and even on settlement date, the liability is remeasured to fair
value. Changes in fair value are recognized in profit or loss.

The most common form of a cash-settled share-based payment transaction is share appreciation
rights (SARs) granted to an employee.

Measurement Of Compensation

The liability for the future cash payment on share appreciation rights in measured, initially and at the
end of each reporting period until settled, at the fair value of the share appreciation rights. Changes in fair
value are recognized in profit or loss.

Employee share option plans Employee share appreciation rights (SARs)

* Share options are not remeasured. * SARs are remeasured at each year-end
Expenses recognized over the vesting and on settlement date. Changes in fair
period are based on the fair value of the value are recognized in profit or loss.
 share options at grant date.
* Settled through the issuance of equity * Settled through payment in cash.
instruments.

Illustration - Share appreciation rights

On January 1, 20x1, Entity A grants 1, 000 share appreciation rights (SARs) to employees with the condition
that the employees remain in service within the next 3 years. Information on the SARs is shown below:

Date No. Of SARs expected to vest Fair value of each SAR

Jan. 1. 20x1 1000 10
Dec. 31, 20x1 900 12
Dec. 31, 20x2 800 15
Dec. 31, 20x3 750 16

 Entity A recognizes salaries expense over the vesting period as follows:

Date Salaries expense
Jan. 1, 20x1
Dec. 31, 20x1 900 x 12 x 1/3 3,600
Dec. 31, 20x2 (800 x 15 x 2/3)- 3,600 4,400
Dec. 31, 20x3 (750 x 16 x 3/3)-3,600-4,400 4,000

Choice between equity-settled and cash-settled

A share-based payment transaction that can be settled either through equity instrument or cash is
accounted for depending on which party is given the right of choice of settlement:

1. The counterparty has the right of choice of settlement: or

2. The entity has the right of choice of settlement.

Counterparty has the right of choice

If the counterparty has the right to choose settlement between cash (or other assets) or equity
instruments, the entity has granted a compound instrument.
 A compound instrument is one which includes both a debt component (e.g., the counterparty's right
to demand payment in cash) and an equity component (i.e., the counterparty's right to demand settlement on
equity instruments rather than in cash).

Transactions with non-employees

For transactions with non-employees, the equity component is computed as the difference between: (a) the
fair value of goods or services received (b) the fair value of the debt component at the date the goods or
services are received.

 The computation resembles the basic accounting equation:

"Assets - Liabilities = Equity."
For example:
If goods or services acquired from a non-employee have fair value of P100 (Asset)
while the cash alternative has a fair value of P80 (Liability) , the equity component is P20.

P100 - P80 = P20

Transactions with employees

For transactions with employees and others providing similar services, the entity measures the fair value of
the compound instrument and its components as follows:

a. If the fair value of one settlement alternative is the same as the other, the fair value of the equity.
Component is zero, and hence the fair value of the compound financial instrument is the same as the fair
value of the debt component.

b. If the fair values of the settlement alternatives differ, the fair value of the equity component will be
greater than zero, in which case, the fair value of the compound financial instrument will be greater than the
fair value of the debt component.

Each component of the compound instruments is accounted separately:

a. Equity alternative on grant date

-Recognized as salaries expense and an increase in equity over the vesting period.

b. Cash alternative

- Recognized as salaries expense, and liability, that is remeasured at each year-end and on
settlement, as the services are received. Changes in fair values are recognized in profit or loss.

Settlement

a. Equity instruments b. Cash

Entity has the right of choice

If the entity has the right to choose settlement between cash (or other asset) or equity instruments, the entity
has not granted a compound instrument.

a. If the entity has a present obligation to pay cash , the transaction is accounted for as cash- settled.
Consequently, the equity alternative is simply ignored.

b. If the entity has no present obligation to pay cash, the transaction is accounted for as equity-settled.
Consequently, the cash alternative is simply ignored.

Settlement

a. Settle in cash, the cash payment is accounted for as a repurchase of an equity interest, as a deduction
from equity, except as noted in (c) below.

b. Settle by issuing equity instruments, no further accounting is required other than a transfer from one
component of equity to another, if necessary, except as noted in (c) below.

c. Settlement alternative with the higher fair value as at the date of settlement, entity recognizes an
additional expense for the:

¡. Excess of cash paid over the fair value of equity instruments that would otherwise have been issued, or

¡¡. Excess of fair value of the equity instruments issued and the amount of cash that would otherwise have
been paid, whichever is applicable.

PRESENTATION

For cash-settled share-based payment transactions, the entity shall measure the goods or services
acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity shall
remeasure the fair value of the liability at the end of each reporting period and at the date of settlement, with
any changes in fair value recognized in profit or loss for the period.

For share-based payment transactions in which the terms of the arrangement provide either the entity
or the counterparty with the choice of whether the entity settles the transaction in cash (or other asset) or by
issuing equity instruments, the entity shall account for that transaction, or the components of that transaction,
as a cash-settled share-based payment transaction if, and to the extent that, the entity has incurred a liability
to settle in cash or other asset, or as an equity-settled share-based payment transaction if, and to the extent
that, no such liability has been incurred.
DISCLOSURE

Required disclosures include:

 An entity shall disclose information the enables users of the financial statements to understand the
nature and extent of share-based payment arrangements that existed during the period.
 An entity shall disclose information that enables users of the financial statements to how the fair
value of the goods or services received, or the fair value of the equity instruments granted, during the
period was determined
 An entity shall disclose information that enables users of the financial statements to understand the
effect of share-based payment transactions on the entity's profit or loss for the period and on its
financial position.