Forex and IFRS 16 Lease Accounting

With the relatively new IFRS 16 Leases standard, companies have to recognize their leases on the balance sheet and one of the key considerations is how to account for foreign exchange rate differences (IAS 21).

If you are not familiar with the treatment of recognizing lease liabilities and right-of-use assets, then I encourage you to please read our complete IFRS 16 guide. It will cover the basics of IFRS 16 lease accounting, but feel free to also read through Rubli’s Practical IFRS 16 Training.

What happens when a company enter a lease contract where the lease payments are different to the company’s normal currency operations? Or how do you present your IFRS 16 lease disclosures to a parent company that requires reporting in another currency than your own? In this article we will take you through the basic principes of how IFRS 16 and IAS 21 co-exists and guide you through answering these questions.

It’s important to understand how foreign exchange rates can affect IFRS 16 Lease Accounting, which is why we will cover the key concepts and provide practical guidance on how to apply this.

Translation Currencies Overview

First, it’s important to understand the concept of the different types of translation currencies.
There are three namely, Denominated CurrencyFunctional Currency, and Presentation Currency.

Denominated CurrencyThe currency in which the lease payments are made. We call this the Lease Currency.
Functional CurrencyThe currency of the primary economic environment in which the entity operates. This is typically the currency in which an entity primarily generates and expends cash.
Presentation CurrencyThe currency used to present the entity’s financial statements.
This can be any currency that the company would like to present their financial results in.

Let’s use the following scenario to illustrate how this would work:

The Vehicle Lease has a term of 5 years, with $25,000 annual payments calculated at an initial measurement of $100,000.

We’ll consider the correct exchange rate to each for the different stages of IFRS for each Translation Currency.

Functional Currency

The general rule for translation to be applied is:
Monetary items – Use the Closing Rate
Non-Monetary items – Measured the historical rate (Spot rate of transaction day)

When the lease is recognised, it will be recognised at the spot exchange rate on the date of commencement. Going forward, the liability will be seen as a monetary item and the right-of-use asset will be a non-monetary item.

IFRS 16 ItemRate to use
Lease PaymentsSpot Rate
Interest ExpenseAverage Rate
DepreciationHistorical Asset Spot Rate

Depreciation will be calculated based on the Historical Rate that the asset was translated at. In the Functional Currency, the Asset is a non-monetary item and no accounting in the Functional Currency should result in any foreign exchange rate differences. See below for an example.

Example: Right-of-use Asset Cost was calculated at $100,000 and the spot rate for USD:EUR was 0.90.
The Asset Cost will be €90,000 in Functional currency.
The Depreciation calculated is €18,000 per year (€90,000 / 5 years).

For the Liability, it is very likely that because of changes in the exchange rates, an income statement item, known as Foreign Exchange (forex) Difference, will be required to account for the remaining movement in the lease liability balance (i.e., to account for the remaining movement in the balance).

Presentation Currency

(Our focus will only be on non-hyperinflationary economies)
The general rule to translate from the Functional Currency to the Presentation Currency is:

  • Asset and Liabilities – Use the Closing Rate at the date of Reporting.
  • Income and Expenses – Use the Average Rate for the period.

When translating to the Presentation Currency on the above guidelines, there will be a difference between the movements of the year and the closing balance. This difference will be disclosed separately in Other Comprehensive Income.

Commonly this line item is referred to as the Foreign Currency Translation Reserve (FCTR), which will be included as part of the movements in equity.

To illustrate this, please see the example.

Example:Rate to ApplyEURGBP
EUR:GBP Opening 0.89 ; Average 0.87 ; Closing 0.85
Opening Right-of-use AssetOpening€90,000£80,100
DepreciationAverage(€18,000)(£15,660)
FCTR AssetN/A (£3,240)
Closing Right-of-use AssetClosing€72,000£61,200

Because the Asset closing balance was revalued to £61,200 there was an additional adjustment required on the asset of £3,240 as the Foreign Currency translation for the Asset.

IFRS 16 Software and Forex

Mixing IFRS 16 leases and foreign exchange rates can become tricky and this means that companies will need to carefully monitor how fluctuating exchange rates affect their lease accounting. It will be crucial to ensure the adjustments posted to the lease liabilities are accurate, whilst maintaining a fair representation of the impact of forex differences.

This creates the need within a company to invest in IFRS 16 Software that will automatically calculate both their lease accounting and forex, reducing the man-hours required for high quality financial reporting.

With Rubli’s flexible lease tool, we not only assist with streamlining your IFRS 16 lease accounting, but we also automate the IFRS 16 reporting to be presented in your required currency.

If you would like to find out more about how we can assist your company, contact us today.

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