Separation of currency component

[From Guidance on implementing IFRS 9 Financial Instruments]

Gains and losses

IFRS 9 and IAS 21financial assets measured at fair value through other comprehensive income: separation of currency component

A financial asset measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A of IFRS 9 is treated as a monetary item. Therefore, the entity recognises changes in the carrying amount relating to changes in foreign exchange rates in profit or loss in accordance with paragraphs 23(a) and 28 of IAS 21 and other changes in the carrying amount in other comprehensive income in accordance with IFRS 9. How is the cumulative gain or loss that is recognised in other comprehensive income determined?

It is the difference between the amortised cost of the financial asset1 and the fair value of the financial asset in the functional currency of the reporting entity. For the purpose of applying paragraph 28 of IAS 21 the asset is treated as an asset measured at amortised cost in the foreign currency.

To illustrate: on 31 December 20X1 Entity A acquires a bond denominated in a foreign currency (FC) for its fair value of FC1,000. The bond has five years remaining to maturity and a contractual par amount of FC1,250, carries fixed interest of 4.7 per cent that is paid annually (FC1,250 × 4.7% = FC59 per year), and has an effective interest rate of 10 per cent. Entity A classifies the bond as subsequently measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A of IFRS 9, and thus recognises gains and losses in other comprehensive income. The entity’s functional currency is its local currency (LC). The exchange rate is FC1 to LC1.5 and the carrying amount of the bond is LC1,500 (= FC1,000 × 1.5).

Dr BondLC1,500
Cr Cash  LC1,500

On 31 December 20X2, the foreign currency has appreciated and the exchange rate is FC1 to LC2. The fair value of the bond is FC1,060 and thus the carrying amount is LC2,120 (= FC1,060 × 2). The amortised cost is FC1,041 (= LC2,082). In this case, the cumulative gain or loss to be recognised in other comprehensive income and accumulated in equity is the difference between the fair value and the amortised cost on 31 December 20X2, ie LC38 (= LC2,120 – LC2,082).

Interest received on the bond on 31 December 20X2 is FC59 (= LC118). Interest revenue determined in accordance with the effective interest method is FC100 (= FC1,000 × 10 per cent). The average exchange rate during the year is FC1 to LC1.75. For the purpose of this question, it is assumed that the use of the average exchange rate provides a reliable approximation of the spot rates applicable to the accrual of interest revenue during the year (see paragraph 22 of IAS 21). Thus, reported interest revenue is LC175 (= FC100 × 1.75) including accretion of the initial discount of LC72 (= [FC100 – FC59] × 1.75). Accordingly, the exchange difference on the bond that is recognised in profit or loss is LC510 (= LC2,082 – LC1,500 – LC72). Also, there is an exchange gain on the interest receivable for the year of LC15 (= FC59 × [2.00 – 1.75]).

Dr BondLC620
Cr Cash LC188
Cr Interest revenue LC175 
Cr Exchange gain LC525
Cr Fair value change in other comprehensive income  LC38

On 31 December 20X3, the foreign currency has appreciated further and the exchange rate is FC1 to LC2.50. The fair value of the bond is FC1,070 and thus the carrying amount is LC2,675 (= FC1,070 × 2.50).

The amortised cost is FC1,086 (= LC2,715). The cumulative gain or loss to be accumulated in other comprehensive income is the difference between the fair value and the amortised cost on 31 December 20X3, ie negative LC40 (= LC2,675 – LC2,715). Thus, the amount recognised in other comprehensive income equals the change in the difference during 20X3 of LC78 (= LC40 + LC38).

Interest received on the bond on 31 December 20X3 is FC59 (= LC148). Interest revenue determined in accordance with the effective interest method is FC104 (= FC1,041 × 10%). The average exchange rate during the year is FC1 to LC2.25. For the purpose of this question, it is assumed that the use of the average exchange rate provides a reliable approximation of the spot rates applicable to the accrual of interest revenue during the year (see paragraph 22 of IAS 21). Thus, recognised interest revenue is LC234 (= FC104 × 2.25) including accretion of the initial discount of LC101 (= [FC104 – FC59] × 2.25).

Accordingly, the exchange difference on the bond that is recognised in profit or loss is LC532 (= LC2,715 – LC2,082 – LC101). Also, there is an exchange gain on the interest receivable for the year of LC15 (= FC59 × [2.50 – 2.25]).

Dr BondLC555
Cr Cash LC148
Dr Fair value change in other comprehensive incomeLC78
Cr Interest revenue LC234
Cr Exchange gain LC547