An American Company borrowed 1 million Canadian dollars to finance the construct

Question

An American Company borrowed 1 million Canadian dollars to finance the construction of a new office building when the Canadian dollar was worth $1 American. At 10% interest, the American Company expected to pay back 1.1 million Canadian dollars which would be 1.1 million American dollars. Unfortunately, based on changes in the value of the Canadian dollar, the American Company must pay 1.1 million Canadian dollars but this costs the American Company 1.3 million American dollars. How will this extra $200,000 difference between what they actually paid and what they expected to pay be shown under U.S. GAAP? How would this have been shown if the American Company used IFRS? Which gives more relevant information to investors? Defend your choice.

Explanation / Answer

Accounting under US GAAP :

As per US GAAP, Gain/loss on foreign exchange transactions should be accounted on (a) Transaction date and (b) Settlement date.

On transaction date, the transaction should be recorded at the rate on transaction date. In our case, Loan should be recorded at 1 million american dollar.

On Settlement date, when the loan is repaid there occured a difference due to foreign exchange fluctuation which should be recorded as a gain or loss. In our case, value Canadian $ increased abd company ended up paying 20,000 american dollar in excess. Company shall record such excess payment as gain or loss on foreign exchange transaction under income statement.

Accounting under IFRS :

A foreign currency transaction 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]

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 recognised 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 recognised, in the consolidated financial statements that include the foreign operation, in other comprehensive income; they will be recognised 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 recognised in other comprehensive income (for example, a property revaluation under IAS 16), any foreign exchange component of that gain or loss is also recognised in other comprehensive income. [IAS 21.30]

Conclusion

For a American Company, it would be more beneficial for following US GAAP and record the difference as a gain or loss under income statement.

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