This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Accounting Standards Board, in October, 2007:
Dear Sir/Madam,
IFRIC Draft Interpretation D22 Hedges of a Net Investment in a Foreign Operation
We are pleased to have the opportunity to comment on the above Draft Interpretation, on behalf of BDO International
Our principal comments are:
- We agree that an entity wishing to hedge its net investment in a foreign operation should only be permitted to designate the hedged risk as relating to the differences arising from a difference between the functional currency of the parent and that of its foreign operation. However, the rationale for this is not entirely clear in the Basis of Conclusions, meaning that the Draft Interpretation may be open to misinterpretation in why it prohibits net investment hedge accounting for exchange differences arising from presentation currencies.
- If a parent entity holds a foreign operation indirectly we agree that the hedged risk may include any foreign exchange differences between the functional currency of the foreign operation and any intermediate or ultimate parent entity.
- We agree that in a parent’s consolidated financial statements the foreign operation that is being hedged may not hold the hedging instrument. However, the reasons that this is the case are not immediately obvious from the Draft Interpretation. It would be helpful if the Basis of Conclusions set out the rationale for this conclusion.
We elaborate further on these points below.
Designation of the Hedged Item
Some argue that, in a parent’s consolidated financial statements, exchange differences that arise on consolidation because IAS 21 (paragraph 44) requires the financial statements of each entity in a group to be re-presented into a group’s presentation currency for consolidation purposes, in accordance with IAS 21 (paragraph 38 to 44), should be eligible for designation in a net investment hedge. This is often based on the arguments set out in paragraph BC11 of the Basis for Conclusions.
As noted above, we agree with the draft proposals that the designation of an amount as the hedged item in a net investment hedge should be based on functional, and not presentation, currencies as the economic exposure is derived from functional currencies. However, it would be helpful if a fuller explanation of the rationale for this restriction were given.
Which Entity within the Group May Hold the Hedging Instrument
As paragraph BC20 of the Draft Interpretation notes, IAS 39 does not require the operating unit exposed to the risk to be a party to the hedging instrument. Whilst we agree that it is not necessary for a qualifying hedging relationship in a hedge of a net investment in a foreign operation to be established only if the entity hedging its net investment is a party to the hedging instrument, the Draft Interpretation does not set out why it prohibits the hedged foreign entity from holding the hedging instrument itself.
We assume that the reason is that, where the hedging instrument is held by the hedged entity, the foreign exchange differences on both the net investment and the loan will automatically be taken to reserves as part of the consolidation process. Therefore, given that there is this “natural hedge”, it is not necessary to designate a hedging relationship for the purposes of the consolidated group accounts where the hedged instrument is held by the hedged entity.
It would be helpful if the Basis of Conclusions set out IFRIC’s rationale for the prohibition.
Other Drafting Issues
1. Draft Consensus Paragraph 11
We do not believe that it is necessary for this paragraph to be included in the Draft Interpretation.
2. Draft Transitional Provisions Paragraph 16
We assume that the IFRIC views any change in accounting arising from implementing the Draft Interpretation’s requirements as a change in accounting policy, on the basis that the Draft Interpretation’s transitional rules do not prohibit an entity from applying the related requirements of IAS 8. However, it is not clear why the Draft Interpretation does not require an entity to comply with IAS 8. We assume that the intention is to eliminate the time and cost associated with restatement where existing hedging relationships no longer qualify for hedge accounting as a result of the issue of the Interpretation. However, it would be helpful if the Basis of Conclusions addressed the thinking around the transitional provisions as drafted.
We believe that it would also be appropriate for the transitional provisions to set out how an entity should account for its hedge of a net investment in a foreign operation if, as a result of the publication of an IFRIC Interpretation based on the Draft, it:[<p>]
- amends its hedge documentation, re-designating the hedge from one concerning the presentation currency of its financial statements and the functional currency of the foreign operation to one relating to the differences between the functional currencies of the parent and its foreign operation; or
- transfers the hedging instrument from the entity which is itself being hedged to another entity within the group.[<p>]
We assume that the associated requirements of IAS 39 would apply; it would be helpful if specific reference were made.
3. Illustrative Examples Paragraph IE5
We are unsure whether the reference to Entity X in the first sentence should in fact refer to Entity C.
4. Illustrative Examples Paragraph IE8 and IE9
It would be helpful if the Draft Interpretation clarified whether the conclusion reached in Paragraph IE9 assumes that Entity A prepares consolidated financial statements in AUD by:
- re-presenting in accordance with IAS 21:38-43 its consolidated accounts originally prepared in its functional currency of GBP; or
- initially retranslating each group entity’s accounts in accordance with IAS 21:38-42 into AUD before effecting the consolidation; or
- whether it makes no difference which of these two methods is used.
5. Illustrative Examples Paragraph IE18
Given that the example is using a forward contract as the hedging instrument, it is not necessary for the first sentence to refer to “or borrowing”.
6. Paragraph BC10
The first sentence states that it “is important when the presentation currency of the parent entity [emphasis added] is different from an intermediate or ultimate parent entity’s functional currency”. It is not clear whether the parent entity identified in this sentence sits between the intermediate parent and ultimate parent in the group structure, or whether it sits below the intermediate parent. The text of BC10 would suggest that the parent entity is positioned below an intermediate or ultimate parent entity, one or both of which prepares consolidated financial statements. It would be helpful if this were clarified.
Where the functional currency of the parent entity is different from the presentation currency of the group, it is not quite clear which “translation adjustment will be included in equity”, as a parent can prepare its consolidated financial statements in a specific chosen currency using two different approaches. The first approach involves retranslating the individual financial statements of each group entity into the desired presentation currency by applying the requirements of IAS 21:38-43 and then consolidating the group. Alternatively, the second approach is to first retranslate each group entity into one currency (say the predominant functional currency of group entities) to derive a consolidated set of financial statements and then to re-present those consolidated financial statements into the desired presentation currency by applying the requirements of IAS 21:38-43. Given that both methods will result in the same amounts being included in the financial statements in the chosen presentation currency, it is not clear what the “translation adjustment [that] will be included in equity” is referring to. The adjustment might comprise:
- the exchange differences arising from translating the financial statements of each group entity into the presentation currency of choice under the first approach; or
- the component of exchange differences which arises purely from re-presenting the consolidated financial statements of the parent from one currency (in this case the predominant functional currency of group entities) into the presentation currency of choice.
It would be helpful if this were clarified.
7. Paragraph BC11
Sub paragraph (a) notes that “If the presentation currency is different from the ultimate parent entity’s functional currency, a difference arises on translation that is included in equity”. It is not clear whether the entity whose presentation currency is being referred to in this sentence is the ultimate parent or another entity within the group. It is also not clear to which ‘entity’ reference is being made at the start of the last sentence of sub paragraph (a).
Should you wish to discuss these comments, please contact Helen Thomson of BDO Global Coordination B.V. on +32 2 778 01 30.
Yours faithfully,
BDO Global Coordination B.V.
Draft Interpretation: Comments due 19 October 2007:
1BDO International is a world wide network of public accounting firms, called BDO Member Firms, serving international clients. Each BDO Member Firm is an independent legal entity in its own country.
The network is coordinated by BDO Global Coordination B.V., incorporated in the Netherlands, with an office in Brussels, Belgium, where the Global Coordination Office is located.