Question

Hi, i have 2 cases and would be really appreciate if you can help me to answer it, the first case is already answered and i am wondering is it gonna be same answer with the second case because in first case says Wesfarmers notes that the functional currency and presentation currency of Wesfarmers Ltd and its Australian subsidiaries are the Australian dollar while in the second case it says Wesfarmers lists its overseas subsidiaries and their functional currencies which didnt mention presentation currency in it, and can you please give me the reason in it? thank you!

case 1

In its 2011 annual report (p. 98) Wesfarmers notes that the functional currency and

presentation currency of Wesfarmers Ltd and its Australian subsidiaries are the

Australian dollar. In Note 32 it lists its overseas subsidiaries and their functional

currencies. These include Bunnings (NZ) Ltd for which the functional currency is the

New Zealand dollar (NZD), and Wesfarmers Kleenheat Elpiji Ltd for which the

functional currency is the Bangladesh taka (BDT).

Required

Discuss the translation process that will occur so that these subsidiaries can be included

in the consolidated financial statements of Wesfarmers Ltd.

The foreign operations are being prepared in their functional currencies, generally the

currency of the country in which the country operates e.g. NZ or Bangladesh.

In order to include the financial statements prepared in a functional currency other than the

A$, they must be translated into the presentation currency of A$. This process involves the

following translation process:

Assets: Rates of exchange at balance date (current rates) are used

Liabilities: Rates of exchange at balance date (current rates) are used

Share capital: If on hand at acquisition date, the rate at acquisition date is used

Other reserves: If on hand at acquisition date, the rate at that date is used. For reserves

created by internal transfer, the rate at the date the amounts transferred were originally

recognised in equity is used.

Retained earnings: If on hand at acquisition date, the rate at that date is used. Post-acquisition

profits are carried forward balances.

Revenues/expenses: Rates approximating the foreign exchange rates at the dates of the

transactions are used - probably an average rate is used.

Under this translation method, exchange differences arise because the opening net assets are

translated at a rate different from the closing rate while revenues/expenses are translated at

rates different from the closing rate. These exchange differences are not recognised in profit

or loss. They are recognised in other comprehensive income and transferred to a foreign

currency translation reserve account.

case 2

In its 2017 annual report (note 19) Wesfarmers lists its overseas subsidiaries and their functional currencies. These include Bunnings (NZ) Ltd for which the functional currency is the New Zealand dollar (NZD), and KAS Global Trading Pty Ltd for which the functional currency is the Hong Kong dollar (HK$).

Required

What is meant by 'functional currency'? How is it determined?

Discuss the translation process that will occur so that these subsidiaries can be included in the consolidated financial statements of Wesfarmers Ltd.

Answer 1

Q.1 : What is meant by 'functional currency'? How is it determined?

Functional currency is the currency which is largely used in the economic environment where it operates. Functional  currency should be the currency in which an entity usually generates and spends cash & most of the business transactions of an entity are normally denominated. All of the transactions which are not in the functional currency are treated as foreign transactions

The functional currency is determined by various factors such as :

a. Currency in which prices are quoted and invoices are generated

b. Country regulation, market forces, competitive requirement

c. Currency in which most of the expenses are incurred

d. Currency in which funds generated (Share capital, borrowing)

e. Currency in which customer makes payment for operating activities

Q.2 Discuss the translation process that will occur so that these subsidiaries can be included in the consolidated financial statements of Wesfarmers Ltd.

Westfarmers Ltd which is parent company will have it's own "functional currency". Where it's subsidiaries have different functional currencies than Westfarmers Ltd, it need to be converted into Westfarmers Ltd's functional currency through following process :

The Translation process is under :

Assets & Liabilities : Closing Exchange Rate

Income & Expenses : Actual exchange rate or Average exchange rate during the period

Equities & Reserves : Exchange rate on the date of acquisition. The subsequent changes at exchange rate of such transaction date or period. So in case of Equity and Reserve one need to maintain track of movement and capture exchange rate during those period. It appears complex however if there is opening balance translated in functional currency available (with exchange rate difference) then the changes arising during the current period needs to be added applying actual or average exchange rate.

The differential exchange rate on translation of all the above item recognised in other comprehensive income and transferred to a foreign currency translation reserve account

In essence process will remain same as response to case-1, however translation will be required for those subsidiary where their functional currency is different than Wesfarmers Ltd's functional currency.