How IFRS 16 calculations work when converting to another currency

Managing IFRS 16 becomes even more challenging when amounts need to be converted into another currency. In this article, IFRS 16 expert Richard Nilsson explains what to do and what to consider. Managing IFRS 16 becomes even more challenging when amounts need to be translated into another currency. In this article, IFRS 16 expert Richard Nilsson explains the process and key considerations.

Recalculating into another currency involves more than simply converting with the current exchange rate. Attention must be paid to the rate that applied at the time of the opening balance, meaning the rate that was used for the closing balance of the previous year. It is also necessary to know the rate that applies at the report’s closing date (closing exchange rate). In addition, the average rate for the period must be established.

– For example, when preparing an annual report, there needs to be information about the exchange rate that applied to the closing balance of the previous year (which then becomes the opening balance). If the exchange rate at that time was 11.50 SEK per EUR, that is used as the starting point. But during the period from the beginning to the end, the currency will fluctuate. When a new report is produced a year later, as of 31 December, the exchange rate will have changed. For instance, the closing exchange rate may have shifted to 11.00 SEK per EUR, Richard explains.

– The year began with all amounts in EUR being translated into SEK, where each EUR was worth 11.50 SEK. Now, the situation is that each EUR is worth 11.00 SEK, which affects the carrying amounts in the balance sheet. In addition, transactions have taken place during the year in the income statement (lease payments, depreciation, interest, and tax), and these amounts are translated using an average exchange rate, he says and continues:

– It is therefore impossible to simply reconcile opening balance + movements = closing balance. The difference must instead be handled through a balance item called a currency translation difference. In short, it is the translation difference that accounts for the impact of currency fluctuations.

On the balance sheet, the right-of-use asset is recorded on the asset side and the lease liability on the liabilities side. Since these decrease at different rates, the difference between the two sides will constitute equity. In most cases, the right-of-use asset is depreciated somewhat faster than the lease liability is amortized. This means the asset will usually be slightly lower than the liability. At the beginning of the lease, the effect is reflected on the asset side. From the middle of the lease onward, the effect instead appears on the liability side, as the lease liability decreases more quickly than the remaining right-of-use asset.

– When the lease ends, there is no right-of-use asset remaining, and the final year’s result shows that equity on the balance sheet has the same amount on the debit side as on the credit side – they offset each other, and the total balance equals zero, Richard says.

Illustrated with Numbers

If a right-of-use asset was acquired for 100 EUR last year, and during that year it was depreciated by 10 EUR, the closing balance is 90 EUR. These 90 EUR are then translated into SEK at an exchange rate of 11.5, resulting in 90 × 11.5 = 1,035 SEK. This means that the opening balance is 1,035 SEK.

At the beginning of the new year, the opening balance is the same, that is 1,035 SEK. A new depreciation of 10 EUR is then recorded during the year. These 10 EUR are translated using the average exchange rate, which in this example is 11.25. This results in 10 × 11.25 = –112.5 SEK.

The closing balance in EUR is 90 − 10 = 80 EUR. These 80 EUR are translated into SEK using the closing exchange rate, which in this example is 11. This results in 80 × 11 = 880 SEK.
 

But here a difference appears

 If we take the opening balance of 1,035 SEK and subtract the depreciation of 112.5 SEK, we get 1,035 − 112.5 = 922.5 SEK. However, according to the closing exchange rate, the value is only 880 SEK.

– The difference between 922.5 and 880 is –42.5 SEK. This is the foreign currency translation difference, and therefore we end up with 880 SEK in the closing balance, Richard explains.

To summarize:

• The opening balance at an exchange rate of 11.5 – 90 EUR equals 1,035 SEK.
• The depreciation of the right-of-use asset, 10 EUR, is translated at an average rate of 11.25, which equals 112.5 SEK.
• That leaves 80 EUR, which are translated at the closing exchange rate of 11.00, resulting in 880 SEK.

In the balance sheet, the opening balance plus the year’s movements should reconcile with the closing balance. We started with 90 EUR, depreciated 10, and ended with 80. But when different exchange rates are applied – 11.5, 11.25, and 11.00 – the figures in SEK do not match. Therefore, the difference is adjusted through a currency translation adjustment.