Any business entity that engages in international transactions can choose to undertake its major activities using foreign currencies. However, the financial statement of the parent firm needs to be presented using a common currency. The IAS 21 depicts the rules and regulations of how to incorporate foreign currency transactions and operations in the joint financial statement.
The Venezuelan government decided to peg the local currency to foreign currency to comply with IAS 29. This was aimed to avoid the inflation that was imminent. The benefit of the pegged currency is that it will limit capital outflow and promote growth of local industries.
The Cosmético de Venezuela’s functional currency is BsF. The flash report noted that the subsidiary firm continued to perform exemplarily well despite the political turmoil in Venezuela. The flash report also indicated that the there was an improvement in the quarterly financial statement of 22% from the previous 2008 period. The same report showed that the year-to-date BsF estimated at 21% higher than the previous 2008 report.
A parent firm can have several entities that differ in their functional currencies. The outcome and financial statements of all the entities are expressed in a single currency before the consolidated or combined financial statement is computed.
The Venezuelan government’s official BsF-US$ exchange rate in the year 2009 was BsF 2.15=US$1. The parent’s reporting currency is based on the BsF- €. However, Cosmético de Venezuela C.A. prefers to use a parallel rate (BsF6-US$1) that rivals the official rate. Additionally, the subsidiary firm carries most of its transaction using the parallel rate. Therefore, Cosmético de Espana’s decision to use the official rate is outright wrong. If it uses the official rate, then it will incur a lot of losses. CADIVI was also slower to approve based on the official rate.
To obtain US$ in the semi-legal parallel BsF-US$ market requires a series of transaction involving brokers. The swap and subsequent sale of US$ in the parallel market are done outside of Venezuela. Thus, the semi-legal rate is generally expensive.
Any advantages got from the procurement of foreign operations, and any change in value made to the “carrying” amounts of property arising from the acquisition of any foreign operation, shall be deemed as the foreign entity’s assets and liabilities. Cosmético de Venezuela C.A. does not own any tangible assets; it leases everything including office equipment. Foreign operation is defined as any branch of the parent entity. Most of its foreign activities are conducted in a currency different from that of the parent firm (Muthupandian, 2012).
Exchange disparities may arise when currencies are settled or translated using rates that are different from the rates considered in previous financial statements. Such differences will appear as either profit or loss in the final consolidated financial record. If Cosmétic de Espaňa S.A. decides to use the official rate established in IAS 21, then it will risk incurring losses. The “flash report” states that Cosmético de Venezuela C.A. used the semi-legal parallel rates as its exchange medium.
Perez suspects that the Cosmético de Venezuela C.A., functional currency belongs to a hyperinflationary economy. Therefore, the combined financial declaration needs to be restated to conform to IAS 29 Financial Reporting on Hyperinflationary Economies. According to U.S GAAP and IFRS, hyperinflationary economy is characterized by general population’s preference to keep wealth in the nonmonetary value but evaluated using the foreign currency. Wages and remunerations are also linked to price index with a cumulative inflation rate that is beyond 100% mark.
The financial position of cosmetic de Venezuela C.A.; whose functional currency belongs to a hyperinflationary economic environment shall be translated into a different non-inflationary currency using the standard rate set out in IAS 21.
At times, any entity may choose to express its financial statements or information using a monetary unit different from either its functional currency or presentation currency. This can be done by simply translating all amounts at end-of-period exchange rates to the currency that the entity will choose to use. This provision is called “convenience translation.” However, the disadvantage of using “convenience translation” is that the resulting financial information may fail to comply with IFRS and the IAS 21. The Venezuelan Authorities focus on the BsF- US$ exchange rate, and Cosmético de Espaňa S.A. prefers to use the BsF- € exchange rate.
IAS 21 mandates that international businesses and financial statement translations should apply the national currencies’ changeover mechanism of the European Union member states using the Euro –monetary. Cosmético de Venezuela reports to the parent firm that is headquartered in Madrid. All assets and liabilities held by the subsidiary body must translate the closing rate based on the BsF- € exchange. Cumulative exchange should uphold the overall equity. However, exchange differences accruing from the translation of liabilities/assets outlined in “participating currencies” should not appear in “carrying” amounts of related assets (Muthupandian, 2012).
If Euro is the reporting currency that the parent entity decides to use, then Bolivar Fuertes- Euro exchange rate will translate as BsF3.16=€1. The challenge in choosing this approach is that the subsidiary body operates in a hyperinflationary economy, and the firm may fail to realize any profit at the end of the closing period. Therefore, the parallel rate will work to the advantage of Cosmétic de Espaňa S.A.
The subsidiary’s functional currency should continue to be the BsF. The financial declaration, therefore, should translate to the parent’s reporting currency using the BsF- € rates. However, to avoid running at a loss, it is urged that the parent firm consider using the semi-legal parallel rate.