The following article briefly summarises the main points of new interpretations of the National Accounting Board, I-42 ‒ Provisioned Receivables in Foreign Currencies and I-43 ‒ Provided Prepayments Denominated in Foreign Currencies.
The interpretations provide NAB’s professional opinion on the practical application of Czech accounting principles. The interpretations, which are not legally binding, aim to facilitate the formulation of optimum and unified procedures for accounting and financial reporting. They principally focus on matters that are not addressed by Czech accounting legislation, or are addressed insufficiently, and on issues being resolved differently in the accounting practice.
Interpretation I-42 (hereinafter the “Interpretation”) was issued in November 2020 with the aim of determining the accounting treatment of foreign exchange risk arising from receivables recognised net of provisions.
Section 4 (1) of the Accounting Act states that receivables and related provisions should be denominated in the Czech currency and simultaneously in a foreign currency. In practice, accountants had to address questions such as whether exchange rate gains or losses arise for provisions, where they should recognise exchange rate gains and losses arising from the translation of a receivable denominated in a foreign currency and where those arising from the translation of provisions.
While the Interpretation does not contain an exact accounting policy, it does include an important starting point, namely that the foreign exchange risk of receivables denominated in foreign currencies arises only from future cash flows (income) that the entity expects to receive in the future. The justification of the Interpretation states that the portion of a receivable that a provision has been recognised against no longer represents a future cash flow with sufficient probability, since the entity does not expect it to be paid, and as such there is no related risk of gains or losses arising from exchange rate changes. Based on the Interpretation, the exchange rate gain or loss arises only from the net value of the receivable, i.e. from the value of the receivable net of the related provision (denominated in a foreign currency).
This exchange rate gain or loss is reported as part of the financial profit or loss.
The Interpretation also addresses two approaches to recognising exchange rate gains or losses that are often used in practice for receivables and related provisions:
- The exchange rate gain or loss arising from the translation of a receivable denominated in a foreign currency is recognised in financial income or expenses. The provision created against the foreign-currency receivable is also translated and the resulting difference is recognised in operating income or expenses (as a change in the provision). Based on the Interpretation, this approach does not provide a true view of the foreign exchange risk in the accounting records.
- The exchange rate gain or loss arising from the translation of a receivable denominated in a foreign currency is recognised in financial income or expenses. The provision created against the foreign-currency receivable is also translated and the resulting difference is recognised in financial income or expenses. Based on the Interpretation, this solution does provide a true view of the foreign exchange risk in the accounting records, but it translates the entire (gross) value of the receivable, even though future cash flows will objectively arise only for the portion of the receivable that can be expected to be paid. However, using this method the result is correctly reported as an exchange rate gain or loss on the net receivable.
Full text of Interpretation I-42 is available on the website of the National Accounting Board.
The above situation is of course simplified; it works with a single receivable and includes only a change in exchange rate. In practice, the situation is much more varied and complicated. A change of exchange rate often occurs at the same time as a percentage increase in the provision against the receivable. Both effects have to be reflected separately in the accounting records.
Entities also often have several doubtful foreign-currency receivables from different reporting periods, and they often have algorithms set in their accounting software for the calculation of exchange rate gains and losses as well as for an automatic calculation and recognition of the provision (on the other hand, other entities calculate provisions outside the system, e.g. in Excel, and then enter them in their accounting records as a single entry). Different entities can have very different technical solutions.
Interpretation I-43 (hereinafter the “Interpretation”) was issued in October 2020 and its objective is to determine the accounting treatment of prepayments provided in foreign currencies in the financial statements. The Interpretation does not touch upon prepayments received.
The Interpretation distinguishes whether the provided prepayment is part of the total cost of the asset (service), or whether it is a receivable.
Provided prepayment is part of the total cost of the asset or service
If the delivery of the subject of a contract is expected, the provided prepayment is a result of the payment of (a portion of) the cost of the asset or service before their delivery, and it essentially represents a separate (sub-)part of the total cost of the purchased asset or service, and it is recognised as follows:
- The balance of the prepayment provided is translated to CZK as of the date of provision of the funds; it is not re-translated as of the balance sheet date and therefore no exchange rate gain or loss arises.
- The provided prepayment is reported in the balance sheet as part of fixed assets or inventory based on the nature of the acquired asset. The acquisition of a service is reported as a deferred expense.
- At the time of delivery of the asset or service, the amount of the provided prepayment is not simultaneously translated using the current exchange rate.
- If multiple prepayments are provided before the delivery of the asset or service, each prepayment is translated using the historical exchange rate (as of the date of provision of the funds).
The justification of the Interpretation states that the economic substance of provided receivables corresponds to the definition of deferred expenses, whose accounting treatment is described in I-37 Accruals and Deferrals and Foreign Currency.
When exchange rate gains or losses arising from the translation of provided prepayments are reported for provided prepayments that are not expected to be refunded, the justification of the Interpretation states that this “can be considered as an approach that is contrary to the principle of providing a true and fair view of the financial situation and financial performance of the entity in the financial statements”, even though paragraph 2.2 of Czech Accounting Standard No. 006 refers to the revaluation of foreign-currency prepayments and the origination of exchange rate gains and losses when the invoice and prepayment are recognised.
Provided prepayment is a foreign-currency receivable
If it is probable that the asset or service will not be delivered and the financial amount is expected to be refunded, the provided prepayment represents a foreign-currency receivable and the following method is applied:
Full text of Interpretation I-43 is available on the website of the National Accounting Board.
The implementation of both interpretations is fully within the responsibility of each entity – the interpretations do not address the practical transition to the proposed conceptual solutions, i.e. whether to apply them retrospectively (as a change of accounting method or as a correction of a misstatement – and under what conditions), prospectively, or alternatively as some kind of combination of the two. This also entails tax risks.
We recommend carefully considering the circumstances in each case, their significance, potential risks and tax consequences.
Feel free to contact our professionals should you need any assistance.
Source: www.nur.cz
Seminars, webcasts, business breakfasts and other events organized by Deloitte.
