Overview
Understanding the classification of balance sheet items as monetary and non-monetary is crucial in determining the appropriate exchange rate to use.
According to IFRS 21.21-23 (International Standard) and ASC 842 (US GAAP), the Right-of-Use Asset is a non-monetary item, while the Lease Liability is a monetary item.
Both standards require that non-monetary items should be translated using the historical exchange rate, while monetary items should be translated using the closing foreign exchange rate.
If you want to learn how to set up your foreign exchange accounting in Cradle, refer to this article.
Here is a video explaining the application of foreign exchange rates on Right-of-Use (ROU) asset and Lease Liability.
Video length: 4 minutes
Alternatively, you can read the explanation below.
The Definition of Monetary Item and Non-Monetary Item
Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.
Non-monetary items are those assets and liabilities appearing on the balance sheet that are not cash, or cannot be readily converted into cash. Generally, non-monetary assets include fixed assets such as property, plant and equipment as well as intangible items such as goodwill.
What is the accounting treatment for Right-of-Use (ROU) Asset and Lease Liability when translating foreign exchange rates?
According to IFRS 21-23, At each reporting date,
foreign currency monetary items shall be translated using the closing rate;
non-monetary items that are measured in terms of historical cost in a foreign currency shall be translated using the exchange rate at the date of the transaction; and
monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the date when the fair value was determined
According to PwC ASC 842 Guide 4.7.1,
“The right-of-use asset is a non-monetary asset and lease liability a monetary liability… For both operating and finance leases, the right-of-use asset should be remeasured into the functional currency using the exchange rate on the lease commencement date, while the lease liability should be remeasured based on the period end exchange rate.”
Example
Lease Liability on Jan 1: AU$1,000
ROU Asset on Jan 1: AU$1,000
Exchange Rate on Jan 1: 0.75
Lease Liability on Jan 31: AU$700
ROU Asset on Jan 31: AU$687.50
Exchange Rate on Jan 31: 0.67
Step 1: Translate the Lease Liability and ROU Asset on Jan 1
Lease Liability | ROU Asset | |
AUD | 1,000 | 1,000 |
FX | 0.75 | 0.75 |
USD | 750 | 750 |
Step 2: Identify the changes in foreign currency for both Lease Liability and ROU Asset, then translate into home currency (USD)
Remeasure Lease Liability using the rate on Jan 31
Lease Liability on Jan 1 | Changes | Lease Liability on Jan 31 | |
AUD | 1,000 | 300 | 700 |
FX | 0.75 |
| 0.67 |
USD | 750 |
| 469 |
Record the ROU Asset using the rate on Jan 1 (historical rate)
| ROU Asset on Jan 1 | Changes | ROU Asset on Jan 31 |
AUD | 1,000 | 83.3 | 916.67 |
FX | 0.75 |
| 0.75 |
USD | 750 |
| 687.5 |
How Would Cradle Translate the Foreign Exchange Amounts?
Here is an example. Cradle captures the foreign exchange for HKD and USD as of the following dates:
If we run the balance sheet converting from HKD to USD as the reporting currency as of Jan 1, 2023, the Lease Liability and ROU Asset both apply the Jan 1 exchange rate.
Then, we run the balance sheet converting from HKD to USD as of Jan 31,2023, ROU Asset conversion stay at the exchange rate from Jan 1, 2023, FX = 0.128. While the Lease Liability converses using the exchange rate as of Jan 31,2023, FX = 0.1276
What if we enter a date where the fx rate is unavailable?
Let’s say the balance sheet is run on Feb 16,2023. The exchange rate for that day is not entered in the foreign exchange section. Then, Cradle would use the latest exchange rate available, in this example, the latest exchange rate available is as of Jan 31,2023, therefore the Lease Liability is translated using FX = 0.1276 and ROU Asset would still converted using the Jan 1, 2023 rate.
FAQ:
I don’t want to enter every daily fx rate since that is a lot of data input. What is the minimum I should enter? The bare minimum to ensure the fx can run correct is to enter the exchange rate as of the beginning of each month and the end of each month.
Further Reading: