APB 11, also known as the International Accounting Standard Board's (IASB) "The Effects of Changes in Foreign Exchange Rates," is a financial reporting standard that outlines how companies should handle fluctuations in foreign exchange rates in their financial statements.
One key aspect of APB 11 is the concept of functional currency. A company's functional currency is the currency in which it primarily generates and expends cash. For example, if a company primarily generates revenue in US dollars but incurs expenses in Japanese yen, the US dollar would be its functional currency.
Under APB 11, companies must report their financial statements in their functional currency. Any changes in foreign exchange rates that occur between the functional currency and the reporting currency (the currency in which the financial statements are presented) must be recognized in the financial statements.
There are two approaches for recognizing these changes in the financial statements: the current rate approach and the temporal approach.
The current rate approach involves reporting the effects of foreign exchange rate changes in the current period's income statement. This means that any gain or loss from changes in foreign exchange rates is reflected in the current period's profits or losses. This approach is used when a company has a self-sustaining foreign operation, meaning it is capable of generating profits or losses independent of the parent company.
On the other hand, the temporal approach involves adjusting the carrying value of assets and liabilities in the balance sheet to reflect the effects of changes in foreign exchange rates. This approach is used when a foreign operation is not self-sustaining and is dependent on the parent company for financial support.
In summary, APB 11 provides guidance on how to recognize the effects of foreign exchange rate fluctuations in financial statements. The choice of which approach to use depends on the characteristics of the foreign operation and its relationship with the parent company. Understanding and applying APB 11 is important for companies that have international operations and for investors who rely on financial statements for decision-making.