IAS 21 Summary Notes

IAS 21 The Effects of Changes in Foreign Currency Rates

SCOPE & DEFINITIONS

SCOPE
IAS 21 shall be applied:
(a) in accounting for transactions and balances in foreign currencies, except for derivate
transactions under the scope of IAS 39/IFRS 9;
(b) in translating the results and financial position of foreign operations in the consolidation
process; and
(c) in translating an entity’s results and financial position into a presentation currency.

DEFINITIONS
Closing rate is the spot exchange rate at the SFP date
Exchange is the difference resulting from translating a given number of units of one
difference currency into another currency at different exchange rate.
Exchange rate is the ratio of exchange for two currencies.
The price that would be received to sell an asset or paid to transfer a liability
Fair value
in orderly transaction between market participants at the measurement date.
Foreign currency is a currency other than the functional currency of the entity.
is an entity that is a subsidiary, associate, joint venture or branch of a
Foreign operation reporting entity, the activities of which are based or conducted in a country
or currency other than those of the reporting entity.
Functional is the currency of the primary economic environment in which the entity
currency operates.
are units of currency held and assets and liabilities to be received or paid in
Monetary items
a fixed or determinable number of units of currency.
Net investment in is the amount of the reporting entity’s interest in the net assets of that
a foreign operation.
operation
Presentation is the currency in which the financial statements are presented.
currency
Spot exchange is the exchange rate for immediate delivery.
rate

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IAS 21 Summary Notes

DETERMINING FUNCTIONAL CURRENCY

Each entity whether an individual company, a parent of a group, or an operation within a group
(such as a subsidiary, associate or branch) should determine its functional currency and measure
its results and financial position in that currency. The functional currency is the currency of the
primary economic environment in which the entity operates and it is normally the currency in
which the entity primarily generates and expends cash.

Where an entity is registered in a particular national jurisdiction and the majority of its transactions
take place there, that jurisdiction's currency will be the entity's functional currency. In practice,
many entities operate internationally, with group entities or business divisions located worldwide.
In such circumstances, management will be required to make a reasoned judgment in respect of
each entity/division, based on the available facts. Where the functional currency of an entity is not
obvious, an explanation of why a particular currency was identified as being its functional currency
would aid users' understanding of the business operations of the entity.
Under IAS 21, the management of a company needs to determine the functional
Indicators
currency of the company by assessing various indicators of the economic
of
environment in which the company operates. IAS 21 provides primary and
functional
secondary indicators for use in the determination of an entity's functional currency,
currency
as summarised below.
 The currency that mainly influences sales prices for goods and services (often
the currency in which prices are denominated and settled);
 The currency of the country whose competitive forces and regulations mainly
Primary
determine the sales prices of its goods and services; and
indicators
 The currency that mainly influences labour, material and other costs of
providing goods or services (often the currency in which prices are
denominated and settled).
 The currency in which funds from financing activities (raising loans and issuing
Secondary
equity) are generated; and
indicators
 The currency in which receipts from operating activities are usually retained.
In addition to the five indicators mentioned above, four additional factors are
considered in determining the functional currency of a foreign operation and whether
its functional currency is the same as that of the reporting entity.
 Whether the foreign operation carries out its business as though it were an
extension of the reporting entity rather than with a significant degree of
Functional
autonomy.
currency
 Whether transactions with the parent are a high or a low proportion of the
of foreign
foreign operation's activities.
operations
 Whether cash flows from the activities of the foreign operation directly affect the
cash flows of the parent and are readily available for remittance to it.
 Whether cash flows from the activities of the foreign operation are sufficient to
service existing and normally expected debt obligations without funds being
made available by the reporting entity.

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IAS 21 Summary Notes

REPORTING IN FUNCTIONAL CURRENCY

REPORTING FOREIGN CURRENCY TRANSACTIONS IN THE FUNCTIONAL CURRENCY

Apply the spot exchange rate to foreign currency amount at the date of
Initial
transaction. For practical reasons, an average rate over a period may be used if it
recognition
approximates the actual rate at the date of transaction.
At each SFP date foreign currency item shall be translated as follows:
Items Translation
Monetary items Using the closing rate
Non-monetary items measured Using the exchange rate at the date of
Subsequent
at historical cost the transaction
recognition
Non-monetary items measured Using the exchange rate at the date of
at fair value when the fair value was determined

Exchange difference arising on: To be recognised in:

Settlement of monetary items P&L in the period in which they arise
Translation of monetary items at P&L in the period in which they arise
different rates
Gain or loss on non-monetary items Directly in equity
recognised in equity
Gain or loss on non-monetary items Directly in P&L
Recognition recognised in P&L
of
exchange There is one exception to the above rules, that is, exchange differences arising on
differences monetary items that form part of the reporting entity’s net investment in foreign
operation are recognised in the group financial statements within a separate
component of equity (re-classifiable). They are recognised in P&L on disposal of
net investment.

The exchange difference arising on monetary items that form part of the reporting
entity’s net investment in foreign operation is recognised in P&L in the entity’s
separate financial statements.

Change in When there is a change in an entity’s functional currency, the entity shall apply the
functional translation procedures applicable to the new functional currency prospectively
currency form the date of the change.

EXAMPLE 21A
An entity purchases equipment from a foreign supplier for €6 million on March 31, 2006, when the
exchange rate was €2=$1. The entity also sells goods to foreign customer for €3.5 million on April
30, 2006, when the exchange rate was €1.75=$1. At the entity’s year end of May 31, 2006, the
amounts have not been paid. The closing exchange rate was €1.5=$1. The entity’s functional
currency is the $.

Required:
Calculate the exchange differences that would be recorded in profit or loss for the period ending
May 31, 2006?

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IAS 21 Summary Notes

EXAMPLE 21B
P Limited has foreign subsidiary whose functional currency is the euro. The functional currency of
the entity is the $. On January 1, 2006 when the exchange rate was $1=€1.5 the entity loans the
subsidiary $3 million. At December 31, 2006, the loan has not been repaid and is regarded as part
of the net investment in the foreign subsidiary, as settlement of the loan is not planned or likely to
occur in the foreseeable future. The exchange rate at December 31, 2006 is $1=€2, and the
average rate for the year was $1=€1.75

Required:
Explain how this loan would be treated in subsidiary’s and group financial statements?

USE OF PRESENTATION CURRENCY

USE OF PRESENTATION CURRENCY OTHER THAN THE FUNCTIONAL CURRENCY

If the financial statements of the entity are not in the functional currency of a
hyperinflationary economy, then they are translated into the presentation currency
using the following procedure:
Assets and liabilities (including any Translated at closing rate
goodwill arising on the acquisition
and any fair value adjustment)
Translation Income and expenses (including Translated at spot exchange rates at
to comparatives) the date of transaction (Average rates
presentation may be used if they approximate the
currency actual rates)
All resulting exchange differences Shall be recognised as a separate
component of equity.

In case of a hyperinflationary economy, all amounts are translated at the closing

rate except that the comparative amounts are shown as presented in the previous
period.

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IAS 21 Summary Notes

EXAMPLE 21C
K Limited commenced business on January 1, 2006 with an opening share capital of $2 million.
The income statement and closing balance sheet follow:
SPL&OCI for the year ended December 31, 2006
$m
Revenue 32
Cost of sales (10)
Gross profit 22
Distribution costs (8)
Administrative expenses (2)
Profit before tax 12
Tax expense (4)
Profit for period 8

Statement of financial position as at December 31, 2006

$m
Share capital 2
Retained earnings 8
10
Trade payables 4
Total equity and liabilities 14

Freehold land (acquired December 31, 2006) 8

Inventories 4
Trade receivables 2
Total assets 14

The functional currency is the $, but the entity wishes to present its financial statements using the
Euro as its presentation currency. The entity translates the opening share capital at the closing
rate. The exchange rates in the period were:
$1=
January 01, 2006 €1.0
December 31, 2006 €2.0
Average rate €1.5

Required:
Translate the financial statements from the functional currency to presentation currency?

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IAS 21 Summary Notes

GROUP ACCOUNTS
When preparing group accounts, it is normal to deal with entities that utilise different
Translation currencies. The financial statements should be translated into the presentation
currency of parent.
Any goodwill and fair value adjustments are treated as assets and liabilities of the
Goodwill foreign entity and therefore are retranslated at each SFP date at the closing spot
rate.
Exchange differences on intra-group items are recognised in P&L unless the
Intra group difference arises on retranslation of net investment in a foreign operation when it is
items classified in other comprehensive income [re-classifiable] (becomes part of
equity).
Dividends paid in a foreign currency by a subsidiary to its parent company may lead
Dividends to exchange differences in the parent’s financial statements and such differences
will not be eliminated on consolidation but recognised in P&L.

DISPOSAL OF FOREIGN OPERATION

When a foreign operation is disposed of, the cumulative amount of the exchange differences in
equity relating to that foreign operation shall be recognised in P&L when the gain or loss on
disposal is recognised.

EXAMPLE 21D
H Limited has a 100% owned foreign subsidiary, which it carries at its original cost of $2 million. It
sells the subsidiary on March 31, 2007, for €5 million. As of March 31, 2007, the balance on the
exchange reserve was $300,000 credit. The functional currency of the entity is the $, and the
exchange rate on March 31, 2007 is $1=€2. The net asset value of the subsidiary at the date of
disposal was $2.4 million.

Required:
Discuss the treatment of the disposal of the foreign subsidiary?

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IAS 21 Summary Notes

ANSWER 21A
The entity records the asset at a cost of $3 million (€6m/2) at March 31, 2006, and a liability of the
same amount. At the year end, the amount has not been paid. Thus using the closing rate of
exchange, the amount payable would be retranslated at $4 million (€6m/1.5), which would give an
exchange loss of $1 million to be reported in profit or loss. The cost of the asset remains at $3
million before depreciation.

Similarly, the entity will record a sale of $2 million (€3.5m/1.75) and an account receivable of the
same amount. At year end, the receivable would be stated at $2.33 million, which would give an
exchange gain of $0.33 million, which would be reported in profit or loss.

IAS 21 does not specify where exchange gains or losses should be shown in the income
statement.

ANSWER 21B
There is no exchange difference in the entity’s financial statements, as the loan has been made in
$.

In the foreign subsidiary’s financial statements, the loan is translated into its own functional
currency (Euro) at the rate of $1=€1.5, or €4.5 million as of January 01, 2005. At the year end, the
closing rate will be used to translate this loan. This will result in the loan being restated at €6
million ($3 million x 2), giving an exchange loss of €1.5 million, which will be shown in the
subsidiary’s income statement.

In the group financial statements, this exchange loss will be translated at the average rate, as it is
in the subsidiary’s income statement, giving a loss of ($1.5/1.75 million), or $857,000. This will be
recognised in equity.

There will be a further exchange difference (gain) arising between the amount included in the
subsidiary’s income statement at the average rate and at the closing rate: that is, $857,000 minus
$750,000 (1.5 million Euro/2), or $107,000.

Thus the overall exchange difference is $750,000. This will be recognised in equity.

An alternative way of calculating this exchange loss follows:

The loan at January 01, 2006, is €4.5 million. On retranslation, this becomes $2.25 million at
December 31, 2006 (€4.5/2). The original amount was $3 million, so there is an exchange loss of
($3 – 2.25) million, or $0.75 million.

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IAS 21 Summary Notes

ANSWER 21C

Statement of Comprehensive Income for the year ended

December 31, 2006
(at average rates)
€1.5=$1
Revenue 48
Cost of sales (15)
Gross profit 33
Distribution costs (12)
Administrative expenses (3)
Profit before tax 18
Tax expense (6)
Profit for period 12
Other comprehensive income (see note below) 4
Total comprehensive income 16

Statement of financial position as at December 31, 2006

€2.0=$1
Share capital (closing rate) 4
Retained earnings (as calculated above) 12
Exchange difference (see note below) 4
20
Trade payables 8
Total equity and liabilities 28

Freehold land (acquired December 31, 2006) 16

Inventories 8
Trade receivables 4
Total assets 28

Note:
The retained earnings if translated into Euros would be €16 million. As the income statement has
been translated using the average rate, the profit as per income statement is €12 million, creating
an exchange difference of €4 million.

ANSWER 21D
The subsidiary is sold for €5 million / 2 = $2.5 million. In the parent entity’s accounts, a gain of $0.5
million will be shown ($2.5 – $2 million).

In the group financial statements, the cumulative exchange gain will have to be shown in profit or
loss together with the gain on disposal. The gain on disposal is $100,000 ($2.5 - $2.4 million),
which is the difference between the sale proceeds and the net assets value of the subsidiary. To
this is added the cumulative exchange gain of $300,000 to give a total gain of $400,000, which will
be included in group income statement.

Dated: 23 August 2016

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