IAS 21 “The Effects of Changes in Foreign Exchange Rates”: Key Requirements and Examples

Functional currency and presentation currency

Functional currency is the currency of the primary economic environment in which the entity operates (paragraph 8), normally the environment in which it primarily generates and expends cash (paragraph 9). Any other currency is a foreign currency. Presentation currency is the currency in which the financial statements are presented, and an entity may present them in any currency (paragraph 38).

• primary indicators (paragraph 9): the currency that mainly influences sales prices, the currency of the country whose competitive forces and regulations determine prices, and the currency that mainly influences labour, material and other costs;
• supporting indicators (paragraph 10): the currency in which financing is raised and the currency in which operating receipts are usually retained;
• where indicators are mixed, management uses its judgement to determine the currency that most faithfully represents the economic effects of transactions (paragraph 12);
• once determined, functional currency changes only when the underlying transactions and conditions change (paragraph 13), and the change is applied prospectively (paragraph 35).

Initial recognition of transactions

On initial recognition, a foreign currency transaction is recorded in the functional currency at the spot exchange rate at the date of the transaction (paragraph 21). That date is the date on which the transaction first qualifies for recognition under IFRS (paragraph 22).

For practical reasons an approximate rate may be used, such as an average rate for a week or month applied to all transactions in that period. If exchange rates fluctuate significantly, however, an average rate is inappropriate (paragraph 22). Where several rates exist, the rate used is the one at which future cash flows would have been settled had they occurred at the measurement date (paragraph 26).

Reporting at the end of the period: monetary and non-monetary items

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 (paragraph 8): cash, receivables, payables and loans. At the end of each reporting period (paragraph 23):

• monetary items are translated using the closing rate;
• non-monetary items measured at historical cost (property, plant and equipment, inventories, advances received) are translated at the transaction-date rate, i.e. not retranslated;
• non-monetary items measured at fair value are translated at the rate on the date fair value was measured.

Where exchange differences are recognized

• Exchange differences on settling or retranslating monetary items are recognized in profit or loss in the period in which they arise (paragraph 28).
• If a transaction is settled in the same period, the whole difference is recognized in that period; if it is settled later, each period up to settlement reflects the rate change for that period (paragraph 29).
• The exchange component of a gain or loss on a non-monetary item follows the gain or loss itself: in other comprehensive income when the gain goes there, for example on revaluation under IAS 16, otherwise in profit or loss (paragraph 30).
• Differences on a monetary item that forms part of the net investment in a foreign operation are initially recognized in other comprehensive income in the consolidated financial statements (paragraph 32).

Example: an import with deferred payment

A company whose functional currency is the sum buys equipment from a foreign supplier for 10,000 dollars, payable in three months, and the reporting date falls between delivery and payment.

On delivery, both the equipment and the payable are recorded at the rate on that date (paragraph 21). At the reporting date the payable, a monetary item, is retranslated at the closing rate, and the difference goes to profit or loss (paragraphs 23, 28). The equipment, a non-monetary item at historical cost, stays at the delivery-date rate. On payment in the next period a further exchange difference arises for the rate change between the reporting date and the payment date (paragraph 29).

Translation into a presentation currency

If the statements are presented in another currency, for example a sum-based company preparing dollar statements for a foreign investor, the procedure in paragraph 39 applies:

• assets and liabilities for each statement of financial position presented, including comparatives, at the closing rate;
• income and expenses at the rates on the transaction dates; in practice an average rate for the period may be used unless rates fluctuate significantly (paragraph 40);
• all resulting exchange differences in other comprehensive income; the cumulative amount is presented as a separate component of equity until disposal of the foreign operation (paragraphs 39, 41);
• on disposal of a foreign operation, the cumulative differences are reclassified from equity to profit or loss (paragraph 48).