IAS 21 - THE EFFECTS OF

CHANGES IN FOREIGN
EXCHANGE RATES –
LECTURE NOTES

truongthihanhdung@uel.edu.vn
(+84)96.672.4386
Agenda
1. Objectives
2. Scope
3. Definitions
4. Reporting foreign currency transactions in the functional
currency
5. Use of a presentation currency other than the functional
currency
6. Disclosure
AT UNIVERSITY LEVEL, WE DON’T
RELATE THIS TOPIC INTO BUSINESS
COMBINATION PROCEDURES!
 Objective of the standard
―Foreign Transactions Foreign
activities‖ of in foreign operations
the currencies (investments in
business: associates, joint
ventures or
subsidiaries)

•1 •2
IAS 21 Which exchange rate(s) to use and how to report the
effects of changes in exchange rates in the financial statements?
Scope of IAS 21
Transactions and balances in foreign
currencies, exclude those related to
IFRS 9 Financial Instruments;

Translating the results (income) and financial

position(assets, liabilities &equity) of foreign
operations that are included in the financial
statements of the entity by consolidation or the
equity method;

Translating an entity’s results and

financial position into a
presentation currency
DEFINITIONS
• Functional currency, ie the currency of the primary economic
environment in which the entity operates.
• Presentation currency, ie the currency in which financial
statements are presented.
• A foreign currency is "a currency other than the functional
currency of the entity".
•

Note: there are no more

“measurement currency”,
“reporting currency” in the new
standard
Other definitions
[IAS 21.8]

Exchange
Closing rate Exchange rate
difference

•Net
spot exchange
investment in a
rate at operation
the end of A group
foreign
the reporting
period
Spot exchange rate Foreign operation Monetary items
Features and examples of monetary
items vs non-monetary items (IAS21.16)
Non-monetary items
Monetary items

Absence of a right to receive (or

Right to receive (or an obligation
an obligation to deliver) a fixed or
to deliver) a fixed or determinable
determinable number of units of
number of units of currency
currency
Pensions and other employee Prepaid for goods and services,
benefits to be paid in cash; Goodwill, intangible assets,
provisions that are to be settled in inventories, PPE, provisions that are
cash; cash dividends that are to be settled by the delivery of a non-
recognised as a liability… monetary asset…..
Practical application
• Cash • Inventory
• Cash equivalents • Prepaid expenses (prepayments)
• Debt securities • Equity securities
• Accounts receivable • Investment property
• Notes receivable • Property, plant, and equipment
• Accounts payable • Intangible assets (e.g. goodwill)
• Notes payable • Deferred income
• Bonds payable • Government grant….
• Leases payable
• Accruals
• Deferred tax (usual classification)…

Monetary items Non-monetary

(assets/liabilities) items(assets/liabilities)
CHOOSING FUNCTIONAL CURRENCY
1/Determine sales
prices
MUST

2/ Influence sales
FUNCTIONAL
CURRENCY
prices CONSIDER

3/ Influence labor,
materials & other costs

4/ Operating cash
inflows are retained

5/ Financing funds are

generated

(IAS 21.9-10)
Example 1
ABC stand-alone entity (ie not a foreign operation of another entity)
manufactures a product for the local market in country A. Its sales are
denominated in the local currency, let’s say Dinar. The price of its product in
country A is affected mainly by local supply and demand and regulations.
All of the entity’s inputs are sourced in country A and the prices of the inputs
are denominated in Dinar and are mainly influenced by economic forces
and regulations in country A. Determine the entity’s functional currency.
Analysis and guidance
Example 2
• ABC stand-alone entity extracts a commodity from underground in
country A. The currency of country A is the Dinar. Sales of the commodity
are denominated in the local currency of country Z, Peso. The Peso
sales price of the commodity is affected by the global supply and
demand. Country Z accounts for about 50 per cent of global demand for
the commodity.
• About 90 per cent of the entity’s costs are for expatriate staff salaries and
imported chemicals and specialised machinery imported from country Z.
These costs are denominated and settled in Peso. The entity’s other
costs are incurred and settled in Dinar. Determine the entity’s functional
currency.
Analysis and guidance
Example 3—primary indicators are mixed
ABC stand-alone entity (ie not a foreign operation of another entity) based in country
A manufactures a product in country A for export to country B. Labour and raw
materials are relatively inexpensive in country A.
The entity’s sales prices are nearly always denominated in Dinar (the local currency
of country B) and established predominantly based on prices set by competitive
forces in country B and by country B’s regulations. Customers settle in Dinar and the
entity holds its excess cash in Dinar, only converting sufficient Dinar into Yen (the
local currency of country A) to settle its operating costs as they fall due.
The majority of the entity’s borrowings are in Dinar. Most costs are paid in Yen.
Specialised machinery is purchased from suppliers in country C. Those purchases
are denominated in Peso (ie the local currency of country C). Such costs are not
significant when compared to the Yen-denominated operating costs.
Determine the entity’s functional currency.

LC – A: YEN
LC – B: DINAR
LC – C: PESO
Analysis and guidance
Functional 1/% Operational independence,
currency
for foreign
operations
(additional 2/ Influence of Cash flows,
factors)

3/ % transactions with parents,

4/ Financial autonomy
Compared with parents.

IAS21.11-12
Example 4 —foreign subsidiary operates
with little interference from the parent
ABC - parent company (whose functional currency is the Dinar) manufactures influenza
remedies in country A. It has a subsidiary in country Z. The subsidiary is predominantly
financed by a (Dollar, local currency of country Z) loan.
The subsidiary operates with significant autonomy from the parent. Management of the
subsidiary determine, without interference from the parent entity, the prices of its products,
which are influenced mainly by local competition and regulations. The subsidiary uses
some of the parent’s formulas under a licence agreement.
It also develops and produces some of its own formulas to meet local preferences and local
health and safety regulations. It manufactures its own products in country Z with locally sourced
raw materials and local labour. It sells its products to customers in country Z. Some specialised
machinery is purchased from abroad but the cost of such equipment is insignificant in relation to
other operating costs.
Determine the subsidiary’s functional currency.

LCA – parents: Dinar

LCZ – subsidiary: Dollar
Analysis and guidance

•
 Example 5 —foreign special purpose
entity
A parent entity whose functional currency is the Franc (the local currency of country
A) manufactures influenza remedies in country A.

The parent forms a subsidiary in country B for the sole purpose of undertaking
research and development activities for the parent. Other than paying its suppliers
and employees for raw materials and labour in Won (local currency of country B), its
only transactions are with the parent.

The subsidiary is financed mainly by the parent. The parent pays the subsidiary an
Franc-denominated fee for its research and development services, and the parent
provides its subsidiary with any necessary equipment for the research and
development. That fee is used to settle local expenses.
Determine the subsidiary’s functional currency.

LCA – parents: Franc

LCB – subsidiary: Won
Analysis and guidance

•
Agenda
1. Objectives
2. Scope
3. Definitions
4. Reporting foreign currency transactions in the
functional currency
5. Use of a presentation currency other than the functional
currency
6. Disclosure
Foreign currency transactions (IAS 21.20)
Foreign currency transaction as "a transaction that is
denominated or requires settlement in a foreign
currency“.
• buys or sells goods or services in a
1 foreign currency

• borrows or lends funds in a foreign

2 currency

• acquires or disposes of assets, or incurs

3 or settles liabilities, in a foreign currency.
Initial recognition of foreign
currency transactions
On initial recognition, a foreign currency
transaction should be recorded in the entity's
functional currency by applying the spot
exchange rate between the functional currency
and the foreign currency as at the date of the
transaction.
The spot exchange rate is defined as "the exchange rate for immediate
delivery".

IAS 21.21
Example 6— transactions in a foreign
currency (paragraph 20)
A. An entity with a functional currency of CU sells inventory with a carrying
amount of CU10,000 to a customer on credit for FCU30,000. The spot
exchange rate when the sale is recognised in accordance with IFRS 15
Revenue is CU1 = FCU2.

B. An entity with a functional currency of CU borrows FCU100,000 from a

bank when the spot exchange rate is CU1 = FCU2.5.

C. An entity with a functional currency of CU buys a machine (property, plant

and equipment) from an overseas supplier for cash of FCU10,000. The
spot exchange rate is FCU1 = CU2 on the date the machine is initially
recognised.
Require: Journalize the transactions.

CU = currency unit (local)

FCU = foreign currency unit
Analysis and guidance
 IAS 21.22
“The date of a transaction..”
• The date of a transaction is the date on which the
transaction first qualifies for recognition in accordance with
IFRSs.
• For practical reasons, an average rate for a week or a
month might be used for all transactions in each
foreign currency occurring during that period. However,
if exchange rates fluctuate significantly, the use of the
average rate for a period is inappropriate.
WHY USE AVERAGE WHAT COULD BE DIFFICULTIES IN
RATE? IDENTIFYING THE DATE OF A
TRANSACTION?
EXAMPLE 7 – WHAT COULD BE DIFFICULTIES WITH
THE DATE OF TRANSACTION?
A Belgian entity buys an item of inventory from a Canadian
supplier. The dates relating to the transaction, and the relevant
exchange rates, are as follows:
DATE EVENTS €1=C$
14 April 2021 Goods are ordered 1.50

5 May 2021 Goods are shipped from Canada and invoice 1.53
dated that day
7 May 2021 Invoice is received 1.51
10 May 2021 Goods are received 1.54
14 May 2021 Invoice is recorded 1.56
7 June 2021 Invoice is paid 1.60
What is the date of initial recognition of inventory?
EXAMPLE 8: Establishing the
transaction date
On 30 September 2021 Company A, whose functional currency is the euro,
acquires a US dollar bond for US$8,000 which is measured at amortised
cost. The bond carries fixed interest of 5% per annum paid quarterly, i.e.
US$100 per quarter. The exchange rate on acquisition is US$1 to €1.50.
On 31 December 2021, the US dollar has appreciated and the exchange
rate is US$1 to €2.00. Assuming that the appropriate average rate for the 3
month period is US$1 to €1.75
Analysis and guidance
Subsequent measurement of foreign currency
items (at the end of each reporting periods)
Foreign currency items appearing in the statement of financial position
should be translated as follows:

Non-monetary items Non-monetary items

Monetary items
carried at historical cost carried at FV

Rate at the date

Rate at the end of that the item's FV
Rate at the date of
the period (closing was measured
the transaction
rate) (rate at the date of
valuation)

IAS 21.23
Recognition of exchange differences

• Exchange differences arising on the settlement of or on

translating monetary items  shall be recognised in profit
or loss in the period in which they arise (IAS 21.28-29)
• When the transaction is settled within the same accounting
period as that in which it occurred, all the exchange difference
is recognised in that period. However, when the transaction is
settled in a subsequent accounting period, the exchange
difference recognised in each period up to the date of
settlement is determined by the change in exchange rates
during each period.

Standard excerpt – use illustration instead

Recognition of exchange differences

• When a gain or loss on a non-monetary item is

recognised in other comprehensive income, any
exchange component of that gain or loss shall be
recognised in other comprehensive income.
Conversely, when a gain or loss on a non-monetary
item is recognised in profit or loss, any exchange
component of that gain or loss shall be recognised in
profit or loss (IAS21. 30-31) (there’s a choice)
• Note: Other IFRSs require some gains and losses to be
recognised in other
comprehensive income (IAS 16).

Standard excerpt – use illustration instead

Graphing by KPMG

• Realised: transactions
finalised/occurred!
• Unrealised: we just expect
to earn at the end of period!

IAS 21.28-29
Graphing by KPMG

IAS21. 30-31
Example 10—an entity buys goods on
credit in a foreign currency
a/ On 24 December 20X1, an entity with a functional currency of CU buys raw
materials from a supplier on credit for FCU100,000. The entity pays the
supplier on 17 January 20X2. The entity has a financial year-end of 31
December 20X1.
• The spot exchange rates are as follows:
ꟷ 24 December 20X1: CU2 = FCU1
ꟷ 31 December 20X1: CU2.1 = FCU1
ꟷ 17 January 20X2: CU2.05 = FCU1
Detail the accounting treatment for each transactions.
Example 10— foreign currency loan
payable
b/ On 1 January 20X1, a bank transfers FCU5,000 to an entity in return for a
promise to pay fixed interest of 8% per year for two years (due at the end of each
year of the loan period, 31 December) and a payment of FCU5,000 at the end of
the two-year period.
At the inception of the loan 8% is the market rate for similar two-year fixed-interest
FCU-denominated loans. The entity’s functional currency is CU.
Exchange rates over the loan are (in this example, average rates are determined
on a monthly average basis):
1 January 20X1: CU1 = FCU5
Average exchange rate in 20X1: CU1 = FCU5.06
31 December 20X1: CU1 = FCU5.1
Average exchange rate in 20X2: CU1 = FCU4.9
31 December 20X2: CU1 = FCU4.8
In this example, the average currency exchange rate for the year is not materially
different from the actual rate.
Analysis and guidance b/
Analysis and guidance b/
Recognition of exchange differences
reclassified from OCI to P&L -
instructor
• Exchange differences arising on a monetary item that forms part of a
reporting entity’s net investment in a foreign operation (see paragraph
15) shall be recognised in profit or loss in the separate financial
statements of the reporting entity or the individual financial statements
of the foreign operation, as appropriate. In the financial statements
that include the foreign operation and the reporting entity (eg
consolidated financial statements when the foreign operation is a
subsidiary), such
exchange differences shall be recognised initially in other
comprehensive income and reclassified from equity to profit or loss on
disposal of the net investment in accordance with paragraph 48.

NOT IN SCOPE
Example 11
ABC Inc. has its functional currency as the $USD. It trades with several
suppliers overseas and bought goods costing 400,000 Dinar on 1
December 20X5. ABC paid for the goods on 10 January 20X6. ABC’s
year-end is 31 December. The exchange rates were as follows:
1 December 20X5 4.1 Dinar : $1USD
31 December 20X5 4.3 Dinar : $1USD
10 January 20X6 4.4 Dinar : $1USD
Show how the transaction would be recorded in ABC’s financial
statements.
Change in functional currency
An entity does not have a free choice of functional
currency
An entity cannot change functional currency unless facts
and circumstances relevant to its determination change
When there is a change in an entity’s functional currency,
the entity shall apply the translation procedures applicable
to the new functional currency prospectively from the
date of the change (IAS21.36).
Example 12 - foreign subsidiary changes
operations Instructor only
Several years earlier, an entity (parent), whose functional currency is
CU, purchased an overseas subsidiary. For many years after
acquisition, the subsidiary operated independently of its parent and
during this time the functional currency of the subsidiary was
determined to be FCU (the local currency in the subsidiary’s
jurisdiction).
However, in the current year, because of an increase in labour and
material costs in the subsidiary’s jurisdiction, the subsidiary stopped
manufacturing its own products and began distributing the parent’s
products in its jurisdiction. The subsidiary’s manufacturing facilities
were sold to a third party. Management reassessed the subsidiary’s
functional currency and determined it to be CU.

In accordance with paragraph 36, the effect of the change of functional
currency is accounted for prospectively from the date of the change.
 Examples 13— Effect of changes in
functional currency
• Until 31 December 20X2 (its financial year-end) an entity’s functional currency was
the Dinar. It presented its financial statements in Dinar.
At the start of 20X3, because of a change in circumstances, the functional currency
of the entity changed to the Dollar. The date of the change in the functional currency
was determined to be 1 January 20X3.
• On 1 January 20X0, the entity purchased an item of machinery for $100,000 when
the exchange rate was Dinar1 = Dollar 2. The entity is depreciating the machine
over 10 years on a straight-line basis. On 1 January 20X3 the exchange rate is
Dinar1 = Dollar 1.8.
• Determine the carrying amount of the asset at 31/12/x3.
Agenda
1. Objectives
2. Scope
3. Definitions
4. Reporting foreign currency transactions in the functional
currency
5. Use of a presentation currency other than the
functional currency
6. Disclosure
Translation to a presentation currency
Although most entities present their financial statements in their
functional currency, IAS21 allows entities to use a different presentation
currency if they wish. The process of translating from the functional
currency to the presentation currency is as follows:

Assets and liabilities are translated at the closing rate

at the end of the reporting period;

Income, expenses and OCI are translated at

exchange rates at the dates of the transactions;

All resulting exchange differences shall be

recognised in OCI (IAS 21.39).
Regraphing the translation process for more
IAS 21.39-40

Assets and liabilities • Translated at the closing rate

NO GUIDANCE
FOR EQUITY ACC!

• Rates at the dates of the transactions

Income and expenses & (or average rate if exchange rates
OCI fluctuate insignificantly) (IAS 21.40)

All resulting exchange

differences shall be
recognised in OCI • Reclassify to P/L on disposal
(classified as a separate
component of equity)
Translation to a presentation currency
FOR INSTRUCTOR, Consolidated FSs related!

The exchange differences referred to in paragraph 39(c) result from:

(a) translating income and expenses at the exchange rates at the dates
of the transactions and assets and liabilities at the closing rate.
(b) translating the opening net assets at a closing rate that differs from
the previous closing rate.
• These exchange differences are not recognised in profit or loss
because the changes in exchange rates have little or no direct effect
on the present and future cash flows from operations. The
cumulative amount of the exchange differences is presented in a
separate component of equity until disposal of the foreign
operation. When the exchange differences relate to a foreign
operation that is consolidated but not wholly-owned, accumulated
exchange differences arising from translation and attributable to non-
controlling interests are allocated to, and recognised as part of, non-
controlling interests in the consolidated statement of financial
position(IAS 21.41).
Graphing by KPMG IAS 21.41
FOR INSTRUCTOR, CHECK BACK FIGURES! Students don’t hv to
reconcile!
Example14 a/ —use of a presentation
currency other than the functional currency
Entity A is a stand-alone entity (it is not part of a group). Its functional currency is Swiss Franc.
However, Entity A is required by law to present its financial statements in Singapore dollars,
which is the local currency of the country in which it operates. Entity A has a 31 December
financial year-end.
The exchange rates:
at 31 December 20X1 and 31 December 20X2 are CHF1 = SGD2 and CHF1 = SGD2.3
respectively.
weighted average rate for the year ended 31 December 20X2 is CHF1 = SGD2.2.
In 20X2: Entity A paid a dividend of CHF3,000 when the rate of exchange was CHF1 =
SGD2.25.
The share capital was issued when the exchange rate was CHF1 = SGD1.8.
Entity A records all its transactions in its functional currency in accordance with IAS 21.
Notes
The weighted average exchange rate for the year ended 31 December 20X1 is CHF1 =
SGD1.9.
At 1 January 20X1, a cumulative gain of SGD2,800 has been recognised in the foreign
exchange reserve, which is due to translation of entity’s financial statements into SGD at
previous periods.
Retained earnings at 1 January 20X1 were SGD22,000.
The statement of comprehensive income and an extract from the statement of changes in
equity for the year ended 31 December 20X2 prepared in the functional currency are as follows:
CHF
CHF CHF
SOLUTION
SOLUTION
Example12 b/ —treatment of issue of
additional share capital in the year
The facts are the same as in Example a/, except that on 1
December 20X2 Entity A issued CU10,000 more capital
when the currency exchange rate was CU1 = LCA2.6.
This increases cash by CU10,000 and share capital by
CU10,000. Consequently, on 31 December 20X2 net
assets increased by CU10,000 to CU59,500. Translate the
SFP into LCA.
SOLUTION
Solution
 Translation of a foreign operation
 If an entity has a foreign operation (e.g. a foreign subsidiary,
associate or joint venture) it will be necessary to translate
the financial statements of that operation into the same
currency as is used in the entity's own financial statements.
 Only then will it be possible to include the foreign operation
in the entity's financial statements by consolidation or by the
equity method.
 The translation process is the same as the process adopted
when translating an entity's financial statements from a
functional currency to a presentation currency.

NOT IN SCOPE
Agenda
1. Objectives
2. Scope
3. Definitions
4. Reporting foreign currency transactions in the functional
currency
5. Use of a presentation currency other than the functional
currency
6. Disclosure
Key disclosures
• ♦ Exchange rate differences included in:
- P/L (except for financial instruments measured at FV through
P/L)
- Other comprehensive income
♦ Reminders
- Refer to functional currency and presentation currency
- In accounting policy note disclose that P/L items are
translated at rate at transaction dates
♦ Reasons (if applicable):
- Why there has been a change in the functional currency
- Why the presentation and functional currency are different
♦ If entity’s presentation currency is different from its
functional currency, its financial statements should
be described as compliant with IFRSs only if all the
requirements of IAS 21 are applied