IAS 21

The Effects of Changes in Foreign

Exchange Rates

Concepts, Illustrations and Disclosures

 Areas to be covered
• Objective
• Scope
• Definitions of some relevant key terms
• Reporting foreign currency transactions functional
currency operation
• Recognition of exchange differences
• Change in functional currency
• Use of a presentation currency other than the functional
currency
• Disposal or partial disposal of a foreign operation
• Tax effect of all exchange differences
• Disclosure
 Objectives
The objective of IAS 21 is to

• prescribe how to include foreign currency transactions and

foreign operations in the financial statements of an entity; and

• prescribe how to translate financial statements into a presentation

currency. The principal issues are

• which exchange rate(s) to use; and

• how to report the effects of changes in exchange rates in the financial
statements.
 Scope
IAS 21 shall be applied in

• Accounting for transactions and balances in foreign

currencies, except for
▪ those derivative transactions and balances that are within the
scope of IFRS 9 Financial Instruments.

• Advising the detail procedures of translating the results and

financial position of foreign operations that are included in
the financial statements of the entity by consolidation or the
equity method; and

• Translating an entity’s results and financial position into a

presentation currency.
 Key terms and definitions thereof
Key Terms Definition
a currency other than the functional currency of the entity
Foreign currency

is an entity that is a subsidiary, associate, joint arrangement or branch

of a reporting entity, the activities of which are based or conducted in
Foreign operation a country or currency other than those of the reporting entity

Functional the currency of the primary economic environment in which the

currency entity operates generates and expends cash

Exchange rate the ratio of exchange for two currencies

Closing rate the spot exchange rate at the end of the reporting period

Exchange the difference resulting from translating a given number of units of

difference one currency into another currency at different exchange rates

the price that would be received to sell an asset or paid to transfer a

Fair value liability in an orderly transaction between market participants at the
measurement date
 Key terms and definitions thereof
Key Terms Definition
Group is a parent and all its subsidiaries.

are units of currency held and assets and liabilities to be received or

paid in a fixed or determinable number of units of currency. The
essential feature of a monetary item is a right to receive (or an
obligation to deliver) a fixed or determinable number of units of
currency. Examples include: pensions and other employee benefits to
Monetary items
be paid in cash; provisions that are to be settled in cash; lease
liabilities; and cash dividends that are recognised as a liability. Net
investment in a foreign operation is the amount of the reporting
entity’s interest in the net assets of that operation.

Presentation
is the currency in which the financial statements are presented
currency

Spot exchange
the exchange rate for immediate delivery
rate
 Clarification of few concepts
Factors to be considered in determining the functional currency of
an entity:

The currency:

• that mainly influences sales prices for goods and services (this will
often be the currency in which sales prices for its goods and services
are denominated and settled);

• of the country whose competitive forces and regulations mainly

determine the sales prices of its goods and services;

• that mainly influences labour, material and other costs of providing

goods or services (this will often be the currency in which such costs
are denominated and settled).
 Clarification of few concepts

The following factors may also provide evidence of an entity’s functional

currency:

• the currency in which funds from financing activities (i.e. issuing debt
and equity instruments) are generated; and

• the currency in which receipts from operating activities are usually

retained.
 Reporting foreign currency transactions in
functional currency

Initial recognition
• A foreign currency transaction is a transaction that is denominated or
requires settlement in a foreign currency.

• A foreign currency transaction shall be recorded, on initial recognition

in functional currency.

• On such recognition, the spot exchange rate between the functional

currency and the foreign currency shall be applied to the foreign
currency amount at the date of the transaction and thus the functional
currency amount is arrived.
 Reporting foreign currency transactions in
functional currency
Reporting at the ends of subsequent reporting periods
At the end of each reporting period:

• 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

• non-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 measured.
 Recognition of exchange differences
Settlement of monetary items:
• Exchange differences arising on the settlement of monetary items shall be
recognized in profit or loss in the period in which they arise;
• Exchange differences arising on the settlement of monetary items or on translating
monetary items (except net investments in foreign operation) at rates different from
those at which they were translated on initial recognition during the period or in
previous financial statements shall be recognised in profit or loss in the period in which
they arise.

Reporting entity’s investment in foreign operation:

• Exchange differences arising on a monetary item that forms part of a

reporting entity’s net investment in a foreign operation 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
(e.g. 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.
 Recognition of exchange differences
Exchange component of gain or loss on non-monetary items

• 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
 Recognition of exchange differences
Example-1

An entity, with the BDT as its functional currency, purchases plant from a foreign entity for
$10m on 31 May 2016 when the exchange rate was BDT 78 to $1. The entity also sells goods
to a foreign customer for $2m on 30 September 2008, when the exchange rate was BDT 79 to
$1. At the entity’s year end of 31 December 2008, both amounts are still outstanding and have
not been paid. The closing exchange rate was BDT 80 to $1.

The accounting for the items for the period ending 31 December 2008 would be as
follows:

The entity records the plant and liability at BDT 780m at 31 May 2008. At the year-end, the
amount has not been paid. Thus using the closing rate of exchange, the amount payable
would be retranslated at BDT 800m, which would give an exchange loss of BDT 20m in
profit or loss. The asset remains at BDT 780m before depreciation.

The entity will record a sale and trade receivable of BDT 158m. At the year-end, the trade
receivable would be stated at 160m, which would give an exchange gain of BDT 2m that
would be reported in profit or loss as the receivable is monetary assets and denominated in
foreign currency.
 Change in functional currency
An entity shall apply the translation procedures applicable to the
new functional currency prospectively from the date of the
change.

Use of a presentation currency other than the

functional currency
An entity may present its financial statements in any currency (or
currencies). If the presentation currency differs from the entity’s
functional currency, it translates its results and financial position
into the presentation currency.

Example:
• When a group contains individual entities with different
functional currencies, the results and financial position of each
entity are expressed in a common currency so that consolidated
financial statements may be presented.
 Use of a presentation currency other than the
functional currency
The results and financial position of an entity whose functional currency is
not the currency of a hyperinflationary economy shall be translated into a
different presentation currency using the following procedures:

• (a) assets and liabilities for each statement of financial position presented
(i.e. including comparatives) shall be translated at the closing rate at the
date of that statement of financial position;

• (b) income and expenses for each statement presenting profit or loss and
other comprehensive income (i.e. including comparatives) shall be
translated at exchange rates at the dates of the transactions. For
practical reasons, a rate that approximates the exchange rates at the dates of
the transactions, for example an average rate for the period, is often used to
translate income and expense items. However, if exchange rates fluctuate
significantly, the use of the average rate for a period is inappropriate.

• (c) all resulting exchange differences shall be recognised in other

comprehensive income.
 Use of a presentation currency other than the
functional currency

The results and financial position of an entity whose functional currency

is the currency of a hyperinflationary economy shall be translated into a
different presentation currency using the following procedures:

• (a) all amounts (i.e. assets, liabilities, equity items, income and
expenses, including comparatives) shall be translated at the closing
rate at the date of the most recent statement of financial position,
except that

• (b) when amounts are translated into the currency of a non-

hyperinflationary economy, comparative amounts shall be those that
were presented as current year amounts in the relevant prior year
financial statements (i.e. not adjusted for subsequent changes in the
price level or subsequent changes in exchange rates).
Disposal or partial disposal of a foreign operation

On the disposal of a foreign operation (including partial disposal of

subsidiary regardless whether the entity retains a non-controlling interest:

• the cumulative amount of the exchange differences relating to

that foreign operation, recognised in other comprehensive
income and accumulated in the separate component of equity,
shall be reclassified from equity to profit or loss (as a
reclassification adjustment) when the gain or loss on disposal is
recognised.

In case of partial disposal of a foreign operation:

• the entity shall reclassify to profit or loss only the proportionate

share of the cumulative amount of the exchange differences
recognised in other comprehensive income.
 Disposal or partial disposal of a foreign operation
Example 2
An entity has a 100% owned foreign subsidiary, which has a carrying value at a cost
of BDT 145m. It sells the subsidiary on 31 December 2008 for $2m. As at 31
December 2008, the credit balance on the exchange reserve, which relates to this
subsidiary, was BDT 5m. The functional currency of the entity is the BDT and the
exchange rate on 31 December 2008 is BDT 80 to $1. The net asset value of the
subsidiary at the date of disposal was BDT 152m.

The subsidiary is sold for $2m multiplied by 80 million, therefore BDT 160m. In the
parent entity’s (separate) accounts a gain of BDT 15m will be shown. In the group
financial statements, the cumulative exchange gain in reserves will be transferred to
profit or loss, together with the gain on disposal. The gain on disposal is BDT 160m
minus BDT 152m, therefore BDT 8m, which is the difference between the sale
proceeds and the net asset value of the subsidiary. To this is added the exchange
reserve balance of BDT 5m to give a total gain of BDT 13m, which will be included
in the group statement of comprehensive income.
 Supplementary Examples
Example 1
Cat Ltd, a UK company that uses £ as its functional currency, buys goods from
a US supplier on the 1 April 20X8. The goods are priced at $54,000. Payment
is made 2 months later on the 31May 20X8.
The prevailing exchange rates are:
1 April 20X8 $1.80 : £1
31 May 20X8 $1.75 : £1

Initial transaction
Translate at HR on 1 April, $54,000/1.8 = £30,000
DR Purchases £30,000
CR Payables £30,000

On settlement
Translate at HR on 31 May, $54,000 / 1.75 = £30,857
DR Payables £30,000
DR Income Statement £857
CR Cash £30,857
Example 2

Cat Ltd, a UK company that uses £ as its functional currency, buys goods
from a US supplier on the 1 April 20X8. The goods are priced at $54,000.
Payment is still outstanding at the reporting date 30 June 20X8.
The prevailing exchange rates are:
1 April 20X8 $1.80 : £1
30 June 20X8 $1.70 : £1

Initial transaction

Translate at HR on 1 April, $54,000 / 1.8 = £30,000

DR Purchases £30,000
CR Payables £30,000

At the reporting date

Translate at CR on 30 June, $54,000 / 1.70 = £31,765

DR Income Statement £1,765
CR Payables £1,765
 Sample disclosure of IAS 21
Transactions in foreign currencies are translated to the respective functional
currencies of the Company at exchange rates at the dates of the transactions.
Monetary assets and liabilities denominated in foreign currencies at the
reporting date are retranslated to the functional currency at the exchange rate
at that date. The foreign currency gain or loss on monetary items is the
difference between amortised cost in the functional currency at the
beginning of the year, adjusted for effective interest and payments during the
year, and the amortised cost in foreign currency translated at the exchange
rate at the end of the year.

Non-monetary assets and liabilities denominated in foreign currencies that

are measured at fair value are retranslated to the functional currency at the
exchange rate at the date that the fair value was determined. Non-monetary
items in a foreign currency that are measured based on historical cost are
translated using the exchange rate at the date of the transaction.

Foreign currency differences arising on retranslation are recognised in the

statement of comprehensive income.
 Tax effects of all exchange differences
Gains and losses on foreign currency transactions and exchange
differences arising on translating the results and financial position of
an entity (including a foreign operation) into a different currency may
have tax effects. IAS 12 Income Taxes applies to these tax effects.
 Disclosure
An entity shall disclose:

(a) the amount of exchange differences recognised in profit or loss;

(b) net exchange differences recognised in other comprehensive income and

accumulated in a separate component of equity, and a reconciliation of the
amount of such exchange differences at the beginning and end of the period;

(c) when the presentation currency is different from the functional currency and
the reason for using a different presentation currency;

(d) a change in the functional currency of either the reporting entity or a

significant foreign operation and the reason therefor;

(e) clearly identify the information as supplementary information to distinguish

it from the information that complies with IFRS;

(f) its functional currency and the currency in which the supplementary
information is displayed and the method of translation used to determine the
supplementary information.
Presenter

Mr. Sk Md Tarikul Islam

FCA (ICAB), ACA (ICAEW), MBA (UK)

Partner
Hoda Vasi Chowdhury & Co