MFRS 121 (IAS 21)

FOREIGN CURRENCY
Learning outcomes
After this lecture you should be able to:
 Identify the functional currency of an entity
 Describe the IAS regulations in respect of foreign currency
transactions (individual company)
 Calculate exchange differences (individual company)
 Describe how to translate accounts of foreign entities (group stage)
MFRS 121 The effects of changes in foreign exchange
rates - What does it cover?

1. What is a foreign currency (functional currency)

2. Translation of transactions and balances entered into a
foreign currency (individual company stage)
3. Translation of the financial statements of an overseas
subsidiary (group accounts stage)
 Main terms

• Translation (eg:USD to RM
RM to USD

– the process of expressing monetary amounts that are stated in forms of foreign
currency by direct exchange rate (a direct currency quote asks what amount of
domestic currency is needed to buy one unit of the foreign)
• Exchange rate
- the ratio between a unit of one currency and the amount the other currency for
which that unit can be exchanged for a particular time. (eg. USD 1 = MYR 4.19) this is March month
-the rate is determined by the demand and supply factor called the floating rates that
always fluctuates.
Exchange rate – means of Translation

 Spot rate rate today

- Rate at which currencies can be exchanged today. (10 March – USD 1 –
MYR 4.19)
• Forward or future rate it can be higher or lower
- - Rate at which currencies can be exchanged at some time in future. (10
April – USD1 – MYR can be higher MYR 4.5 or lower MYR 4.05).
• Forward Exchange
- Contract to exchange currencies of different countries on a stipulated at
specified rate (forward rate).
Say Bank ABC agrees to sell USD 1 – MYR 4.25 in a forward contract to XYZ.
On the settlement date the rate is USD1 – MYR 4.30. XYZ will be happy
because now they will only need to pay MYR4.25 instead of MYR 4.30.
The main currency that we need to keep in
mind for accounting purposes
spot rate at the end of reporting period main currency of the company

Closing rate is the Foreign currency is a Functional currency is Presentation

the currency of the currency is the
spot exchange rate currency other than primary economic
at the end of the the functional environment in which
currency in which
reporting period. currency of the entity. the entity operates. the financial
statements are
presented.

• Foreign operation is an • Monetary items are

• Exchange difference is the
difference resulting from
translating a given number
of units of one currency
into another currency at
different exchange rates.
entity that is a subsidiary,
associate, joint venture or
branch of a reporting entity,
the activities of which are
based or conducted in a
country or currency other
than those of the reporting
entity.
units of currency held
and assets and liabilities • Spot exchange rate is the
to be received or paid in exchange rate for
a fixed or determinable immediate delivery.
number of units of
currency.
double entry
 Factors in determining Functional currency

The activities of the foreign operations are carried out as an extension of the
reporting entity or has its own autonomy.
Example
1)
If foreign company was acquired to manufacture products for a reporting entity in
Malaysia or the products are exported to Malaysia entity for distribution or is an
extension of the Malaysian entity, then the functional currency of the foreign company
will be in RM. (functional currency)
2) However if the foreign company manufactures products for distribution to its own

markets and conducts other operations independent of the Malaysian entity or is not
considered as an extension of the Malaysian entity , then the functional currency will
not be the same as that of the Malaysian reporting entity.
Determining the Functional Currency

PRIMARY INDICATORS
1. The currency that mainly influences the entity’s sales and services
(generally, this would be the currency in which the sales and services
are denominated and settled).
2. The currency of the country whose competitive forces and
regulations mainly determine the sales prices of the entity’s goods
and services.
3. The currency that influences labour, material and other costs of
providing goods or services (generally, this would be the currency in
which the costs are denominated and settled).
Determining the Functional Currency
1. PRIMARY INDICATORS
• The currency that mainly influences the entity’s sales and services
(generally, this would be the currency in which the sales and
services are denominated and settled).
Example
A company operates in Thailand that manufactures bicycles
primarily for export to Indonesia. All its sales are
denominated and settled in Rupiah. Its primary economic
conditions is that of Indonesia and its functional currency
would be the Rupiah.
Determining the Functional Currency

PRIMARY INDICATORS
2. The currency of the country whose competitive forces and regulations
mainly determine the sales prices of the entity’s goods and services.
Example:
A company is located in Malaysia and sells its products to the
Malaysian public. It faces competition from other Malaysian
businesses selling similar products and it has to comply with
rules and regulations governing the sale of that product in
Malaysia. Thus its primary economic environment would be the
Malaysian economic environment and its functional currency
would be the Malaysian Ringgit
Determining the Functional Currency
PRIMARY INDICATORS

The currency that influences labour, material and other costs of providing goods
or services (generally, this would be the currency in which the costs are
denominated and settled).
Example 1:
Aliran Motors operates in Malaysia. It manufactures car parts for the
US market. All sales are quoted and remitted in USD. A significant
portion of the operations is financed by American investors. Thus its
primary economic environment would be that of the American
economy and its functional currency would be in USD.
Determining the Functional Currency (cont.)
ADDITIONAL INDICATORS
• The currency in which funds from financing activities are generated (e.g. the
currency in which debt instruments are issued).
Example :
Company in Malaysia takes a loan from local bank but are not able to pay the
loan on its own but need to borrow from the parent company. Then the
functional currency will be of the parent’s.
Determining the Functional Currency (cont.)
ADDITIONAL INDICATORS
.
• The currency in which receipts from operating activities are usually retained
(e.g. currency or currencies of bank accounts).
Example:
Foreign operation acts as distributor (M’sia) for parent company in China. All
cash collected from the sale is remitted back to parent company. Hence the
functional currency will be of the parent company in China.
 Summary
Foreign operations Functional Currency
As the Parent’s Not the parents
Sales and costs (expenses) demoninated in parent’s functional YES NO
currency
Borrowings in parent’s functional currency YES NO
Funds from operations retained in parent’s functional currency YES NO
Activities are an extension of the parent’s YES NO
High volume of transactions with parent YES NO
Cash flows of foreign operation affect the parent YES NO
Debt obligations of foreign operation handled by foreign operation NO YES
foreign company take the loan then they will settle the loan (it is not parent)
 Functional Currency is Indeterminable
Where the functional currency is not easily determinable, management has to rely on its own judgement to determine the
functional currency that faithfully represents the economic effects of the transactions, events and conditions. The primary
factors will be considered before looking at the other factors. refer back to primary indicator

They include:
• Purchases and sales of goods and services where the transactions are
denominated in the foreign currency,
• Borrowings and lending where the receivables and payables are denominated in
the foreign currency, and
• Acquisition and disposal of assets, or incurring or settling liabilities denominated in
a foreign currency.
Functional Currency is Indeterminable
• Example
Philly is a Danish company that manufactures all its television sets in Thailand,
kitchen appliances in China and Indonesia. The Danish company sells its products in
Europe. What should be its functional currency?

The functional currency should be the company of the primary economic

environment in which Philly operates and generally the currency in which it
generates and expends cash. In this case Philly has to examine which currency
influences its prices or costs most.

H/W- Q1 and Q2 done it before coming to class

Transaction Exposure
• EXPORT SIDE selling- other company paying (receivable)
- Exist when the exporter allows the buyer to pay in foreign currency and also
allows the buyer to pay after sometime.
- The exporter is exposed to risk, that the foreign currency might decrease
between the date of purchase and the date of settlement. Hence this will
decrease the amount of domestic currency into which the foreign currency can
be converted.
- What exporter wants?
Say the company in Malaysia (exporter) is to receive payment in USD (importer).
The Malaysian company want the USD currency to increase and the RM to
decreases as they want to collect more USD.
 What exporter wants?
• A Malaysian company enters into a contract with a US company to export furniture.
The value of the furniture is USD 100,000. which is receivable 3 months later. The
spot rate was at USD1 – RM4.00. The Malaysian company is now exposed to
currency exchange risk.
• On the date of transaction – Account receivable is RM 400,000 (USD 100,000 x RM4)
• Say the exchange rate in 3 months is USD 1 – RM 4.20 (M’sia currency weaken) , the
A/C Receivable will be RM420,000. This means Malaysian company will get more RM.
The difference will be exchange gain of RM20000.
• Say the exchange rate in 3 months is USD1 – RM3.90 (M’sia currency strengthen), the
account receivable will be RM390,000. This means the Malaysian company will get
lesser RM. The difference is will be exchange loss of RM10,000.
 Transaction Exposure

IMPORTER SIDE
- Exist when the importer is required to pay in foreign currency and is allowed to pay
sometime after the purchase has been made.
- The risk here is that the foreign currency will increase between the date of purchase
and the date of payment, thereby increasing the amount of the domestic currency
that as to be paid for the imported goods.
What importer wants?
Say a company in Malaysia imports from US. The company in Malaysia wants RM to
increase so that less RM will be used to make the payment and hopes USD weakens.
 What Importer wants?
• A Malaysian company enters into a contract with a US company to import Toys. The
value of the toys is USD 50,000. which is payable 3 months later. The spot rate was at
USD1 – RM4.00. The Malaysian company is now exposed to currency exchange risk.
• On the date of transaction – Account payable is RM 200,000 (USD 50,000 x RM4)
• Say the exchange rate in 3 months is USD 1 – RM 4.20 (M’sia currency weaken) , the
A/C payables will be RM 210,000 (USD50000 x 4.20) . This means Malaysian
company will have to pay more RM to get USD. The difference will be exchange loss
of RM10000.
• Say the exchange rate in 3 months is USD1 – RM3.90 (M’sia currency strengthen), the
account payables will be RM195,000 (USD50,000 x 3.90) . This means the Malaysian
company will have to pay less RM to get USD. The difference is will be exchange gain
of RM5,000.
 Foreign Transactions

Initial measurement
The transaction will be recorded in functional currency using the spot
rate.

Subsequent measurement Loan to buy machiene

• All monetary items are retranslated at the closing or reporting
date rate.
• Non-monetary items are not retranslated; they are measured at
exchange rate at the date of the transaction.
If i buy the machine then i won't retranslate
Importing or exporting of goods and services.

Transaction Date Balance Sheet Date Settlement Date

Transaction was on 1 Financial year end is 31 Settlement date to pay or

July 2022 December 2022 receive is 1 February 2023

Increase or decrease is generally as foreign currency exchange gain or loss (on balance sheet date)
which will be reported in the profit and loss (income statement)
 Class Exercise 1

A company in Malaysia sold electronic products to Singapore for SGD 100,000 on 1 December 2021.
The spot rate was RM1 – SGD 0.30. The settlement date is 1 February 2022.

The transaction date for Malaysian company will be :

DR DB CR CR

1/12 333,333
Account Receivable

Sales 333,333
 Class Exercise 1

Assuming on the balance sheet date the rate was RM1 – SGD 0.32 . Prepare the adjusting entries at
31 December 2021
1/12-333,333
31/12-312,500
Loss on exchange-20,833

DB CR

1/12 Loss on exchange 20,833

Account receivable 20,833

 Class Exercise 1

Assuming on settlement date 1 Feb 2022 the rate was RM1 – SGD 0.25 . Prepare the adjusting
entries at 31 December 2021

DB CR

Cash/Bank 400,000
1/2

Account Receivable 312,500

Gain on exchnage 87,500

Overall the net gain is = 87,500- loss on exchange 20,833= RM 66,667

Class Exercise 2

A company in US purchased mirco chips from Taiwan on 1 November 2021. The contract was
denominated at 500,000 new Taiwan dollar. The spot rate was Taiwan dollar 1 = USD 0.0391. The
settlement date was at 1 March 2022.

On transaction date for US company

DB CR

1/11 Purchases 19550

Account payable 19550

Class Exercise 2

Assuming on 31 December the rate was Taiwan dollar 1 = USD 0.0351. Prepare the adjusting entries

On 31 December 2021 for US company 1/11-19550

31/12-17550
Gain on exchange= 2000 (you want to pay less)

DB CR

31/12 Account payable 2000

Gain on exchange 2000

Class Exercise 2

On 1 March 2022 the rate was Taiwan dollar 1 = USD 0.0398.

On 1 March 2022 for US company 1/3-19,900
31/12-17,550
Loss on exchange 2350

DB CR

1/3 Account payable 17,550

Loss on exchange 2350

Cash 19,900

Net exchange loss=2350-2000=350

Accounting for Transactions in a Foreign
Currency
Initial Recognition
• Foreign currencies transactions: measured and recorded in
the functional currency of the entity.
• The foreign currency has to be translated into the functional
currency by applying the spot rate of exchange.
• However, if the transactions are voluminous, then apply an
average rate for the period to translate all the transactions
conducted during the period.
Refer to example 2, 19.4, 19.5
Accounting for Transactions in a Foreign
Currency (cont.)
Recognition and Measurement at Settlement Dates
• The rate of exchange on the settlement date may be different from
the rate of exchange on the date of the initial recognition.
• For a liability, if the exchange rate at the settlement date results in
paying a higher amount than the amount initially recognized, this
would lead to a loss on exchange.
Key point
If exchange rate at settlement date >initial amount = LOSS

If exchange rate at settlement date < initial amount = GAIN

Accounting for Transactions in a Foreign
Currency (cont.)
Recognition and Measurement at Settlement Dates
• For an asset, if the exchange rate on the settlement date results in
receiving a higher amount than the amount initially recognized, a gain
on exchange would arise.
Key point :
If exchange rate at settlement > initial amount = GAIN
If exchange rate at settlement < initial amount = LOSS
 Accounting for Transactions in a Foreign
Currency (cont.)
• If the date of the settlement is prior to the reporting date, the
transaction gain or loss is realized.
• MFRS 121 requires that all realized transaction gains or losses should be
recognized as gains or losses in the period in which they are incurred.
Refer to Example 19.6
Accounting for Transactions in a Foreign Currency
(cont.)
Recognition at Subsequent Reporting Dates
• An entity may have some foreign currency items that remain unsettled at
the reporting date.
• The treatment of such items at the reporting date will depend on whether
the item is a monetary or non-monetary item.
• MFRS 121 requires that all monetary items (e.g. cash, bank, receivables,
payables) denominated in foreign currencies to be translated at the
reporting date using the closing rates.
• Unrealized exchange gains or losses should be recognized in the profit and
loss for the period in which they arise. (when the settlement date is after
the balance sheet date.
Refer to Example 19.7, 19.8, 19.9
Non-Monetary Items At Fair Value In Foreign Currency

• If the asset is a foreign asset and is to be measured at NM Item

Asset-do not retranslate at YE
fair value, the asset has to be translated into the
functional currency by using the exchange rate ruling at
the date when the fair value was determined. The
translated ‘fair value’ is compared with the ‘historical
cost’ carrying amount.
Refer to Example 19.11, Example 3 & 4

Other Non-monetary Items Subjected to Remeasurement

• Some assets’ carrying amounts are determined by
comparing two or more amounts. Example of such an item Refer to Example 5
is inventories where the carrying amount of inventories is
the lower of cost and net realisable value in accordance
with MFRS 102 Inventories.
 Exchange Differences on Non-monetary Assets

However, if the items are carried at their fair

A gain or loss in fair value of a non-
values (fair value model) or are revalued OCI
monetary item is recognized in other
(revaluation model), they should be
comprehensive income, together with
remeasured and translated at the rate ruling
its exchange difference.
on the date the fair value is recognized.

For assets valued at

historical cost, they will be
no FV adjustment
translated initially at the Non-monetary items Conversely, when a gain
spot rate on the date of acquired in a foreign or loss on a
acquisition. currency would be nonmonetary item is
• Subsequently, at the translated at initial recognized in profit or
reporting date, they are recognition using the spot loss, any exchange
not remeasured. exchange rate on the date of component of that gain
the acquisition, but their or loss shall be
• This means that no
subsequent measurements recognized in profit or
transaction difference
at the reporting date differs loss.
would arise for these
items. from that of monetary
items.
Translation of Financial Statements of Foreign Operations
Translating Financial Statements Prepared in the Functional Currency

The following rules should be used in translating the financial statements of a foreign
entity:
• All assets and liabilities both monetary and non-monetary, shall be translated at
the closing rate at the date of that statement of financial position.
• Income and expense items should be translated at the exchange rates at the
dates of the transactions/spot rate (if exchange rates are not available, then apply
average rate).
Refer to Example 19.13
Translating Financial Statements Prepared in a Currency Other
Than the Functional Currency
 Paragraph 34 of MFRS 121 requires the entity to remeasure or
translate all the amounts recorded in the foreign currency into its
functional currency using the principles of translating foreign currency
transactions.

 The translated or remeasured amounts should be used to prepare the

financial statements in the functional currency.

 At the end of each subsequent reporting period, the amounts recognized in

the foreign currency are to be translated to the functional currency. This is
known as the temporal method.
Translating Financial Statements Prepared in a
Currency Other Than the Functional Currency
(cont.)

Refer to eg.19.14