IAS 21 The Effects of

Changes in Foreign
Exchange Rates
 IAS 21 The Effects of Changes in Foreign Exchange Rates
outlines how to account for foreign currency transactions and
operations in financial statements, and also how to translate
financial statements into a presentation currency. An entity is
required to determine a functional currency (for each of its
operations if necessary) based on the primary economic
environment in which it operates and generally records foreign
currency transactions using the spot conversion rate to that
functional currency on the date of the transaction.

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 Transactions in Exchange
Foreign Rate to use
FOREIGN Currency
ACTIVITIES Accounting
Issues
Foreign How to report the
Operations changes in FC

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 the currency of the primary economic
Functional
Currency
environment in which the entity operates.

Foreign
CURRENCIES Currency
the currency other than the local currency

Presentation the currency in which financial statements

Currency
are presented.

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How to determine functional currency?

The most important factor in determining the functional currency is

the entity’s primary economic environment in which it operates. In
most cases, it will be the country where an entity operates, but this
is not necessarily true.

The primary economic environment is normally the one in which the

entity primarily generates and expends the cash.

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The following factors can be considered:

❖What currency does mainly influence sales prices for goods and
services?
❖In what currency are the labor, material and other costs
denominated and settled?
❖In what currency are funds from financing activities generated
(loans, issued equity instruments)?

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Sometimes, sales prices, labor and material costs and other items
might be denominated in various currencies and therefore, the
functional currency is not obvious.

In this case, management must use its judgment to determine the

functional currency that most faithfully represents the economic
effects of the underlying transactions, events and conditions.

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Foreign currency transactions

Foreign Transaction should be recorded “INITIALLY”

@ SPOT RATE

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 Monetary Closing rate
Foreign to
Functional Non -
Historical Rate @ date of
Monetary transaction
FV
Rate when FV
YEAR-END
was determined

Asset Closing rate

Functional Closing rate
SFP Liabilities
to Share Capital
Rate @ date of
Presentation Equity transaction
Retained Earnings Average rate
IS 1. Rate @ date of
transaction
2. Average rate
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Recognition of Exchange Difference
Exchange difference occurs when there is a change in the
exchange rate between the transaction date and the settlement
date of monetary items arising from a foreign currency
transactions.

Exchange differences arising on the settlement of monetary

items(receivables, payables, loans, cash in foreign currency) or on
transalating an entity’s monetary items at rates different from
those at which they were translated initially, or reported in
previous financial statements, should be recognized in P/L in the
period in which they arise.
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How to report foreign exchange differences?
All exchange rate differences shall be recognized in profit or
loss, with the following exceptions:

⮚ Exchange rate gains or losses on non-monetary items are

recognized consistently with the recognition of gains or
losses on an item itself. For example, when an item is
revalued with the changes recognized in other
comprehensive income, then also exchange rate component
of that gain or loss is recognized in OCI, too.

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⮚ Exchange rate gain or loss on a monetary item that forms a
part of a reporting entity’s net investment in a foreign
operation shall be recognized:

- In the separate entity’s or foreign operation’s financial

statements: in profit or loss;
- In the consolidated financial statements: initially in other
comprehensive income and subsequently, on
disposal of net investment in the foreign
operation, they shall be reclassified to profit or
loss.
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