MOHAMMAD ALI JINNAH UNIVERSITY

ASSIGNMENT

ASSIGNMENT NO: 2

SUBMITTED BY: MUHAMMAD TUHA

STUDENT I.D.: FA16-MBAR-0005

COURSE: CORPORATE REPORTING

SECTION: AW

SUBMITTED TO: SIR GHIAS UL HASSAN KHAN

DATE: 15/12/2021
Dec 15, 2021,

Managing Director,
Orient Textile Mills Ltd,
501, Main National Highway Landhi,
Karachi.

SUBJECT: SUMMARY OF IAS 21 – THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

Dear Sir,

As per your instruction, I have made a summary of IAS 21 – The Effects of Changes in Foreign Exchange
Rates with appropriate examples for your understanding. The summary are as follows.

WHAT IS THE OBJECTIVE OF IAS 21?

The objective of IAS 21: The Effects of Changes in Foreign Exchange Rates is to prescribe:

 How to include foreign currency transactions and foreign operations in the financial
statements of an entity; and
 How to translate financial statements into a presentation

In other words, IAS 21 answers 2 basic questions:

 What exchange rates shall we use?

 How to report gains or losses from foreign exchange rates in the financial statements?

DEFINITIONS
Exchange Rate
The ratio of exchange for two currencies

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

Spot Rate
The exchange rate for immediate delivery

Exchange difference
Results from translating a given number of units of one currency into another currency at different
exchange rates
Functional Currency
An entity’s functional currency is the currency of the primary economic environment in which it
operates.

Foreign Currency
Foreign currency is a currency other than functional currency of the entity.

Fair Value
Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.

Presentation Currency
The currency in which the financial statements are presented.

Monetary items
Units of currency held and assets and liabilities to be received or paid in a fixed or determinable number
of units of currency.

PRINCIPLES
 Recognize foreign exchange gains/losses in profit or loss (except if non-monetary item
recognized in equity; recognize exchange gain/loss in equity too)
 No need to present financial statements in functional currency. A presentation currency can be
selected.
 Accounting records must be kept in functional currency

 A group does not have a functional currency. Functional currency is assessed separately for each
entity in the group.

BASIC STEPS
1. Reporting entity determines functional currency
2. Entity translates all foreign currency items to functional currency
3. Exchange differences from translation are recorded in accordance with IAS 21

FUNCTIONAL CURRENCY
Determine functional currency of each entity within a group.

The primary indicators are:

• Currency mainly influencing sales prices for goods/services

• Currency of country whose competitive forces and regulations mainly determine sale prices
• Currency mainly influencing input costs If no clear answer, other indicators are the currency in
which funds/receipts:
• From financing activities are generated (issuing debt/equity)
 • From operating activities are usually retained. If no clear answer, additional factors are:
• Level of autonomy from parent company (reporting entity).
• If not autonomous, functional currency is the same as parent.

If mixed indicators, give priority to the primary indicators.

MEASUREMENT
Initial Recognition
• Spot rate at transaction date
• Approximate rates may be used (if no major fluctuations)

Subsequent Measurement
Monetary items
• Translated at closing rate at reporting date
• Gain or loss is recognized in P&L.

Non-monetary items
• Rate at transaction date (if item carried at cost)
• Rate at revaluation date (if item carried at revalued amount/Fair Value)

Impairment tests/Revaluations

Measure non-monetary assets at the lower of either:

• Cost/carrying amount x historical rate
• Net realizable value/recoverable amount x spot rate at the revaluation date (e.g. end of
reporting date)

If revaluation gain/loss is recognized in:

• OCI – recognize exchange difference in OCI
• P&L – recognize exchange difference in P&L
EXAMPLE:
Jones Inc. has its functional currency as the $USD.

It trades with several suppliers overseas and bought goods costing 400,000 Dinar on 1 December 2015.

Jones paid for the goods on 10 January 2016. Jones’s year-end is 31 December. The exchange rates were
as follows:

1 December 2015 4.1 Dinar: $1USD

31 December 2015 4.3 Dinar: $1USD
10 January 2016 4.4 Dinar: $1USD

Show how the transaction would be recorded in Jones’s financial statements.

Solution:
Transaction 400,000 Dinar

1 Dec - Transaction Date 31 Dec - Reporting Date 1 Dec - Realized Date

400,000 / 4.1 97,561 400,000 / 4.3 93,023 400,000 / 4.4 90,909

Unrealized Gain Realized Gain

CONSOLIDATIONS
Translation method
• Assets & liabilities – closing rate
• Income & expenses – rate at transaction date (average rates may be used)
• All resulting exchange differences are recognized in other comprehensive income (and equity
under ‘Foreign currency translation reserve’).

Loan forming part of net investment in subsidiary

• Exchange gains and losses to equity on consolidation only. Recorded in P&L in separate (entity
only) financial statements.

Disposal of a subsidiary
The cumulative amount of exchange differences recognized in equity is reclassified to profit and loss
when the gain/loss on disposal is recognized.
Example – translating the financial statements
The UK parent acquired a German subsidiary on 3 January 2015 when the subsidiary’s retained earnings
amounted to EUR 4 000. On 30 November 2016, the UK parent purchased goods from the German
subsidiary for EUR 5 000. The goods remained unsold at the year-end and the payable was unpaid.

The applicable exchange rates:

 3 January 2015:0,78
 30 November 2016: 0,8525
 31 December 2016: 0,8562
 Average in 2016: 0,8188
 Average in 2015: 0,7261

The financial statements of the German subsidiary at 31 December 2016:

German Subsidiary
Statement of Financial Position as on 31/12/2016 Profit or Loss Statement
As on 31/12/2016 For the Year 2016
EUR EUR
Property, plant and Equipment 80,000 Sales 135,000
Inventories 23,000 Cost of Sales - 110,000
Receivables 23,000 Other Expenses - 7,000
Cash 20,000 Profit before tax 18,000
Total Assets 146,000 Income Tax Expenses - 3,000
Profit after tax 15,000
Share Capital 100,000
Retained Earnings 31,000
Bank Loan 10,000
Trade Payables 5,000
Total Equity and Liabilities 146,000

Required: Translate the financial statements of the German subsidiary at 31 December 2016 in

the presentation currency of GBP for the purposes of consolidation.

Solution:
Before you start working on the translation, you should present the intragroup balances
separately – please see the table below.

Also, I strongly recommend analyzing the retained earnings and equity items and present
them separately as appropriate.

In this example, it’s appropriate to present the retained earnings by the individual years when
they were generated, because you need to apply different rates to translate them.
Here, you should apply the acquisition date rate to the translation of pre-acquisition retained
earnings, then the rate applicable in 2015 for 2015 profits, etc.

Please also note, that no rate was applied for the profit 2016 presented in the statement of
financial position (under equity). The reason is that you simply transfer this profit from the
statement of profit or loss.

The statement of financial position translated to GBP:

DESCRIPTION EUR RATE GBP

Property, plant and equipment 80,000 Closing 0.8562 68,496
Inventories 23,000 Closing 0.8562 19,693
Receivables – intragroup 5,000 Closing 0.8562 4,281
Receivables – other 18,000 Closing 0.8562 15,412
Cash 20,000 Closing 0.8562 17,124
Total assets 146,000 125,005

Share capital 100,000 Acquisition date 0.78 78,000

Retained earnings – pre-acquisition 4,000 Acquisition date 0.78 3,120
Profit 2015 12,000 From 2015 statements* 0.7261 8,713
Profit 2016 15,000 From P/L statement 12,451
Currency translation difference (CTD) Balancing figure** 9,879
Bank loan 10,000 Closing 0.8562 8,562
Trade payables 5,000 Closing 4,280
Total equity and liabilities 146,000 125,005

The statement of profit or loss translated to GBP:

DESCRIPTION EUR RATE GBP

Sales – other 130,000 Average 2016 0.8188 106,444
Sales – intragroup 5,000 Transaction date 0.8525 4,263
Cost of sales - 110,000 Average 2016 0.8188 - 90,068
Other expenses - 7,000 Average 2016 0.8188 - 5,732
Profit before tax 18,000 14,907
Income tax expense - 3,000 Average 2016 0.8188 - 2,456
Net profit 15,000 12,451
Notes:

 *Accumulated profit 2015 comes from the previous year’s financial statements. In this
case, we can apply the average rate for 2015, as we assume everything was translated
by the average rate. In reality, just take the previous year’s statements.
 **CTD is calculated in the end, after everything else is done. It is the balancing figure to
make assets equal liabilities + equity.

DISCLOSURES
• The functional currency of the entity (if different to presentation currency)
• The functional currency of the parent
• Exchange differences recognized in P&L
• Net exchange differences recognized in equity (and OCI)
• If change in functional currency, fact and reasons for change
• If presentation currency is different to functional currency, describe FS as IFRS compliant only if
each applicable standard and translation method was complied with.
• If information is presented that is neither in the functional or presentation currency; o identify
this information as supplementary o disclosure currency of supplementary information o
disclose entity’s functional currency and method of translation

DIFFICULTIES IN FUNCTIONAL CURRENCY TRANSALATION / ISSUES RELATED TO

IAS – 21

Following issues raised by IASB Research Committee:

• Long-term liabilities

In the case of long-term liabilities, although any translation gains must be recognised in
profit or loss, and treated as part of reported profit, in some jurisdictions, these gains
are treated as unrealised for the purpose of computing distributable profit. 

The reasoning is that there is a greater likelihood in the case of long-term liabilities that
the favourable fluctuation in the exchange rate will reverse before repayment of the
liability falls due.

As stated already, IAS 21 requires all foreign currency monetary amounts to be reported
using the closing rate; non-monetary items carried at historical cost are reported using
the exchange rate at the date of the transaction and non-monetary items carried at fair
value are reported at the rate that existed when the fair values were determined. As
monetary items are translated at the closing rate, although the items are not stated at
fair value, the use of the closing rate does provide some fair value information.
 However, this principle is not applied to non-monetary items as, unless an item is
measured at fair value, the recognition of a change in the exchange rate appears not to
provide useful information.

A foreign operation is defined in IAS 21 as a subsidiary, associate, joint venture, or

branch whose activities are based in a country or currency other than that of the
reporting entity. Thus the definition of a foreign operation is quite restrictive. It is
possible to conduct operations in other ways; for example, using a foreign broker.
Therefore, the definition of a foreign operation needs to be based upon the substance
of the relationship and not the legal form.

Although the exchange rate at the transaction date is required to be used for foreign
currency transactions at initial recognition, an average exchange rate may also be used.
The date of a transaction is the date on which the transaction first qualifies for
recognition in accordance with IFRS. For practical reasons, a rate that approximates to
the actual rate at the date of the transaction is often used. For example, 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.

• Average exchange rate

A question arises as to which exchange rate to use and therefore it would be useful to
have more specific guidance on the use of the average exchange rate. IAS 21 allows a
certain amount of flexibility in calculating the average rate. The determination of the
average rate depends upon factors such as the frequency and value of transactions, the
period over which the rate will apply and the nature of the entity’s systems. There are a
large number of methods that can be used to calculate the average rate, but no
guidance is given in IAS 21 as to how such a rate is determined.

The IASB has completed its initial assessments on this project and decided that narrow
scope amendments were unnecessary. In May 2015, it had no plans to undertake any
additional work and is to remove this project from the research programme, subject to
feedback in the next agenda consultation.
CONCLUSION
An entity may carry on foreign activities in two ways. It may have transactions in foreign
currencies or it may have foreign operations. IAS 21 prescribes how an entity should:

• Account for  foreign currency transactions; 

• Translate financial statements of a foreign operation into the entity’s functional currency; and
• Translate the entity’s financial statements into a presentation currency, if different from the
entity’s functional currency. IAS 21 permits an entity to present its financial statements in any
currency (or currencies).

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.

An entity’s functional currency is the currency of the primary economic environment in which
the entity operates (i.e., the environment in which it primarily generates and expends cash).
Any other currency is a foreign currency.

Hence, the responsibility to determine the functional currency lies with the entity’s
management, yet it is also the responsibility of the auditors to review critically and exercise
professional judgement and skepticism, to ensure that the assessment made by management is
appropriate and in accordance with IAS 21 principles.

I hope that my report will help you in understanding about ISA 21.

Yours, Sincerely,

Muhammad Tuha
CFO