DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

SCHOOL OF GRADUATE STUDIES

Individual Coursework Assignment

Accounting for Accounting for foreign currency transactions and translation of

financial statement

SUMITED TO Mesfin Ymer (Ass. professor)

By

Chanie Teshome engida

December 26 2021

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 Topic of assignment: students are expecting to critically discuss on the
following questions:

o Write foreign exchange concepts and definitions

o Define foreign currency transaction
o Write the difference between conversion and translation of foreign currency transaction.
o Discuss concept and definition of functional currency,
o Identify the available methods of recognition and measurement : Initial and Subsequent
o Show how to treatment and Recognition of Foreign Exchange Differences: Gain and
Loss.
o Identify and discuss foreign currency translation methods
o Identify and discuss the available foreign currency translation exchange rates.

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 1. Foreign exchange concepts and definitions

Foreign Exchange (forex or FX) is the trading of one currency for another. For example, one can
swap the U.S. dollar for the euro. Foreign exchange transactions can take place on the foreign
exchange market, also known as the forex market.
The forex market is the largest, most liquid market in the world, with trillions of dollars changing
hands every day. There is no centralized location. Rather, the forex market is an electronic
network of banks, brokers, institutions, and individual traders (mostly trading through brokers or
banks).

Foreign Exchange (forex or FX) is a global market for exchanging national currencies with one
another.
Foreign exchange venues comprise the largest securities market in the world by nominal value,
with trillions of dollars changing hands each day.
Foreign exchange trading utilizes
Currency pairs, priced in terms of one versus the other
Forwards and futures are another way to participate in the forex market.

Understanding Foreign Exchange

The market determines the value, also known as an exchange rate, of the majority of currencies.
Foreign exchange can be as simple as changing one currency for another at a local bank. It can
also involve trading currency on the foreign exchange market. For example, a trader is betting a
central bank will ease or tighten monetary policy and that one currency will strengthen versus the
other.

When trading currencies, they are listed , such as USD/CAD, EUR/USD, or USD/JPY. These
represent the U.S. dollar (USD) versus the Canadian dollar (CAD), the euro (EUR) versus the
USD, and the USD versus the Japanese yen (JPY)

Trading in the Foreign Exchange Market

The market is open 24 hours a day, five days a week across major financial centers across the
globe. This means that you can buy or sell currencies at any time during the day.

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The foreign exchange market isn't exactly a one-stop shop. There are a whole variety of different
avenues that an investor can go through in order to execute forex trades. You can go through
different dealers or through different financial centers which use a host of electronic networks.
From a historical standpoint, foreign exchange was once a concept for governments, large
companies, and hedge funds. But in today's world, trading currencies is as easy as a click of
mouse accessibility is not an issue, which means anyone can do it. Many investment
companies offer the chance for individuals to open accounts and trade currencies however and
whenever they choose.
When you're making trades in the forex market, you're basically buying or selling the currency of
a particular country. But there's no physical exchange of money from one hand to another. That's
contrary to what happens at a foreign exchange kiosk—think of a tourist visiting Times
Square in New York City from Japan. They may be converting their (physical) yen to actual U.S.
dollar cash (and may be charged a commission fee to do so) so they can spend their money while
they're traveling.
But in the world of electronic markets, traders are usually taking a position in a specific
currency, with the hope that there will be some upward movement and strength in the currency
that they're buying (or weakness if they're selling) so they can make a profit. 

Differences in the Forex Markets

There are some fundamental differences between foreign exchange and other Markets. First of
all, there are fewer rules, which mean investors aren't held to as strict standards or regulations as
those in the stock, futures, or options markets. That means there are no clearing houses and no
central bodies that oversee the forex market.

Second, since trades don't take place on a traditional exchange, you won't find the same fees
or commissions that you would on another market. Next, there's no cutoff as to when you can
and cannot trade. Because the market is open 24 hours a day, you can trade at any time of day.
Finally, because it's such a liquid market, you can get in and out whenever you want and you can
buy as much currency as you can afford.

The Spot Market

Spot for most currencies is two business days; the major exception is the U.S. dollar versus the
Canadian dollar, which settles on the next business day. Other pairs settle in two business days.
During periods that have multiple holidays, such as Easter or Christmas, spot transactions can
take as long as six days to settle. The price is established on the trade date, but money is
exchanged on the value date.

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The U.S. dollar is the most actively traded currency.3 The most common pairs are the USD
versus the euro, Japanese yen, British pound, and Australian dollar.4 Trading pairs that do not
include the dollar are referred to as crosses. The most common crosses are the euro versus the
pound and yen.

The spot market can be very volatile. Movement in the short term is dominated by technical
trading, which focuses on direction and speed of movement. People who focus on technicals are
often referred to as chartists. Long-term currency moves are driven by fundamental factors such
as relative interest rates and economic growth.

The Forward Market

A forward trade is any trade that settles further in the future than spot. The forward price is a
combination of the spot rate plus or minus forward points that represent the interest rate
differential between the two currencies. Most have a maturity of

less than a year in the future but longer is possible. Like with a spot, the price is set on the
transaction date, but money is exchanged on the maturity date.

A forward contract is tailor-made to the requirements of the counterparties. They can be for any
amount and settle on any date that is not a weekend or holiday in one of the countries.

The Futures Market

A futures transaction is similar to a forward in that it settles later than a spot deal, but is for
standard size and settlement date and is traded on a commodities market. The exchange acts as
the counterparty.

Example of Foreign Exchange

A trader thinks that the European Central Bank (ECB) will be easing its monetary policy in the
coming months as the Eurozone’s economy slows. As a result, the trader bets that the euro will
fall against the U.S. dollar and sells short €100,000 at an exchange rate of 1.15. Over the next
several weeks the ECB signals that it may indeed ease its monetary policy. That causes the
exchange rate for the euro to fall to 1.10 versus the dollar. It creates a profit for the trader of
$5,000.
By shorting €100,000, the trader took in $115,000 for the short sale. When the euro fell, and the
trader covered their short, it cost the trader only $110,000 to repurchase the currency. The
difference between the money received on the short-sale and the buy to cover it is the profit. Had
the euro strengthened versus the dollar, it would have resulted in a loss.

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How Big Is the Foreign Exchange Market?

The foreign exchange market is extremely liquid and dwarfs, by a huge amount, the daily trading
volume of the stock and bond markets. According to the latest triennial survey conducted by
the Bank for International Settlements (BIS), trading in foreign exchange markets averaged $6.6
trillion per day in 2019.2 By contrast, the total notional value of U.S. equity markets on Oct. 7,
2021, was approximately $501 billion.5 The largest forex trading centers are London, New York,
Singapore, Hong Kong, and Tokyo.

What Is Foreign Exchange Trading?

When you're making trades in the forex market, you're basically buying the currency of a
particular country and simultaneously selling the currency of another country. But there's no
physical exchange of money from one hand to another. Traders are usually taking a position in a
specific currency, with the hope that there will be some strength in the currency, relative to the
other currency that they're buying (or weakness if they're selling) so they can make a profit. In
today's world of electronic markets, trading currencies is as easy as a click of a mouse.

How Does Foreign Exchange Differ from Other Markets?

There are some fundamental differences between foreign exchange and other markets. There are
no clearing houses and no central bodies to oversee the forex market which means investors
aren't held to the strict standards or regulations as those in the stock, futures, or options markets.
Second, there aren't the fees or commissions that exist for other markets that have traditional
exchanges. There is no cutoff time for trading, aside from the weekend, so one can trade at any
time of day. Finally, its liquidity lends to its ease of trading access.

2.Define foreign currency transaction

What is Foreign Currency Translation?

Foreign currency translation is used to convert the results of a parent company's foreign
subsidiaries to its reporting currency. This is a key part of the financial statement consolidation
process. The steps in this translation process are as follows:

Determine the functional currency of the foreign entity.

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Premeasured the financial statements of the foreign entity into the reporting currency of the
parent company

Record gains and losses on the translation of currencies.

How to Determine the Functional Currency

The financial results and financial position of a company should be measured using its functional
currency, which is the currency that the company uses in the majority of its business
transactions.

If a foreign business entity operates

Primarily within one country and is not dependent upon the parent company, its functional
currency is the currency of the country in which its operations are located. However, there are
other foreign operations that are more closely tied to the operations of the parent company, and
who’s financing is mostly supplied by the parent or other sources that use the dollar. In this latter
case, the functional currency of the foreign operation is probably the dollar. These two examples
anchor the ends of a continuum on which you will find foreign operations. Unless an operation is
clearly associated with one of the two examples provided, it is likely that you must make a
determination of functional currency based on the unique circumstances pertaining to each
entity. For example, the functional currency may be difficult to determine if a business conducts
an equal amount of business in two different countries.

The functional currency in which a business reports its financial results should rarely change. A
shift to a different functional currency should be used only when there is a significant change in
the economic facts and circumstances.

Example of Functional Currency Determination

Armadillo Industries has a subsidiary in Australia, to which it ships its body armor products for
sale to local police forces. The Australian subsidiary sells these products and then remits
payments back to corporate headquarters. Armadillo should consider U.S. dollars to be the

Functional currency of this subsidiary

Armadillo also owns a subsidiary in Russia, which manufactures its own body armor for local
consumption, accumulates cash reserves, and borrows funds locally. This subsidiary rarely

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remits funds back to the parent company. In this case, the functional currency should be the
Russian ruble.

How to Translate Financial Statements

When translating the financial statements of an entity for consolidation purposes into the
reporting currency of a business, translate the financial statements using the following rules:

Assets and liabilities translate using the current exchange rate at the balance sheet date for assets
and liabilities.

Income statement items Translate revenues, expenses, gains, and losses using the exchange rate
as of the dates when those items were originally recognized.

Allocation Translate all expense and revenue allocations using the exchange rates in effect when
those allocations are recorded. Examples of allocations are depreciation and the amortization of
deferred revenues.

Different balance sheet date if the foreign entity is being consolidated has a different balance
sheet date than that of the reporting entity; use the exchange rate in effect as of the foreign
entity’s balance sheet date.

Profit eliminations If there are intra-entity profits to be eliminated as part of the consolidation,
apply the exchange rate in effect on the dates when the underlying transactions took place.

Statement of cash flows. In the statement of cash flows, state all foreign currency cash flows at
their reporting currency equivalent using the exchange rates in effect when the cash flows
occurred. A weighted average exchange rate may be used for this calculation.

If there are translation adjustments resulting from the implementation of these

Rules, record the adjustments in the shareholders' equity section of the parent company’s
consolidated balance sheet.

If the process of converting the financial statements of a foreign entity into the reporting
currency of the parent company results in a translation adjustment, report the related profit or
loss in other comprehensive income.

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3).Write the difference between conversion and translation of foreign
currency transaction

A. Conversion is the process of exchanging amounts of one foreign for another.

Conversion refers to foreign currency transactions that are immediately converted at the time of
entry to the ledger currency of the ledger in which the transaction takes place. Revaluation
adjusts assets or liability accounts that may be understated or overstated at the end of a period
due to fluctuation in the exchange rate between the time the transaction was entered and the end
of the period.

B. Translation is required at the end of an accounting period when a company still

holds assets or liabilities in its statement of financial position which were obtained
or incurred in a foreign currency.
Translation refers to the act of restating an entire ledger of balances for a company from the
ledger currency to foreign currency.

Translation is done from functional currency to reporting currency foreign exchange rate of
particular account In Translation period end rates and average rates are used Translation is
optional Difference in Translation will go to translation adjustment account

Translation should satisfy the conditions namely prior period and following period should be
open and translation cannot be done for first period No conditions is required for Revaluation.

4). Discuss concept and definition of functional currency,

Functional currency

1) The primary economic environment in which an entity operates is normally the one in which it
primarily generates and expends cash. An entity considers the following factors in determining
its functional currency:

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(a) The currency:
(i) 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); and
(ii) Of the country whose competitive forces and regulations mainly determine
the sales prices of its goods and services?
(b) the currency 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).
2) The following factors may also provide evidence of an entity’s functional currency:
(a) The currency in which funds from financing activities (ie issuing debt and equity
instruments) are generated.
(b) The currency in which receipts from operating activities are usually retained.
3) The following additional factors are considered in determining the functional currency of a
foreign operation, and whether its functional currency is the same as that of the reporting
entity (the reporting entity, in this context, being the entity that has the foreign operation
as its subsidiary, branch, associate or joint venture):
(a) Whether the activities of the foreign operation are carried out as an extension of the
reporting entity, rather than being carried out with a significant degree of
autonomy. An example of the former is when the foreign operation only sells
goods imported from the reporting entity and remits the proceeds to it.
An example of the latter is when the operation accumulates cash and other
monetary items, incurs expenses, generates income and arranges borrowings, all
substantially in its local currency.
(b) Whether transactions with the reporting entity are a high or a low proportion of
the foreign operation’s activities.
(c) Whether cash flows from the activities of the foreign operation directly affect the
cash flows of the reporting entity and are readily available for remittance to it.
(d) Whether cash flows from the activities of the foreign operation are sufficient to
service existing and normally expected debt obligations without funds being made
available by the reporting entity.
When the above indicators are mixed and the functional currency is not obvious, management
uses its judgment to determine the functional currency that most faithfully represents the
economic effects of the underlying transactions, events and conditions. As part of this approach,
management gives priority to the primary indicators in paragraph 1 before considering the
indicators in paragraphs 2 and 3, which are designed to provide additional supporting evidence to
determine an entity’s functional currency.

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An entity’s functional currency reflects the underlying transactions, events and conditions that
are relevant to it. Accordingly, once determined, the functional currency is not changed unless
there is a change in those underlying transactions, events and conditions.
If the functional currency is the currency of a hyperinflationary economy, the entity’s financial
statements are restated in accordance with IAS 29 Financial Reporting in Hyperinflationary
Economies. An entity cannot avoid restatement in accordance with IAS 29 by, for example,
adopting as its functional currency a currency other than the functional currency determined in
accordance with this Standard (such as the functional currency of its parent).

The notion of ‘reporting currency’ has been replaced with two notions:
• Functional currency, ie the currency of the primary economic environment in
which the entity operates. The term ‘functional currency’ is used in place of
‘measurement currency’ (the term used in SIC-19) because it is the more
commonly used term, but with essentially the same meaning.
• Presentation currency, ie the currency in which financial statements are presented.
Functional Currency: Definition & Examples

Functional currency is the primary type of money that a company uses in its business activities.
It is most relevant for multinational corporations that conduct business in multiple currencies.
With the Functional currency properly identified, overall business performance can be measured
most accurately.

Definition

International Accounting Standard 21 (IAS 21) defines functional currency as the currency of the

primary economic environment in which the entity operates. It is a term that generally applies to
multinational companies. The choice of the functional currency depends on many factors, and is
usually either the local currency or that of its parent company. It is important to establish the
functional currency so that overall business performance can be properly measured And the
financial statements can most accurately represent the true financial state of the company.

When a reporting entity prepares financial statements, the Standard requires each individual
entity included in the reporting entity whether it is a stand-alone entity, an entity with foreign
operations (such as a parent) or a foreign operation (such as a subsidiary or branch) to determine
its functional currency and measure its results and financial position in that currency. The new
material on functional currency incorporates some of the guidance previously included in SIC-19
on how to determine a measurement currency. However, the Standard gives greater emphasis

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than SIC-19 gave to the currency of the economy that determines the pricing of transactions, as
opposed to the currency in which transactions are denominated.
As a result of these changes and the incorporation of guidance previously in SIC-19:
• An entity (whether a stand-alone entity or a foreign operation) does not have a
free choice of functional currency.
• an entity cannot avoid restatement in accordance with IAS 29 Financial
Reporting in Hyperinflationary Economies by, for example, adopting a stable
currency (such as the functional currency of its parent) as its functional currency.
The Standard revises the requirements in the previous version of IAS 21 for distinguishing
between foreign operations that are integral to the operations of the reporting entity (referred to
below as ‘integral foreign operations’) and foreign entities. The requirements are now among the
indicators of an entity’s functional currency. As a result:
• There is no distinction between integral foreign operations and foreign entities.
Rather, an entity that was previously classified as an integral foreign operation
will have the same functional currency as the reporting entity.
• only one translation method is used for foreign operations—namely that described
in the previous version of IAS 21 as applying to foreign entities (see paragraph
IN13).
• the paragraphs dealing with the distinction between an integral foreign operation
and a foreign entity and the paragraph specifying the translation method to be
used for the former have been deleted.

Examples

Consider the case of the Spanish branch of a U.S. entity. In this company, the total receipts and
expenditures of cash lead to no clear decision on the proper functional currency, as the total
transaction values in both U.S. dollars and Euros is the same.

Either dollars or Euros could be used as the functional currency. The company chooses euros as
the functional currency because it is the local currency.

In another circumstance, a Mexican company with most of its operations in the United States
would use the U.S. dollar as its functional currency, even if its financial statements are expressed
in terms of Mexican pesos.

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 Factors Indicating Foreign Currency (Local Currency)Factors
Is the Functional Currency
Indicating U.S. Dollar (Parent’s Currency) Is the Functional Currency
Primarily in foreign currency and do not
Directly
affectimpact
parent’s
thecash
parent’s
flows current cash flows and are readily available to the parent com
Indicator Responsive to short-term changes in exchange rates and worldwide competition
Cash flows

termined bySales
local
prices
competition or local government regulation; not generally responsive to changes in exchange rates
sales markets for company’s products; possibly, significant amounts of exports
rials, and other costs are primarily local costs
ained from, and denominated in, local currency units; entity’s operations generate funds sufficient to service financing needs
Sales markets
mpany transactions with parent Sales markets mostly in parent’s country, or sales contracts are denominated in parent’s

Expenses Production components generally obtained from the parent company’s country
Primarily from the parent, or other dollar- denominated financing
Financing

ercompany transactions and arrangements Frequent intercompany transactions with parent, or foreign entity is an investment or financing ar

Choosing the Functional Currency

There are several factors that should be considered in determining the most appropriate
functional currency. The currency that most affects sales price is often the most important factor
In addition, the currency in which inventory, labor, and expenses are incurred is also very
significant. The currency for borrowing transactions and in which the company maintains cash
should also be considered. In the end, management uses its own judgment and weighs all factors
to make the determination.

Often the choice for functional currency is between the local currency and that of the parent
company. At times the local currency is quite inflationary. If this is the case, the local currency
should not be used due to this lack of stability.

Why is Choosing the Functional Currency Important?

An incorrect functional currency can result in significant misstatement in the financial

statements. This is because the choice of functional currency affects the accounting treatment of
certain transactions. The following is one example that demonstrates how one set of transactions
is accounted differently due to this choice.

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 5. Identify the available methods of recognition and measurement: Initial and
Subsequent

A) Initial recognition
A foreign currency transaction is a transaction that is denominated or requires settlement
in a foreign currency, including transactions arising when an entity:
(a) Buys or sells goods or services whose price is denominated in a foreign currency;
(b) Borrows or lends funds when the amounts payable or receivable are denominated
in a foreign currency; or
(c) Otherwise acquires or disposes of assets, or incurs or settles liabilities,
denominated in a foreign currency.

A foreign currency transaction shall be recorded, on initial recognition in the functional

currency, by applying to the foreign currency amount the spot exchange rate between the
functional currency and the foreign currency at the date of the transaction.
The date of a transaction is the date on which the transaction first qualifies for recognition in
accordance with International Financial Reporting Standards. For practical reasons, a rate
that approximates 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.

B) Reporting at subsequent balance sheet dates

At each balance sheet dates:
(a) Foreign currency monetary items shall be translated using the closing rate;
(b) 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
(c) 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 determined.
The carrying amount of an item is determined in conjunction with other relevant
Standards. For example, property, plant and equipment may be measured in terms of fair value or
historical cost in accordance with IAS 16 Property, Plant and Equipment. Whether the carrying
amount is determined on the basis of historical cost or on the basis of fair value, if the amount is

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determined in a foreign currency it is then translated into the functional currency in accordance
with this Standard.
The carrying amount of some items is determined by comparing two or more amounts.
For example, the carrying amount of inventories is the lower of cost and net realizable value in
accordance with IAS 2 Inventories. Similarly, in accordance with IAS 36 Impairment of Assets,
the carrying amount of an asset for which there is an indication of impairment is the lower of its
carrying amount before considering possible impairment losses and its recoverable amount.
When such an asset is non-monetary and is measured in a foreign currency, the carrying amount
is determined by comparing:
(a) the cost or carrying amount, as appropriate, translated at the exchange rate at the
date when that amount was determined (ie the rate at the date of the transaction
for an item measured in terms of historical cost); and
(b) The net realizable value or recoverable amount, as appropriate, translated at the
exchange rate at the date when that value was determined (eg the closing rate at
the balance sheet date).
The effect of this comparison may be that an impairment loss is recognized in the
functional currency but would not be recognized in the foreign currency, or vice versa.
When several exchange rates are available, the rate used is that at which the future cash
flows represented by the transaction or balance could have been settled if those cash flows had
occurred at the measurement date. If exchangeability between two currencies is temporarily
lacking, the rate used is the first subsequent rate at which exchanges could be made.

Recognition of exchange differences

As noted in paragraph 3, IAS 39 applies to hedge accounting for foreign currency items.
The application of hedge accounting requires an entity to account for some exchange differences
differently from the treatment of exchange differences required by this Standard. For example,
IAS 39 requires that exchange differences on monetary items that qualify as hedging instruments
in a cash flow hedge are reported initially in equity to the extent that the hedge is effective.
Exchange differences arising on the settlement of monetary items or on translating
monetary items 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, except as described in paragraph 32.
When monetary items arise from a foreign currency transaction and there is a change in
the exchange rate between the transaction date and the date of settlement, an exchange difference
results. When the transaction is settled within the same accounting period as that in which it
occurred, all the exchange difference is recognized in that period. However, when the transaction

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is settled in a subsequent accounting period, the exchange difference recognized in each period
up to the date of settlement is determined by the change in exchange rates during each period.
When a gain or loss on a non-monetary item is recognized directly in equity, any
exchange component of that gain or loss shall be recognized directly in equity. Conversely,
when a gain or loss on a non-monetary item is recognized in profit or loss, any exchange
component of that gain or loss shall be recognized in profit or loss.
Other Standards require some gains and losses to be recognized directly in equity. For
example, IAS 16 requires some gains and losses arising on a revaluation of property, plant and
equipment to be recognized directly in equity. When such an asset is measured in a foreign
currency, of this Standard requires the revalued amount to be translated using the rate at the date
the value is determined, resulting in an exchange difference that is also recognized in equity.
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 recognized 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
recognized initially in a separate component of equity and recognized in profit or loss on
disposal of the net investment
When a monetary item forms part of a reporting entity’s net investment in a foreign operation
and is denominated in the functional currency of the reporting entity, an exchange difference
arises in the foreign operation’s individual financial statements.
If such an item is denominated in the functional currency of the foreign operation, an exchange
difference arises in the reporting entity’s separate financial statements in accordance with
paragraph 28. If such an item is denominated in a currency other than the functional currency of
either the reporting entity or the foreign operation, an exchange difference arises in the reporting
entity’s separate financial statements and in the foreign operation’s individual financial
statements in accordance with paragraph 28. Such exchange differences are reclassified to the
separate component of equity in the financial statements that include the foreign operation and
the reporting entity (ie financial statements in which the foreign operation is consolidated,
proportionately consolidated or accounted for using the equity method).
When an entity keeps its books and records in a currency other than its functional
currency, at the time the entity prepares its financial statements all amounts are translated into
the functional currency in accordance with paragraphs 20–26. This produces the same amounts
in the functional currency as would have occurred had the items been recorded initially in the
functional currency. For example, monetary items are translated into the functional currency
using the closing rate, and non-monetary items that are measured on a historical cost basis are
translated using the exchange rate at the date of the transaction that resulted in their recognition.

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 Change in functional currency

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. The functional currency of an entity reflects the underlying
transactions, events and conditions that are relevant to the entity. Accordingly, once the
functional currency is determined, it can be changed only if there is a change to those
underlying
transactions, events and conditions. For example, a change in the currency that mainly influences
the sales prices of goods and services may lead to a change in an entity’s functional currency.
The effect of a change in functional currency is accounted for prospectively. In other words, an
entity translates all items into the new functional currency using the exchange rate at the date of
the change. The resulting translated amounts for non-monetary items are treated as their
historical cost. Exchange differences arising from the translation of a foreign operation
previously classified in equity.

Use of a presentation currency other than the functional currency

Translation to the presentation 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. For 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.
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 balance sheet presented (ie including
comparatives) shall be translated at the closing rate at the date of that
balance sheet;
(b) income and expenses for each income statement (ie including comparatives)
shall be translated at exchange rates at the dates of the transactions; and
(c) All resulting exchange differences shall be recognized as a separate
component of equity.
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.

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The exchange differences referred to in 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. Such exchange
differences arise both on income and expense items recognized in profit or loss
and on those recognized directly in equity.
(b) Translating the opening net assets at a closing rate that differs from the previous
closing rate.
These exchange differences are not recognized 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. 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 minority interests are allocated to, and recognized as part
of, minority interest in the consolidated balance sheet.
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 (ie assets, liabilities, equity items, income and expenses,
including comparatives) shall be translated at the closing rate at the date of
the most recent balance sheet, 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 (ie not adjusted
for subsequent changes in the price level or subsequent changes in exchange
rates).
When an entity’s functional currency is the currency of a hyperinflationary
economy, the entity shall restate its financial statements in accordance with IAS 29 before
applying the translation method set out in paragraph 42, except for comparative amounts
that are translated into a currency of a non-hyperinflationary economy. When the economy
ceases to be hyperinflationary and the entity no longer restates its financial statements in
accordance with IAS 29, it shall use as the historical costs for translation into the
presentation currency the amounts restated to the price level at the date the entity ceased
restating its financial statements.

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 Translation of a foreign operation

Apply when the results and financial position of a foreign operation are translated into a
presentation currency so that the foreign operation can be included in the financial statements of
the reporting entity by consolidation, proportionate consolidation or the equity method.
The incorporation of the results and financial position of a foreign operation with those of
the reporting entity follows normal consolidation procedures, such as the elimination of
intergroup balances and intergroup transactions of a subsidiary (see IAS 27 and IAS 31 Interests
in Joint Ventures). However, an intergroup monetary asset (or liability), whether short-term or
long-term, cannot be eliminated against the corresponding intergroup liability (or asset) without
showing the results of currency fluctuations in the consolidated financial statements. This is
because the monetary item represents a commitment to convert one currency into another and
exposes the reporting entity to a gain or loss through currency fluctuations. Accordingly, in the
consolidated financial statements of the reporting entity, such an exchange difference continues
to be recognized in profit or loss or, if it arises from the circumstances described in paragraph 32,
it is classified as equity until the disposal of the foreign operation.
When the financial statements of a foreign operation are as of a date different from that of
the reporting entity, the foreign operation often prepares additional statements as of the same
date as the reporting entity’s financial statements. When this is not done, IAS 27 allows the use
of a different reporting date provided that the difference is no greater than three months and
adjustments are made for the effects of any significant transactions or other events that occur
between the different dates. In such a case, the assets and liabilities of the foreign operation are
translated at the exchange rate at the balance sheet date of the foreign operation. Adjustments are
made for significant changes in exchange rates up to the balance sheet date of the reporting entity
in accordance with IAS 27. The same approach is used in applying the equity method to
associates and joint ventures and in applying proportionate consolidation to joint ventures in
accordance with IAS 28 Investments in Associates and IAS 31.
Any goodwill arising on the acquisition of a foreign operation and any fair value
adjustments to the carrying amounts of assets and liabilities arising on the acquisition of
that foreign operation shall be treated as assets and liabilities of the foreign operation.
Thus they shall be expressed in the functional currency of the foreign operation and shall
be translated at the closing rate in accordance with paragraphs 39 and 42.

Disposal of a foreign operation

On the disposal of a foreign operation, the cumulative amount of the exchange
differences deferred in the separate component of equity relating to that foreign operation
shall be recognized in profit or loss when the gain or loss on disposal is recognized.
An entity may dispose of its interest in a foreign operation through sale, liquidation,
repayment of share capital or abandonment of all, or part of, that entity. The payment of a

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dividend is part of a disposal only when it constitutes a return of the investment, for
example when the dividend is paid out of pre-acquisition profits. In the case of a partial
disposal, only the proportionate share of the related accumulated exchange difference is
included in the gain or loss. A write-down of the carrying amount of a foreign operation
does not constitute a partial disposal. Accordingly, no part of the deferred foreign exchange
gain or loss is recognized in profit or loss at the time of a write-down.

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.
Functional currency
All transactions are recognized in the functional currency of the entity. All currencies other
than the functional currency are foreign currencies. A legal or economic entity may have more
than one functional currency if it has a foreign operation (subsidiary, associate, joint venture or
branch with activities based or conducted in a different country or currency). The basis for
determining each entity’s functional currency is discussed below.
The functional currency of an entity depends on the primary economic environment, which is
normally the environment in which the entity primarily generates and expends cash. Primary
factors considered in identifying the functional currency are:
a. the currency:
– that mainly influences sales prices for goods and services; and
– of the country whose competitive forces and regulations determine the sales price of its
goods and services;
b. The currency that mainly influences labor, material and other costs of providing goods or
services.

The following may also provide evidence of the functional currency; however the results of
these tests do not over- ride the results of the primary factors test:
– The currency in which funds are generated from debt and equity instruments; and
– The currency in which receipts from operating activities are usually retained.
In determining the functional currency of a foreign operation and whether its functional
currency is the same as the reporting entity (the reporting entity in this context being the
entity that has the foreign operation as its subsidiary, branch, associate or joint venture)
a. whether its activities are an extension of the reporting entity’s activities rather than
involving significant degree of autonomy;

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 b. the proportion of its transactions that are with the reporting entity;
c. whether its cash flows directly affect those of the reporting entity and are readily
distributable to it; and
d. Whether its cash flows are sufficient to service its existing and normally expected `

Initial recognition
A foreign currency transaction is recorded, on initial recognition in the functional
currency, by applying to the foreign currency amount the spot exchange rate between the
functional currency and the foreign currency at the date of the transaction.
Subsequent reporting periods
At the end of each subsequent reporting period:
• any foreign currency monetary items are translated using the closing rate;
• non-monetary items that are measured in terms of Historical cost in a foreign currency are
translated using the exchange rate at the date of transaction; and
• Non-monetary items that are measured at fair value in a foreign currency are
translated using the exchange rates at the date when the fair value was determined.
Exchange differences
Any exchange difference arising on the settlement of a monetary item or on translating
monetary items at rates different from those in which they were translated on initial recognition
during the period or in previous financial statements, are included in profit or loss in the period
in which they arise unless it relates to exchange differences arising on a monetary item that
forms part of a reporting entity’s net investment in a foreign operation. These exchange
differences are recognized in the 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 includes the foreign operation and the reporting entity (e.g. the
consolidated financial statements when the foreign operation is a subsidiary), such exchange
differences are recognized initially in other comprehensive income and reclassified from equity
to profit or loss on disposal of the net investment.
When a gain or loss on a non-monetary item is recognized in other comprehensive income, any
exchange component of that gain or loss is recognized in other comprehensive income.
Conversely, when a gain or loss on a non- monetary item is recognized in profit or loss, any
exchange component of that gain or loss shall be recognized in profit or loss.
Translation into presentation currency
An entity may elect to present its financial report in any currency (referred to as the
presentation currency). For operations where the functional currency is not the presentation

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 currency:
• assets and liabilities for each statement of financial position presented (including
comparatives) are translated to the presentation currency using the closing rate at
the date of that statement of financial position;
• income and expenses for each statement presenting profit or loss and other
comprehensive income (including comparatives) are translated using the
exchange rate at the transaction dates; and
• Any resulting exchange difference is recognized in other comprehensive
income.
For groups, translation of each entity within the group to the group’s presentation currency is
performed before preparing the consolidated financial report. A similar process is also adopted in
an individual entity’s financial statements where, for example, there is a branch operation with a
different functional currency

6). Show how to treatment and Recognition of Foreign Exchange Differences:

Gain and Loss.
What is a Foreign Exchange Gain/Loss?

A foreign exchange gain/loss occurs when a company buys and/or sells goods and services in a
foreign currency, and that currency fluctuates relative to their home currency. It can create
differences in value in the monetary assets and liabilities, which must be recognized periodically
until they are ultimately settled.

The difference in the value of the foreign currency, when converted to the local currency of the
seller, is called the exchange rate Trade-Weighted Exchange Rate The Trade-Weighted
Exchange Rate is a complex measure of a country's currency exchange rate. It measures the
strength of a currency weighted by the amount of trade with other countries.. If the value of the
home currency increases after the conversion, the seller of the goods will have made a foreign
currency gain.

However, if the value of the home currency declines after the conversion, the seller will have
incurred a foreign exchange loss. If it is impossible to calculate the current exchange rate at the
exact time when the

Transaction is recognized, the next available exchange rate can be used to calculate the
conversion.

How Currency Exchange Affects Businesses

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Companies that conduct business abroad are continually affected by changes in the foreign
currency exchange rate. This applies to businesses that receive foreign currency payments from
customers outside the company’s home country or those that send payments to suppliers in a
foreign currency.

For example, a resident of the United States will have the US dollar as their

Home currency and may receive payments in euro or GBP.

Since exchange rates are dynamic, it is possible that the exchange rate will be different from the
time when the transaction occurs to when it is actually paid and converted to the local currency.

For example, if a US seller sends an invoice How to Record Payments in Accounting Recording
payments in accounting can otherwise be referred to as "accounts payable," which means the
total amount a given company owes to worth €1,000 and the customer pays the invoice after 30
days, there is a high probability that the exchange rate for euros to US dollars will have changed
at least slightly. The seller may end up receiving less or more against the same invoice,
depending on the exchange rate at the date of recognition of the transaction.

Realized and Unrealized Foreign Exchange Gain/Loss

Realized and unrealized gains or losses from foreign currency transactions differ depending on
whether or not the transaction has been completed by the end of the accounting periodYear to
Date (YTD)Year to date (YTD) refers to the period from the beginning of the current year to a
specified date. Year to date is based on the number of days from the beginning of the calendar
year (or fiscal year). It is commonly used in accounting and finance for financial reporting
purposes.
 
1. Realized Gains/Losses

Realized gains or losses are the gains or losses on transactions that have been completed. It
means that the customer has already settled the invoice prior to the close of the accounting
period.

For example, assume that a customer purchased items worth €1,000 from a US seller, and the
invoice is valued at $1,100 at the invoice date. The customer settles the invoice 15 days after the
date the invoice was sent, and the invoice is valued at $1,200 when converted to US dollars at the
current exchange rate.

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It means that the seller will have a realized foreign exchange gain of $100 ($1,200–$1,100). The
foreign currency gain is recorded in the income section of the income statement Income
Statement the Income Statement is one of a company's core financial statements that shows their
profit and loss over a period of time. The profit or.

2. Unrealized Gains/Losses

Unrealized gains or losses are the gains or losses that the seller expects to earn when the invoice
is settled, but the customer has failed to pay the invoice by the close of the accounting period.
The seller calculates the gain or loss that would have been sustained if the customer paid the
invoice at the end of the accounting period.

For example, if a seller sends an invoice worth €1,000, the invoice will be valued at $1,100 as at
the invoice date. Assume that the customer fails to pay the invoice as of the last day of the
accounting period, and the invoice is valued at $1,000 at this time.

When preparing the financial statements for the period, the transaction will be recorded as an
unrealized loss of $100 since the actual payment is yet to be received. The unrealized gains or
losses are recorded in the balance sheet under the owner’s equity Owner’s Equity Owner's
Equity is defined as the proportion of the total value of a company’s assets that can be claimed
by the owners (sole proprietorship or partnership) and by the shareholders (if it is a corporation).
It is
Calculated by deducting all liabilities from the total value of an asset (Equity = Assets –
Liabilities). Section.
Recording Foreign Exchange Transactions

When preparing the annual financial statements, companies are required to report all transactions
in their home currency to make it easy for all stakeholders to understand the financial reports. It
means that all transactions carried out in foreign currencies must be converted to the home
currency at the current exchange rate when the business recognizes the transaction.

For example, assume that a company paid €10,000 in salaries for part-time contractors located in
Europe at an exchange rate of $1.15 to 1 euro, the transaction is recorded in the income
statement as $11,500 at the end of the accounting period.

Example of Foreign Exchange Gain/Loss

Company ABC is a US-based business that manufactures motor vehicle spare parts
for Bugatti and May bach vehicles. The company sells spare parts to its distributors located in

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the United Kingdom and France. During the last financial year, ABC sold €100,000 worth of
spare parts to France and GBP 100,000 to the United Kingdom

At the time of sending the invoices, one GBP was equivalent to 1.3 US dollars, while one euro
was equivalent to 1.1 US dollars. When the payments for the invoices were received, one GBP
was equivalent to 1.2 US dollars, while one euro was equivalent to 1.15 dollars.

Therefore, the gains or losses from the currency conversions can be calculated as follows:

Sales to France

= (1.15 x 100,000) – (1.1×100,000)

= 115,000 – 110,000

= $5,000 (Foreign currency gain)

Sales to the UK

= (1.2 x 100, 000) – (1.3 x 100,000)

=120,000 – 130,000

= –$10,000 (Foreign currency loss)

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7. Identify and discuss foreign currency translation methods
Currency Translation Accounting Methods

There are two main accounting standards for handling currency translation.

Current rate method

The current rate method: A method of foreign currency translation where most items in

the financial statements are translated at the current exchange rate. The current rate method is
utilized in instances where the subsidiary isn't well integrated with the parent company, and the
local currency where the subsidiary operates is the same as its functional currency.

Temporal Method
The temporal method is a currency exchange method used to convert the currency that a foreign
subsidiary ordinarily does business in into the currency used by its parent company. The parent
company’s commonly used currency is referred to as the subsidiary’s “functional currency.” It
may also be referred to as the “reporting currency” because it is the currency used in the parent
company’s published financial statements.

The reason for the currency conversion is the fact that the parent company is required to produce
consolidated financial statements such as its income statement and balance sheet  that include the
financials of its subsidiary companies.

The temporal method: Also known as the historical method, this technique converts the
currency of a foreign subsidiary into the currency of the parent company. The temporal method
is used when the local currency of the subsidiary is not the same as the currency of the parent
company. Differing exchange rates are used depending on the financial statement item being
translated.

The temporal method is a means of converting the currency used by a foreign subsidiary into the
currency of its parent company.

Various currency exchange rates are used in order to most accurately reflect the true value of the
subsidiary’s assets and liabilities.

Because of fluctuating exchange rates and the use of different exchange rates, the foreign
subsidiary’s financial statements may reflect considerable volatility.

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Example of Temporal Method

Assume Company ABC is headquartered in the United States, but it operates a subsidiary
company in Australia. The Australian subsidiary will, of course, ordinarily conduct business in
Australia using the Australian dollar. However, when the time comes for the parent company in
the US to issue financial statements, the assets, liabilities, expenses, revenues, etc., of its
Australian subsidiary must be converted from Australian dollars into US dollars.

How the Temporal Method is Applied

Converting all of the foreign subsidiary’s financial activity into another currency can get rather
complicated. This is because the basis for the currency conversion rate varies according to
exactly what it is being applied to. In other words, not just one, but several, currency exchange
rates must be considered. Here’s a brief breakdown of how this works:

Monetary items, such as cash on hand and accounts receivable and payable, are converted using
the current exchange rate at the time of producing the financial report.

Non-monetary items, which include things such as fixed assets (such as PP&E – property,
plant, and equipment) and inventory, are converted using the currency exchange rate that was in
effect when the assets were acquired. This is referred to as the “historical exchange rate.”

Stock is converted using the prevailing currency exchange rate when the stock was issued, as it
most accurately reflects the amount of capital that the company received from selling the stock
shares.

Sales and some expense items are converted using yet another currency exchange calculation a
weighted average of the exchange rate for the current reporting period.

Some non-monetary items that appear on the company’s balance sheet, such as depreciation
and amortization, are converted using whatever the associated exchange rate listed on the
balance sheet is.

When converting the foreign subsidiary’s retained earnings figure to the company’s functional
currency, it is important that the equation Retained Earnings (Ending) = Retained Earnings
(Beginning) + Net Income – Dividends must balance so that the income and retained
earnings reported on the balance sheet match.

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 Importance of Currency Conversion

The rise of multinational companies made currency conversion operations necessary for accurate
financial reporting by parent companies. As more companies domiciled in one country oversee
subsidiary firms in foreign countries, the importance of the temporal method continues to grow.

Translation Risk

Translation risk is the exchange rate risk associated with companies that deal in foreign
currencies and list foreign assets on their balance sheets.

Companies that own assets in foreign countries, such as plants and equipment, must convert the
value of those assets from the foreign currency to the home country's currency for accounting
purposes. In the U.S., this accounting translation is typically done on a quarterly and annual
basis. Translation risk results from how many the assets value fluctuate based on exchange rate
movements between the two counties involved.

Multinational corporations with international offices have the greatest exposure to translation
risk. However, even companies that don't have offices overseas but sell products internationally
are exposed to translation risk. If a company earns revenue in a foreign country, it must convert
that revenue into its home or local currency when it reports its financials at the end of the
quarter. 

Example of Currency Translation

International sales accounted for 64% of Apple Inc.’s revenue in the quarter ending Dec. 26,
2020.6

 In recent years, a recurring theme for the iPhone maker and other big multinationals has been
the adverse impact of a rising U.S. dollar. When the greenback strengthens against other
currencies, it subsequently weighs on international financial figures once they are converted into
U.S. dollars.

The likes of Apple seek to overcome adverse fluctuations in foreign exchange rates by hedging
their exposure to currencies. Foreign exchange (forex) derivatives, such as futures contracts and
options, are acquired to enable companies to lock in a currency rate and ensure that it remains the
same over a specified period of time.

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Constant Currencies

Constant currencies are another term that often crops up in financial statements. Companies with
overseas operations often choose to publish reported numbers alongside figures that strip out the
effects of exchange rate fluctuations. Investors generally pay a lot of attention to constant
currency figures as they recognize that currency movements can mask the true financial
performance of a company.

In its fiscal second-quarter ending Nov. 30, 2020, Nike Inc. reported a 9% increase in revenues,
adding that sales rose 7% on a constant currency basis.7 Compete Risk Free with $100,000 in
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How the Current Rate Method Works

The current rate method is a method of foreign currency translation where most financial
statement items are translated at the current exchange rate.

Temporal Method

The temporal method is a set of currency translation rules a company applies to its integrated
foreign businesses to compute profits and losses.

Accounting Currency

Accounting currency is the monetary unit used when recording transactions in a company's
general ledger.

What Is a Reporting Currency?

Reporting currency is the currency used for an entity's financial statements with the goal of using
only one currency for ease of understanding.
Remeasurement is the re-evaluation of the value of a long-term asset or foreign currency on a
company's financial

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8. Identify and discuss the available foreign currency translation exchange rates.

How Do Currency Exchange Rates Work?

The Balance / Miguel Co

Exchange rates tell you how much your currency is worth in a foreign currency. Think of it as
the price being charged to purchase that currency. For example, in April 2020, 1 euro was equal
to $1.2335 U.S. dollars, and $1 U.S. dollar was equal to 0.81 euros. Foreign exchange
traders decide the exchange rate for most currencies. They trade the currencies 24 hours a day,
seven days a week. As of 2019, this market trades $6.6 trillion a day.

Key Takeaways

 An exchange rate is how much of your country's currency buys another foreign currency.
 For some countries, exchange rates constantly change, while others use a fixed exchange
rate.
 The economic and social outlook of a country will influence its currency exchange rate
compared to other countries.

2 Kinds of Exchange Rates

There are two kinds of exchange rates: flexible and fixed. Flexible exchange rates change
constantly, while fixed exchange rates rarely change.

Flexible

Most currency exchange rates are determined by the foreign exchange market, or forex. Such
rates are called flexible exchange rates. For this reason, exchange rates fluctuate on a moment-
by-moment basis.

Prices change constantly for the currencies that Americans are most likely to use. These include
Mexican pesos, Canadian dollars, European euros, British pounds, and Japanese yen. These
countries use flexible exchange rates. the government and central bank don't actively intervene to
keep the exchange rate fixed. Their policies can influence rates over the long term, but for most
countries, the government can only influence, not regulate, exchange rates.

Fixed

Other currencies, like the Saudi Arabian riyal, rarely change. That's because those countries
use fixed exchange rates that only change when the government says so. These rates are usually
pegged to the U.S. dollar. Their central banks have enough money in their foreign currency
reserves to control how much their currency is worth.

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To keep the exchange rate fixed, the central bank holds U.S. dollars. If the value of the local
currency falls, the bank sells its dollars for local currency. That reduces the supply in the
marketplace, boosting its currency's value. It also increases the supply of dollars, sending its
value down. If demand for its currency rises, it does the opposite.

The Chinese yuan used to be a fixed currency. Now, the Chinese government is slowly
transitioning to a flexible exchange rate. That means it changes less frequently than a flexible
exchange rate, but more frequently than a fixed exchange rate. As of January 21, 2021, $1 U.S.
dollar was worth about 6.4800 Chinese yuan. Since February 2003, the U.S. dollar has weakened
against the yuan. One U.S. dollar could be exchanged for 8.28 yuan at that time. The U.S. dollar
has weakened because it can buy fewer yuan today than it could in 2003.

Why the Euro Is So Special

Most exchange rates are given in terms of how much a dollar is worth in the foreign currency.
The euro is different. It's given in terms of how much a euro is worth in dollars. It is hardly ever
given the other way around. So, although $1 U.S. dollar was worth 0.85 Euros in October 2020,
you would only hear that 1 euro was worth $1.1706.

The euro has weakened considerably since April 2008. At that time the euro was at its all-time
high of $1.60. Since then, the future of the European Union and the euro itself was in doubt after
the United Kingdom voted to leave the European Union. In addition, the European Central Bank
(ECB) had been lowering its interest rate. This reduced bank rates for anyone lending or saving
in Euros. That reduced the value of the currency itself.

The ECB announced its version of quantitative easing in March 2015. That dropped the euro's
value to $1.10. The euro also weakened during the Greek debt crisis.

Yet, the euro is special. It's the second most popular currency after the dollar. More than 341
million people use it as their sole currency. The euro's popularity derives from the power of the
European Union. It's one of the largest economies in the world.

Three Factors Affecting Exchange Rates

Interest rates, money supply, and financial stability all affect currency exchange rates. Because
of these factors, the demand for a country's currency depends on what is happening in that
country.

First, the interest rate paid by a country's central bank is a big factor. The higher interest rate
makes that currency more valuable. Investors will exchange their currency for the higher-paying
one. They then save it in that country's bank to receive the higher interest rate.

Second, is the money supply that's created by the country's central bank. If the government prints
too much currency, then there's too much of it chasing too few goods. Currency holders will bid
up the prices of goods and services. That creates inflation. If way too much money is printed, it
causes hyperinflation.

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Hyperinflation usually only happens when a country must pay off war debts. It's the most
extreme type of inflation.

Some cash holders will invest overseas where there isn't inflation, but they'll find that there isn't
as much demand for their currency since there's so much of it. That's why inflation can push the
value of a currency down. 

Third, a country's economic growth and financial stability impact its currency exchange rates. If
the country has a strong, growing economy, then investors will buy its goods and services.
They'll need more of its currency to do so. If the financial stability looks bad, they will be less
willing to invest in that country. They want to be sure they will get paid back if they hold
government bonds in that currency. 

How Exchange Rates Affect You

If you're traveling overseas to another country that uses a different currency, you must plan for
exchange rate values. When the U.S. dollar is strong, you can buy more foreign currency and
enjoy a more affordable trip. If the U.S. dollar is weak, your trip will cost more because you can't
buy as much foreign currency. Since the exchange rate varies, you might find the cost of your
trip has changed since you started planning it. This is just one of the ways exchange rates affect
your personal finances.

You can search online to find the exchange rate of the U.S. dollar to foreign currency for any
given day. Google has a tool to help with this. It even shows a chart revealing whether the dollar
is strengthening or weakening. If it's strengthening, you can wait until right before your trip to
buy your currency.

Check to see if your credit card company charges conversion fees. If not, then using your credit
card overseas will get you the cheapest exchange rate.

If the dollar is weakening, you might want to buy the foreign currency now rather than waiting
until you travel. Banks charge a higher exchange rate, but it might be cheaper than what you'll
pay in the future.

What Affects the U.S. Dollar Rate?

What the Dollar Is Worth in Five Other Currencies

The U.S. dollar rate tells you the dollar's value as compared to another currency. The U.S. dollar
is the world's reserve currency. As a result, most businesses, government officials, and travelers
around the world need to know the exchange rate between their own currencies and the dollar.
That's especially important for contracts that are priced in dollars, such as gold and oil.

U.S. travelers need to know the current dollar value before they go on an international trip.
Although some foreign businesses take dollars if necessary, they usually charge a fee.

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About the U.S. Dollar Rate

You can get the cheapest dollar rate by using your credit card, especially if your card has no
foreign transaction fees so when traveling internationally, pay for almost everything you can
with your card to get the best rate.

Take a look at the chart below, which illustrates the trade-weighted U.S. dollar index from 2000
through today.

The dollar rate is of vital interest to foreign exchange (forex) traders. Many of them work for
businesses that seek to hedge their exposure to foreign currency volatility. This risk occurs
when businesses trade internationally. They either get their supplies from other countries or
export to foreign markets. They also often have offices or plants overseas. Hedging allows them
to protect these transactions from exchange rate changes that could damage their profitability.

Many forex traders seek to profit from the currency trade alone. one way is by buying a currency
they think will appreciate against the dollar. Once the currency grows in value, they trade it back
for more dollars than they paid for it. When enough traders think a currency will rise,
that increases demand and forces the currency's value up. Traders’ actions can also force
the dollar to decline.

Many traders also borrow in a currency that charges low interest rates, then invest in a currency
that pays high interest rates. For years, many traders did this with yen. That's called the yen carry
trade. The Bank of Japan encouraged this, because it kept the value of the yen low, which
allowed Japanese manufacturers to competitively price their exports.

Four Factors That Affect U.S. Dollar Rates

U.S. dollar rates rise and fall, but not at random. There are four major factors that impact the
U.S. dollar rate.

Supply and Demand

The first factor impacting the U.S. dollar rate is the law of supply and demand. Because the
dollar is the world's reserve currency, it's automatically in higher demand than other currencies.
This has allowed the U.S. to sell a lot more Treasury notes—and it can increase supply without
suffering from higher interest rates. As a result of this increased fiscal stimulus, the U.S.
economy was very strong until the 2008 financial crisis.

Strength of the Economy

A strong U.S. economy will buoy the dollar's value. In addition, since the dollar is the global
currency, the dollar rate actually strengthens during any global crisis.

Even though decisions made in the U.S. caused the 2008 financial crisis, investors flocked to the
dollar because it was seen as a safe haven.

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The dollar also strengthened in the summers of 2011 and 2012. Investors fled from the euro
during the euro zone debt crisis.

Interest Rates

Every currency's value is affected by the interest rates paid in its country. For the U.S. dollar, it's
the interest rate paid on U.S. Treasuries. Usually, the lower the interest rate paid the less demand.
The U.S. dollar is a safe haven in an uncertain world.

This allows the U.S. Treasury to pay a low interest rate and still receive high-bid prices—
meaning that the U.S. can run a larger debt. Other countries must pay higher yields to renew their
debt.

Debt-to-GDP Ratio

Pay attention to the country's debt-to-gross-domestic-product ratio. A high ratio would normally

reduce its currency's value. Again, the dollar's role as the global currency changes that dynamic a
bit.

Until the 2008 financial crisis, the more the debt grew, the faster the dollar's value fell.

The high U.S. debt doesn't impact the dollar as much while it's being used as a safe haven.

Euro to Dollar Rate

The euro to U.S. dollar conversion rate depends on the relative strength of the European Union's
economy. In 2007, the EU surpassed the U.S. as the world's largest economy. As the success of
the EU grew, so did the value of the euro. Between 2002 and 2008, the euro rose 63% against the
dollar.

The euro peaked on April 22, 2008, with an exchange rate of $1.60.

Since 2008, the euro's value has fallen. First, the European Central Bank raised interest rates too
soon after the Great Recession. That sparked fears of a double-dip recession. The euro fell even
further once the euro zone debt crisis called into question the future of the euro zone itself.

The euro strengthened in 2013 as it looked like the worst was over, but in 2014, it plummeted to
$1.21. In 2016, Brexit and weakness in Italian banks sent the euro down to $1.04.

In 2017, the euro strengthened to $1.20 after investigations into the connections
between President Trump's administration and Russia.

By March 2020, the euro had fallen to $1.07. That's when Europe was hit hard by the COVID-19
pandemic.3 By July, the U.S. had taken the lead when it came to COVID-19 cases, while
Europe's cases had declined.4 As a result, the euro rose to $1.18 by July 31.

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Dollar Rate in India

The dollar's strength sent the rupee to a record low of 63.04 to the dollar by the end of
2014.5  The rupee strengthened in 2015, ending the year at 66.19. Low oil prices helped India's
economy, which imports oil.

India has a very high current account deficit, which means that it borrows and buys more from
overseas than it saves and exports. That could be a problem if dollar-denominated loans come
due at higher interest rates.

The U.S. Federal Reserve began raising rates in 2015. By 2017, the rupee had weakened to
63.83. By December 2019, it had risen to 71.36.

In March 2020, when the pandemic began to take hold, it rose to 76.37. It has not changed
significantly as of December 2021.

British Pound to the Dollar

Right after the 2008 financial crisis, the British pound fell 30%. It went from $2.10 to $1.43 in
2010. Expansive monetary policy increased supply, keeping downward pressure on the currency.
In 2012, it strengthened slightly to between $1.50 and $1.65. Fears that the euro zone debt crisis
would hurt British exports kept the pound in this range.

In July 2014, fears subsided, and the pound rose to $1.72, though by the end of 2015 it was at
$1.47.

On June 23, 2016, the United Kingdom voted to leave the EU. The pound plummeted to $1.36.
The uncertainty over what Brexit would mean for the economy sent traders scattering. By
August 2019, it had dropped even further, to $1.21. The UK formally left the EU on Jan. 31,
2020. The pound then recovered slightly to $1.32 as some of the uncertainty waned.

Canadian Dollar Rate

The Canadian dollar, known as the "loonier," has generally traded in a narrow range of $0.80 to
$1.01 against the U.S. dollar since the 2008 financial crisis. Both currencies are seen as safe
havens, compared to the euro and other riskier investments.

In 2013, the Canadian dollar fell to $0.88, as its economy weakened and the dollar strengthened.
After strengthening to $0.93 in July 2014, it fell to $0.86 by the end of the year. By the end of
2015, plummeting oil prices sent the loonier down to $0.72 against the dollar.

In 2017, it rose to $0.83. That was a vote of confidence in Canada's new Prime Minister, Justin
Trudeau, who promised to spend C$60 billion on new infrastructure. By the end of 2018, the
loonie had fallen to $0.73. Low oil prices were slowing the Canadian economy.

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The COVID-19 pandemic sent the Canadian dollar plummeting to $0.69 in March 2020. By
April 2021, it had recovered to $0.81.

Dollar to Yen Rate

In 2014, Japan's currency weakened due to Prime Minister Abe's expansion of the money supply,
undertaken to boost economic growth. By December 31, 2014, the dollar was worth 119.85
yen. That continued a long-term weakening trend, as the dollar was seen as a better safe haven
during the recession. In 2015, the Japanese yen ended the year at 120.27.

The U.S. dollar weakened in 2017 due to uncertainty over President Trump's economic policies.
As a result, the yen strengthened. A dollar could only buy 112.69 yen by the end of 2017, and the
yen continued strengthening to 104.83 by March 2018.

After staying in the range of 104–114 for two years, the yen strengthened to 102.52 on March 9,
2020. However, it weakened slightly to 111.44 as a result of a strengthening dollar during the
onset of the pandemic. By April 2021, the yen had recovered to 107.94.

The yen is also a safe-haven currency, but the Japanese economy has been fundamentally
weaker. It is plagued by a 200% debt-to-GDP ratio, deflation, and an aging workforce. These are
seen as worse problems than those affecting the U.S. economy. Whenever economic trends in the
U.S. look worse, the yen strengthens as the world's No. 2 safe-haven currency.

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 Basis for Conclusions on
IAS 21 the Effects of Changes in Foreign Exchange Rates

This Basis for Conclusions accompanies, but is not part of, IAS 21.
Paragraph BC1 was amended and paragraphs BC25A-BC25F were added in relation to the
amendment to IAS 21 issued in December 2005.

Introduction

BC1 This Basis for Conclusions summarizes the International Accounting Standards Board’s
considerations in reaching its conclusions on revising IAS 21 The Effects of Changes in
Foreign Exchange Rates in 2003, and on the amendment to IAS 21 Net Investment in a
Foreign Operation in December 2005. Individual Board members gave greater weight to
some factors than to others.
BC2 In July 2001 the Board announced that, as part of its initial agenda of technical projects, it
would undertake a project to improve a number of Standards, including IAS 21. The
project was undertaken in the light of queries and criticisms raised in relation to the
Standards by securities regulators, professional accountants and other interested parties.
The objectives of the Improvements project were to reduce or eliminate alternatives,
redundancies and conflicts within Standards, to deal with some convergence issues and to
make other improvements. In May 2002 the Board published its proposals in an Exposure
Draft of Improvements to International Accounting Standards, with a comment deadline
of 16 September 2002. The Board received over 160 comment letters on the Exposure
Draft.
BC3 Because the Board’s intention was not to reconsider the fundamental approach to
accounting for the effects of changes in foreign exchange rates established by IAS 21,
this Basis for Conclusions does not discuss requirements in IAS 21 that the Board has not
reconsidered.

Functional currency

BC4 The term ‘reporting currency’ was previously defined as ‘the currency used in presenting
the financial statements’. This definition comprises two separate notions (which were
identified in SIC-19 Reporting Currency—Measurement and Presentation of Financial
Statements under IAS 21 and IAS  29):
The measurement currency (the currency in which the entity measures the items in the
financial statements); and

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 The presentation currency (the currency in which the entity presents its financial
statements)
The Board decided to revise the previous version of IAS 21 to incorporate the SIC-19
approach of separating these two notions. The Board also noted that the term ‘functional
currency’ is more commonly used than ‘measurement currency’ and decided to adopt the
more common term.
BC5 The Board noted a concern that the guidance in SIC-19 on determining a measurement
currency could permit entities to choose one of several currencies, or to select an
inappropriate currency. In particular, some believed that SIC-19 placed too much
emphasis on the currency in which transactions are denominated and too little emphasis
on the underlying economy that determines the pricing of those transactions. To meet
these concerns, the Board defined functional currency as ‘the currency of the primary
economic environment in which the entity operates’. The Board also provided guidance
on how to determine the functional currency (see paragraphs 9–14 of the Standard). This
guidance draws heavily on SIC-19 and equivalent guidance in US and other national
standards, but also reflects the Board’s decision that some factors merit greater emphasis
than others.
BC6 The Board also discussed whether a foreign operation that is integral to the reporting
entity (as described in the previous version of IAS 21) could have a functional currency
that is different from that of its ‘parent’.1 The Board decided that the functional
currencies will always be the same, because it would be contradictory for an integral
foreign operation that ‘carries on business as if it were an extension of the reporting
enterprise’s operations’2 to operate in a primary economic environment different from its
parent.
BC7 It follows that it is not necessary to translate the results and financial position of an
integral foreign operation when incorporating them into the financial statements of the
parent—they will already be measured in the parent’s functional currency. Furthermore,
it is not necessary to distinguish between an integral foreign operation and a foreign
entity. When a foreign operation’s functional currency is different from that of its parent,
it is a foreign entity, and the translation method in paragraphs 38–49 of the Standard
applies.
BC8 The Board also decided that the principles in the previous version of IAS 21 for
distinguishing an integral foreign operation from a foreign entity are relevant in

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 determining an operation’s functional currency. Hence it incorporated these principles
into the Standard in that context.
BC9 The Board agreed that the indicators in paragraph 9 are the primary indicators for
determining the functional currency and that paragraphs 10 and 11 are secondary. This is
because the indicators in paragraphs 10 and 11 are not linked to the primary economic
environment in which the entity operates but provide additional supporting evidence to
determine an entity’s functional currency.

Presentation currency

BC10 A further issue is whether an entity should be permitted to present its financial statements
in a currency (or currencies) other than its functional currency. Some believe it should
not. They believe that the functional currency, being the currency of the primary
economic environment in which the entity operates, most usefully portrays the economic
effect of transactions and events on the entity. For a group that comprises operations with
a number of functional currencies, they believe that the consolidated financial statements
should be presented in the functional currency that management uses when controlling
and monitoring the performance and financial position of the group. They also believe
that allowing an entity to present its financial statements in more than one currency may
confuse, rather than help, users of those financial statements. Supporters of this view
believe that any presentation in a currency other than that described above should be
regarded as a ‘convenience translation’ that is outside the scope of IFRSs.
BC11 Others believe that the choice of presentation currency should be limited, for example, to
the functional currency of one of the substantive entities within a group. However, such a
restriction might be easily overcome—an entity that wished to present its financial
statements in a different currency might establish a substantive, but relatively small
operation with that functional currency.
BC12 Still others believe that, given the rising trend towards globalisation, entities should be
permitted to present their financial statements in any currency. They note that most large
groups do not have a single functional currency, but rather comprise operations with a
number of functional currencies. For such entities, they believe it is not clear which
currency should be the presentation currency, or why one currency is preferable to
another. They also point out that management may not use a single currency when
controlling and monitoring the performance and financial position of such a group.
In addition, they note that in some jurisdictions, entities are required to present their
financial statements in the local currency, even when this is not the functional currency. 3
Hence, if IFRSs required the financial statements to be presented in the functional
currency, some entities would have to present two sets of financial statements: financial

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 statements that comply with IFRSs presented in the functional currency and financial
statements that comply with local regulations presented in a different currency.
BC13 The Board was persuaded by the arguments in the previous paragraph. Accordingly, it
decided that entities should be permitted to present their financial statements in any
currency (or currencies).
BC14 The Board also clarified that the Standard does not prohibit the entity from providing, as
supplementary information, a ‘convenience translation’. Such a ‘convenience translation’
may display financial statements (or selected portions of financial statements) in a
currency other than the presentation currency, as a convenience to some users. The
‘convenience translation’ may be prepared using a translation method other than that
required by the Standard. These types of ‘convenience translations’ should be clearly
identified as supplementary information to distinguish them from information required by
IFRSs and translated in accordance with the Standard.

Translation method

BC15 The Board debated which method should be used to translate financial statements from
an entity’s functional currency into a different presentation currency.

BC16 The Board agreed that the translation method should not have the effect of substituting
another currency for the functional currency. Put another way, presenting the financial
statements in a different currency should not change the way in which the underlying
items are measured. Rather, the translation method should merely express the underlying
amounts, as measured in the functional currency, in a different currency.
BC17 Given this, the Board considered two possible translation methods. The first is to
translate all amounts (including comparatives) at the most recent closing rate. This
method has several advantages: it is simple to apply; it does not generate any new gains
and losses; and it does not change ratios such as return on assets. This method is
supported by those who believe that the process of merely expressing amounts in a
different currency should preserve the relationships among amounts as measured in the
functional currency and, as such, should not lead to any new gains or losses.
BC18 The second method considered by the Board is the one that the previous version of
IAS 21 required for translating the financial statements of a foreign operation. 4 This
method results in the same amounts in the presentation currency regardless of whether
the financial statements of a foreign operation are:
(a) First translated into the functional currency of another group entity (eg the parent)
and then into the presentation currency, or

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 (b) Translated directly into the presentation currency.
BC19 This method avoids the need to decide the currency in which to express the financial
statements of a multinational group before they are translated into the presentation
currency. As noted above, many large groups do not have a single functional currency,
but comprise operations with a number of functional currencies. For such entities it is not
clear which functional currency should be chosen in which to express amounts before
they are translated into the presentation currency, or why one currency is preferable to
another. In addition, this method produces the same amounts in the presentation currency
for a stand-alone entity as for an identical subsidiary of a parent whose functional
currency is the presentation currency.
BC20 The Board decided to require the second method, ie that the financial statements of any
entity (whether a stand-alone entity, a parent or an operation within a group) whose
functional currency differs from the presentation currency used by the reporting entity are
translated using the method set out in paragraphs 38–49 of the Standard.
BC21 With respect to translation of comparative amounts, the Board adopted the approach
required by SIC-30 for:
(a) an entity whose functional currency is not the currency of the hyperinflationary
economy (assets and liabilities in the comparative balance sheet are translated at
the closing rate at the date of that balance sheet and income and expenses in the
comparative income statement are translated at exchange rates at the dates of the
transactions); and
(b) An entity whose functional currency is the currency of a hyperinflationary
economy, and for which the comparative amounts are being translated into the
currency of a hyperinflationary economy (both balance sheet and income
statement items are translated at the closing rate of the most recent balance sheet
presented).
BC22 However, the Board decided not to adopt the SIC-30 approach for the translation of
comparatives for an entity whose functional currency is the currency of a
hyperinflationary economy, and for which the comparative amounts are being translated
into a presentation currency of a non-hyperinflationary economy. The Board noted that in
such a case, the SIC-30 approach requires restating the comparative amounts from those
shown in last year’s financial statements for both the effects of inflation and for changes
in exchange rates. If exchange rates fully reflect differing price levels between the two
economies to which they relate, the SIC-30 approach will result in the same amounts for
the comparatives as were reported as current year amounts in the prior year financial
statements. Furthermore, the Board noted that in the prior year, the relevant amounts had
been already expressed in the non-hyperinflationary presentation currency, and there was
no reason to change them. For these reasons the Board decided to require that all
comparative amounts are those presented in the prior year financial statements (ie there is

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 no adjustment for either subsequent changes in the price level or subsequent changes in
exchange rates).
BC23 The Board decided to incorporate into the Standard most of the disclosure requirements
of SIC-30 Reporting Currency—Translation from Measurement Currency to
Presentation Currency that apply when a different translation method is used or other
supplementary information, such as an extract from the full financial statements, is
displayed in a currency other than the functional currency (see paragraph 57 of the
Standard). These disclosures enable users to distinguish information prepared in
accordance with IFRSs from information that may be useful to users but is not the subject
of IFRSs, and also tell users how the latter information has been prepared.

Capitalization of exchange differences

BC24 The previous version of IAS 21 allowed a limited choice of accounting for exchange
differences that arise ‘from a severe devaluation or depreciation of a currency against
which there is no practical means of hedging and that affects liabilities which cannot be
settled and which arise directly on the recent acquisition of an asset’. 5 The benchmark
treatment was to recognise such exchange differences in profit or loss. The allowed
alternative was to recognise them as an asset.
BC25 The Board noted that the allowed alternative (of recognition as an asset) was not in
accordance with the Framework for the Preparation and Presentation of Financial
Statements because exchange losses do not meet the definition of an asset. Moreover,
recognition of exchange losses as an asset is neither allowed nor required by any liaison
standard setter, so its deletion would improve convergence. Finally, in many cases when
the conditions for recognition as an asset are met, the asset would be restated in
accordance with IAS 29 Financial Reporting in Hyperinflationary Economies. Thus, to
the extent that an exchange loss reflects hyperinflation, this effect is taken into account
by IAS 29. For all of these reasons, the Board removed the allowed alternative treatment
and the related SIC Interpretation is superseded.

Net investment in a foreign operation

BC25A The principle in paragraph 32 is that exchange differences arising on a monetary

item that is, in substance, part of the reporting entity’s net investment in a foreign
operation are initially recognized in a separate component of equity in the consolidated
financial statements of the reporting entity. Among the revisions to IAS 21 made in 2003
was the provision of guidance on this principle that required the monetary item to be

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 denominated in the functional currency of either the reporting entity or the foreign
operation. The previous version of IAS 21 did not include such guidance.
BC25B The requirements can be illustrated by the following example. Parent P owns 100
per cent of Subsidiary S. Parent P has a functional currency of UK sterling. Subsidiary S
has a functional currency of Mexican pesos. Parent P grants a loan of 100 US dollars to
Subsidiary S, for which settlement is neither planned nor likely to occur in the
foreseeable future. IAS 21 (as revised in 2003) requires the exchange differences arising
on the loan to be reco gnised in profit or loss in the consolidated financial statements of
Parent P, whereas those differences would be recognised initially in equity in the
consolidated financial statements of Parent P, if the loan were to be denominated in
sterling or Mexican pesos.
BC25C After the revised IAS 21 was issued in 2003, constituents raised the following
concerns:
(a) It is common practice for a monetary item that forms part of an entity’s
investment in a foreign operation to be denominated in a currency that is not the
functional currency of either the reporting entity or the foreign operation. An
example is a monetary item denominated in a currency that is more readily
convertible than the local domestic currency of the foreign operation.
(b) An investment in a foreign operation denominated in a currency that is not the
functional currency of the reporting entity or the foreign operation does not
expose the group to a greater foreign currency exchange difference than arises
when the investment is denominated in the functional currency of the reporting
entity or the foreign operation. It simply results in exchange differences arising in
the foreign operation’s individual financial statements and the reporting entity’s
separate financial statements.
(c) It is not clear whether the term ‘reporting entity’ in paragraph 32 should be
interpreted as the single entity or the group comprising a parent and all its
subsidiaries. As a result, constituents questioned whether the monetary item must
be transacted between the foreign operation and the reporting entity, or whether it
could be transacted between the foreign operation and any member of the
consolidated group, ie the reporting entity or any of its subsidiaries.
BC25D The Board noted that the nature of the monetary item referred to in paragraph 15
is similar to an equity investment in a foreign operation, ie settlement of the monetary
item is neither planned nor likely to occur in the foreseeable future. Therefore, the
principle in paragraph 32 to recognize exchange differences arising on a monetary item
initially in a separate component of equity effectively results in the monetary item being
accounted for in the same way as an equity investment in the foreign operation when
consolidated financial statements are prepared. The Board concluded that the accounting
treatment in the consolidated financial statements should not be dependent on the

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 currency in which the monetary item is denominated, nor on which entity within the
group conducts the transaction with the foreign operation.
BC25EAccordingly, in 2005 the Board decided to amend IAS 21. The amendment requires
exchange differences arising on a monetary item that forms part of a reporting entity’s net
investment in a foreign operation to be recognized initially in a separate component of
equity in the consolidated financial statements. This requirement applies irrespective of
the currency of the monetary item and of whether the monetary item results from a
transaction with the reporting entity or any of its subsidiaries.
BC25F The Board also proposed amending IAS 21 to clarify that an investment in a foreign
operation made by an associate of the reporting entity is not part of the reporting entity’s
net investment in that foreign operation. Respondents to the exposure draft disagreed
with this proposal. Many respondents said that the proposed amendment added a detailed
rule that was not required because the principle in paragraph 15 was clear. In red
liberations, the Board agreed with those comments and decided not to proceed with that
proposed amendment.

Goodwill and fair value adjustments

BC26 The previous version of IAS 21 allowed a choice of translating goodwill and fair value
adjustments to assets and liabilities that arise on the acquisition of a foreign entity at (a)
the closing rate or (b) the historical transaction rate.
BC27 The Board agreed that, conceptually, the correct treatment depends on whether goodwill
and fair value adjustments are part of:
(a) the assets and liabilities of the acquired entity (which would imply translating
them at the closing rate); or
(b) the assets and liabilities of the parent (which would imply translating them at the
historical rate).
BC28 The Board agreed that fair value adjustments clearly relate to the identifiable assets and
liabilities of the acquired entity and should therefore be translated at the closing rate.
BC29 Goodwill is more complex, partly because it is measured as a residual. In addition, the
Board noted that difficult issues can arise when the acquired entity comprises businesses
that have different functional currencies (eg if the acquired entity is a multinational
group). The Board discussed how to assess any resulting goodwill for impairment and, in
particular, whether the goodwill would need to be ‘pushed down’ to the level of each
different functional currency or could be accounted for and assessed at a higher level.
BC30 One view is that when the parent acquires a multinational operation comprising
businesses with many different functional currencies, any goodwill may be treated as an
asset of the parent/acquirer and tested for impairment at a consolidated level. Those who

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 support this view believe that, in economic terms, the goodwill is an asset of the parent
because it is part of the acquisition price paid by the parent. Thus, they believe, it would
be incorrect to allocate the goodwill to the many acquired businesses and translate it into
their various functional currencies. Rather, the goodwill, being treated as an asset of the
parent, is not exposed to foreign currency risks, and translation differences associated
with it should not be recognised. In addition, they believe that such goodwill should be
tested for impairment at a consolidated level. Under this view, allocating or ‘pushing
down’ the goodwill to a lower level, such as each different functional currency within the
acquired foreign operation, would not serve any purpose.
BC31 Others take a different view. They believe that the goodwill is part of the parent’s net
investment in the acquired entity. In their view, goodwill should be treated no differently
from other assets of the acquired entity, in particular intangible assets, because a
significant part of the goodwill is likely to comprise intangible assets that do not qualify
for separate recognition. They also note that goodwill arises only because of the
investment in the foreign entity and has no existence apart from that entity. Lastly, they
point out that when the acquired entity comprises a number of businesses with different
functional currencies, the cash flows that support the continued recognition of goodwill
are generated in those different functional currencies.
BC32 The Board was persuaded by the reasons set out in the preceding paragraph and decided
that goodwill is treated as an asset of the foreign operation and translated at the closing
rate. Consequently, goodwill should be allocated to the level of each functional currency
of the acquired foreign operation. This means that the level to which goodwill is allocated
for foreign currency translation purposes may be different from the level at which the
goodwill is tested for impairment. Entities follow the requirements in IAS 36 Impairment
of Assets to determine the level at which goodwill is tested for impairment.

By

Chanie Teshome engida

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