IAS 21:

The Effects of
Changes in Foreign
Exchange Rates

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Agenda
01 02
Key Definitions Determine the
Functional
Currency

03 04
Translate Foreign Foreign Currency
Currency Translation of
Transactions Financial
Statements

05
Disclosures

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Key Definitions

3
Key Definitions

Presentation currency
Functional Currency The currency in which the financial
The currency of the primary
statements are presented
economic environment in which the
entity operates.

Foreign Currency
A currency other than the functional currency
of an entity.

*Under Indian GAAP- Foreign currency is a currency other than the reporting currency which is the currency in which financial statements are presented.
There is no concept of functional currency.

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Determine the
Functional
Currency

5
Determining the Functional Currency

The primary economic environment is normally the environment in which the entity primarily generates and expends cash

01 02
Primary indicators Secondary indicators
The currency in which:
The currency that mainly influences:
• funds from financing activities are generated (debt and
• sales prices
equity)
• labour, material and other costs of providing goods or
• receipts from operating activities are usually retained
services

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Determining the Functional Currency
Example
Entity A operates an oil refinery in Saudi Arabia. All of the entity’s income is denominated and settled in US dollars. The oil price is subject to the
worldwide supply and demand, and crude oil is routinely traded in US dollars around the world. Around 45% of entity A’s cash costs are imports or
expatriate salaries denominated in US dollars. The remaining 55% of cash expenses are incurred in Saudi Arabia and denominated and settled in riyal.

The crude oil sales prices are influenced by global demand and supply. Crude oil is globally traded in US dollars around the world. The revenue analysis
points to US dollars. The cost analysis is mixed. Depreciation (or any other non-cash expenses) is not considered, because the primary economic
environment is where the entity generates and expends cash. Operating cash expenses are influenced by the riyal (55%) and the US dollar (45%).

Solution
Management is able to determine the functional currency of entity A as US dollars, because the revenue is clearly influenced by US dollars and expenses
are mixed

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Monetary Assets
– Exchange gains and losses

Realized
exchange
differences

Recognized in P/L
Monetary assets (both gains and
Unrealized losses)
exchange
differences

Recognition of Exchange gains and losses

on monetary assets

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Non-Monetary Assets
– Exchange gains and losses

Gain or loss Exchange component

recognized in P/L recognized in P/L

Non-Monetary assets

Gain or loss Exchange component

recognized in equity recognized in equity

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Determining the Functional Currency
Presentation currency is the currency in which the financial statements are presented.

Question
True or false: An entity can choose its presentation currency

Answer
True: IAS 21 permits an entity to present its financial statements in any currency; however, if a currency other than the functional currency is chosen, that
fact shall be stated together with the reason for selecting the different presentation currency .

Question
True or false: An entity can choose its functional currency

Answer
False: functional currency is a matter of fact.

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Determining the Functional Currency
– additional factors for foreign operations
Foreign operation is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the activities of which are based or conducted
in a country or currency other than those of the reporting entity.

Degree of
Proportion of
operational
transactions with
independence
parent
from parent

Financial
Influence of cash
autonomy
flows on parent’s
compared with
cash flows
parent

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Determining the Functional Currency
Example
• XYZ Ltd., a subsidiary in India, purchases goods from ABC Inc., its holding company in USA.

• XYZ Ltd Purchases in USD and also purchase prices are based on the US Market

• It sells goods in USD and the sale price is influenced by the holding company.

• Other expenses are incurred locally.

• XYZ Ltd. has an External Commercial Borrowing from ABC Inc. for financing its activities.

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Determining the Functional Currency
Solution

Factors to be considered Influencing currency

Sales USD

Sales Market influenced by USD

Expenses INR

Purchases USD

Financing USD

Cash flows INR/USD

Functional Currency (based on Primary indicators ) USD

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Determining the Functional Currency

Example
• ABC Ltd owns a subsidiary in India, XYZ Ltd.

• XYZ assembles all goods in India using a combination of locally sourced materials and materials manufactured by ABC.

• All goods are then exported and sold in Australia, based on selling prices determined by ABC and influenced by Indian market.

• The company has a loan from an Indian Bank.

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Determining the Functional Currency
Solution

Factors to be considered Influencing currency

Sales AUD

Sales Market influenced by INR

Expenses INR

Purchases INR/USD

Financing INR

Cash flows INR/USD/AUD

Functional Currency (based on Primary indicators ) INR

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Determining the Functional Currency
Example
• XYZ Ltd., a subsidiary in India, purchases goods from ABC Inc., its holding company in USA.

• Purchases are done in USD and are based on prices in US Market.

• It sells goods in INR and the sale price is market determined.

• Other expenses are incurred locally.

• It remits its proceeds to the holding company.

Solution
• Sales are in INR and are market determined whereas goods are purchased from USA.

• The primary indicators do not give a clear picture.

• On the basis of additional factors, in the given case XYZ Ltd. is carrying out its activities as an extension of holding company’s foreign operations
since it only sells goods imported from the reporting entity and remits its proceeds to it, its functional currency should be USD.

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Translate Foreign
Currency
Transactions

17
Translate Foreign Currency Transactions
Initial Measurement
spot exchange rate
• the exchange rate for
immediate delivery

• the amount is measured in the foreign currency in accordance with the relevant
Standard
• the foreign currency transaction is translated into the functional currency
all foreign currency
• apply the spot exchange rate between the functional currency and foreign currency at
transactions
the date of the transaction

An average exchange rate for a specific period may be a suitable approximate rate for transactions during that period, particularly if exchange rates
do not fluctuate significantly.

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Translate Foreign Currency Transactions
Subsequent Measurement

non-monetary item non-monetary item

monetary items (measured at historical
(measured at fair value)
cost)

translate using the

translate at the exchange
exchange rate at the date rate at the date the fair
translate at closing rate of the transaction value was measured
(historical rate)

exchange differences are

changes in profit or loss in recognised in the same
n/a statement as the fair value
period they arise differences (P&L or OCI)

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Translate Foreign Currency Transactions
Subsequent Measurement
Monetary items are:
1. units of currency held
2. assets to be received in a fixed or determinable number of units of currency and
3. liabilities to be paid in a fixed or determinable number of units of currency.

Non Monetary items other than monetary (Items that will not be received in a fixed or determinable amount of cash)

Item Monetary Non-monetary

Employee benefits to be paid in cash

Prepaid expenses

Provisions to be settled in cash

Inventory

Intangible assets

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Translate Foreign Currency Transactions
Example
• Aston has a financial year end of 31 December 2017.

• On 25 October 2017 Aston buys goods from a Mexican supplier for Peso 286,000.

• On 16 November 2017 Aston pays the Mexican supplier in full. The goods remain in inventory at 31 December 2017.

• Exchange rates 2017

25 October $1:Peso 11.16

16 November $1:Peso 10.87

31 December $1:Peso 11.02

• Required:

• Show the accounting entries for the transactions in each of the following situations:

(a) on 16 November 2017 Aston pays the Mexican supplier in full;

(b) the supplier remains unpaid at 31 December 2017.

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Translate Foreign Currency Transactions
Solution
a) Supplier paid

Date Particulars Dr/Cr Debit Credit

(in $) (in $)

25-Oct Purchases (W1) Dr 25,627

Trade payables Cr 25,627

(Being purchases made)

16-Nov Trade payables Dr 25,627

Foreign Exchange loss(Other operating expense) Dr 684

Cash (W2) Cr 26,311

(Being supplier paid in full and exchange difference

transferred)
The goods will remain in inventory at end of the reporting period at $25,627.

(1) Peso 286,000 ÷ 11.16 = $25,627

(2) Peso 286,000 ÷ 10.87 = $26,311

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Translate Foreign Currency Transactions
Solution (Continued…)
b) Year-end trade payable

Date Particulars Dr/Cr Debit Credit

(in $) (in $)

25-Oct Purchases (W1) Dr 25,627

Trade payables Cr 25,627
(Being purchases made)

31 December Foreign exchange loss(Other operating expense) Dr 326

Trade payables Cr 326

(being Exchange difference transferred)

The goods will remain in inventory at the end of the reporting period at $25,627.

WORKING

(1) Peso 286,000 ÷ 11.16 $25,627

(2) Peso 286,000 ÷ 11.02 $25,953

(3) Exchange difference $ 326

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Translate Foreign Currency Transactions
Example
• Warrior has a reporting period ending 31 December 2015. On 29 November 2015 Warrior received a loan from an Australian bank of AUD
1,520,000.

• The proceeds are used to finance in part the purchase of a new office block. The loan remains unsettled at 31 December 2015.
• Exchange rates 2015

• 29 November USD 1 = AUD 1.52

• 31 December USD 1 = AUD 1.66

• Required:

Show the accounting entries for these transactions.

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Translate Foreign Currency Transactions
Solution (Continued…)

Date Particulars Dr/Cr Debit Credit

(in $000 ) (in $000 )
29 November Cash Dr 1,000

Loan Cr 1,000

(Being loan taken)

31 December Loan Dr 84
Foreign exchange gain(Operating income) Cr 84

(Being exchange difference transferred)

The goods will remain in inventory at the end of the reporting period at $25,627.

WORKING

WORKINGS(in thousands)

• AUD 1,520,000 ÷ 1.52 $1,000

• AUD 1,520,000 ÷ 1.66 $916

Exchange Difference $ 84
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Foreign Currency
translation of
financial
statements

26
Foreign Currency Translation of Financial
Statements - Functional currency to Presentation
currency
assets and liabilities (including comparatives) should be
Statement of financial
translated at the closing rate at the date of the reporting
position
period exchange differences recognised in
OCI and presented in a separate
component of equity (recycled to p/l
income and expenses (including comparatives) upon disposal)
Statement of profit or should be translated at exchange rates at the dates
loss and OCI of the transaction
(practically, periodic averages)

equity should be translated at actual rates.

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Foreign Currency Translation of Financial
Statements - Putting it all together
• Entity A has a functional currency of INR
• Entity A elects a presentation currency of Euro
• Entity A has a USD loan

How should exchange differences on the loan be accounted for?

foreign currency transactions in

functional currency INR presentation currency Euro
USD

income statement
(part of translating foreign OCI
currency transactions)

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Foreign Currency Translation of Financial
Statements - Other application issues
Question
How does an entity account for a change in its presentation currency?

Answer
As the selection of the presentation currency is a choice, a change is deemed to be a change in accounting policy and accounted for in accordance with
IAS 8 (should be applied retrospectively)

Question
How does an entity account for a change in its functional currency?

Answer
IAS 21 require the entity apply the translation procedures applicable to the new functional currency prospectively from the date of change.

No restatement of previous period.

You simply need to translate all items of assets and liabilities into the new functional currency using the exchange rate at the date of change.

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Example:
Let’s say your functional currency was EUR.

You decided to change your functional currency to USD on 1 January 2019 when the exchange rate was 1,145 USD/EUR.

In your balance sheet, there’s a property, plant and equipment (PPE) with the cost of EUR 10,000 as at 1 January 2019.

After the change in functional currency, the cost will be 11 450 USD and this is the new historical cost of PPE (no further currency revaluation in functional
currency).

And, this will be the new historical cost event if you bought the same property in USD.

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How to present Comparatives when the
Functional Currency Changes
So, if you change your functional currency and you always present your financial statements in the same currency as your functional currency, then we
are facing two changes in fact:

1.The change in functional currency itself – as I explained above, you need to make this change prospectively without any restatement of previous
periods.

2.The change in presentation currency – the change in presentation currency is treated as a change in accounting policy and is to be applied
retrospectively.

Imagine you presented in EUR last year. Your new functional currency is USD and you plan to present your financial statements in USD.

1. Thus you need to translate your comparative financial statements in EUR to USD using the appropriate exchange rates applicable for the
comparative reporting period.
2. Now, if you decide to present in EUR despite your new functional currency is USD, then you will use IAS 21 rules for translating amounts in your
functional currency to presentation currency

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Foreign Currency Translation of Financial
Statements: Consolidation – Fair valuation upon
acquisition

Question
How does an entity account for goodwill and fair value acquisition accounting adjustments related to foreign operation?

Answer
Goodwill and any fair value adjustments are considered to be assets/ liabilities of the foreign operation. Therefore, they are expressed in the functional
currency of the subsidiary and translated at the reporting date like any other asset or liability of the subsidiary

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Foreign Currency Translation of Financial
Statements: Monetary items forming part of the net
investment in a foreign operation (treatment in CFS)

Monetary payable or receivables

forms part of the net investment in a foreign operation does not form part of the net investment in a foreign
operation

foreign exchange gains and losses to be

foreign exchange gains and losses to
recognised in OCI and presented within
be recognised in P&L
equity

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Disclosures

34
Disclosures
• The amount of exchange differences included in profit.

• Net exchange differences classified in equity as a separate component of equity, and a reconciliation of the amount of such exchange differences

at the beginning and end of the period.

• When presentation currency is different to the functional currency, that fact must be stated along with the functional currency and the reason for

using a different reporting currency.

• Any changes in functional currency, and the reasons for the change loss for the period.

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Thank you for your attention

Any questions?

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