CORPORATE REPORTING

(AQ056-3-2-CRPT)

Foreign Currency Translation

 Topic & Structure of the lesson

1. Reporting foreign currency transactions in

the functional currency
2. Functional and presentation currencies

3. Translating foreign operations

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 What is currency translation?

Currency translation is the process of quoting the amount

of money denominated in one currency in the denomination
of another currency in the financial statements.

Currency translation is done using current exchange

rates.

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 Definitions
Closing rate - It is the spot exchange rate at the end of the reporting period.
Foreign operations - It 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.
Functional currency - It is the currency of the primary economic environment
in which the entity operates.
Foreign currency - It is the currency other than the functional currency of the
entity.
Exchange difference - It is the difference resulting from translating a given
number of units of one currency into another at different exchange rate.
Presentation currency - It is the currency in which the financial statements
are presented.
Monetary items - Monetary items are ‘units of currency held or assets and
liabilities to be received or paid in a fixed or determinable number of units of
currency’.
Spot rate - It is the exchange rate for immediate delivery.

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 Determining the Functional Currency
The primary factors are:
a. the currency:
i. that mainly influences sales prices for goods and services (the
currency in which the sales prices are denominated) 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 (the currency in which the costs are
denominated).

Secondary factors that may provide evidence of an entity’s functional

currency are:
a. the currency in which funds from financing activities (issuing of debt
and equity instruments) are generated.
b. the currency in which receipts from operating activities are usually
retained.

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 Determining the functional currency
of a foreign operation
• Level of autonomy. Whether the foreign operations are carried out as an
extension of the parent or the foreign operation operates with a significant
level of autonomy.
• The volume of transactions between the foreign operation and the parent is
high or low.
• Whether the cash flows from the foreign operation’s activities directly affect
the cash flows of the parent and whether the funds are readily available for
remittance to the parent.
• Whether the foreign operation is financed mainly from its own operation or
borrowing rather than by the parent.

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 Functional Currency is
Indeterminable
Where the functional currency is not easily determinable, management has to
rely on its own judgement to determine the functional currency that faithfully
represents the economic effects of the transactions, events and conditions. The
primary factors will be considered before looking at the other factors.

An entity would have:

a. Foreign currency transactions
b. Foreign operations

They include:
• Purchases and sales of goods and services where the
transactions are denominated in the foreign currency,
• Borrowings and lending where the receivables and payables are
denominated in the foreign currency, and
• Acquisition and disposal of assets, or incurring or settling
liabilities denominated in a foreign currency.
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 Foreign Transactions

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

Subsequent measurement
– All monetary items are retranslated at the closing or reporting date
rate.
– Non-monetary items are not retranslated; they are measured at
exchange rate at the date of the transaction.

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 Illustration 1

On 1 June 2018, an US company, XYZ Ltd acquired

goods on credit from a UK supplier. The cost of the goods
was £200 000, and remained unpaid at 30 June 2018.

On 1 June 2018 the exchange rate was $1.00 = £0.50.

On 30 June 2018 it was $1.00 = £0.55.

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 Illustration 1—Solution
As at 1 June, the debt would be equal to $400 000 (which is
200 000/0.50). It is converted at the spot rate.
As at 30 June, the debt would be equal to $363 636 (which
is 200 000/0.55 using the reporting date spot rate).
IAS 21 requires that:
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.
Hence, the initial entry on 1 June 2018 would be:
Dr Purchase/Inventory 400 000
Cr Accounts payable 400 000

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 End of reporting period adjustments
IAS 21 requires that foreign currency monetary items
(which includes payables and receivables) outstanding at
the end of the reporting period shall be translated at the
spot rate at reporting date (referred to as the ‘closing rate’).
IAS 21 requires that the exchange differences relating to
monetary items shall be brought to account as part of profit
or loss in the financial period in which the exchange rates
change.
Hence, the entry on 30 June 2018 would be:
Dr Accounts payable 36 364
(400 000-363 636)
Cr Exchange gain 36 364

Note that the adjustment goes to profit or loss, and not

to inventory.
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 Functional Currency and Presentation
currency are different

• IAS 21 allows an entity to have a presentation currency which is not its

functional currency.
• Such an entity has to record the transactions in its functional currency and
then translate the financial statements into Ringgit Malaysia.

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 Recognition of Exchange Difference

• The standard requires the exchange difference that arises when monetary
items are settled, and from retranslating monetary items at the reporting
date to be recognised in the income statement in the period in which they
arise.

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 Exceptions to recognising the difference
on exchange to income statement

a. Exchange Difference on Non-monetary Items

Where gains or losses of non-monetary items are recognised in other
comprehensive income and equity (reserve), any exchange component of
that gain or loss is also recognised in other comprehensive income and
equity.

b. Exchange Difference of Monetary Items Being Part of Net

Investment in a Foreign Operation
An entity may have a monetary item such as loans and long-term
receivables that is unlikely to be settled in the foreseeable future. In such
a case, the monetary item is in substance a net investment and the
difference on exchange goes directly to equity.

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 Foreign Operations

Two types of foreign operations:

a. Foreign operation whose functional currency is that of the parent.
b. Foreign operation has its own functional currency and the parent’s
functional currency may be its presentation currency.

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 Translation of the Financial Statements

Translating from Local Currency to Functional Currency which is that of the Parent

Property, plant and equipment Closing rate

Property, plant and equipment Closing rate
at fair value/revalued
Cost of inventory Date when the cost was incurred
Net realisable value of the Date on which the realisable value
inventory was determined
Monetary assets and liabilities Closing rate

Revenue and expenses Rates on date of transactions or

average rate for the period
Depreciation charge Average rate

Share capital and pre- Historical rate

acquisition reserves
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 Presentation Currency is Not the
Functional Currency

All assets including goodwill Closing rate

All liabilities Closing rate

Revenue and expenses Rates at the dates of the

transactions or average rate for
the period provided there are no
significant fluctuation in exchange
rates

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 Disposal of Foreign Operation

• When a foreign operation is disposed of, the cumulative amount of the

difference on exchange will be recognised in the income statement when
the operation is disposed of and the gain or loss on disposal is recognised.
If there is a partial disposal of the operation, the proportionate share of the
cumulative difference on exchange is recognised in the income statement.
• Write-down of the carrying amount of the foreign operation is not considered
as disposal and so no part of the cumulative difference on exchange is
recognised in the income statement.

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 Translation of a foreign operation
The Standard permits an entity to present its financial
statements in any currency (or currencies). For this purpose,
an entity could be a stand-alone entity, a parent preparing consolidated
financial statements or a parent, an investor or a venturer preparing separate
financial statements in accordance with IAS 27 Consolidated and Separate
Financial Statements.

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.

An entity is required to translate its results and financial position from its
functional currency into a presentation currency (or currencies) using the
method required for translating a foreign operation for inclusion in the reporting
entity’s financial statements.

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 Translation of a foreign operation
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 statement of financial position presented (ie:
including comparatives) shall be translated at the closing rate at the date of that
statement of financial position;

(b) income and expenses for each statement of comprehensive income or separate
income statement presented (ie: including comparatives) shall be translated at
exchange rates at the dates of the transactions; and

(c) all resulting exchange differences shall be recognized in other comprehensive

income. 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. 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.
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 Student’s Reading

Reference to related standards:-

• IAS 21 / MFRS 23 – The Effect of Changes in Foreign Exchange Rate

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 Question and Answer Session

Q&A

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