IPSAS 4―THE EFFECTS OF CHANGES IN FOREIGN

EXCHANGE RATES
Objectives
 Understand the concept of a functional currency in
general purpose financial information;
 Understand how to determine the functional currency;
and
 Understand some of the main judgements made setting
in determining the functional currency.
 Describe how a foreign currency transaction shall be
recorded initially and subsequently.
 Describe the disclosure requirements according to IPSAS 4
Definition
 Foreign currency. A currency other than the functional
currency of the entity.
 Functional currency. The currency of the primary
economic environment in which the entity operates.
 Presentation currency. The currency in which the
financial statements are presented.
 Exchange rate. The ratio of exchange for two
currencies.
 Exchange difference. The difference resulting from
translating a given number of units of one currency
into another currency at different exchange rates.
Definition
 Closing rate. The spot exchange rate at the year end date.
 Spot exchange rate. The exchange rate for immediate
delivery.
 Each entity –should determine its functional currency and
measure its results and financial position in that currency.
Functional 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.

source: paragraph 24 of IPSAS 4

 Application guidance
source: paragraph 11 of IPSAS 4
 Functional currency is determined (not chosen)
 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:
(a) The currency:
▪ (i) that revenue is raised from, such as taxes, grants, and fines;
▪ (ii) 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
▪ (iii) of the country whose competitive forces and regulations mainly determine the sale prices of
its goods and services.
(b) The currency that mainly influences labour, material, and other costs of providing
goods and services (this will often be the currency in which such costs are denominated
and settled).
 Application guidance
source: paragraphs 12, 14 and 15 of IPSAS 4

The following factors may also provide evidence of an entity’s functional currency:
(a) The currency in which funds from financing activities (i.e., issuing debt and equity
instruments) are generated.
(b) The currency in which receipts from operating activities are usually retained.
 When 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 11 before considering other indicators, which are designed to provide
additional supporting evidence to determine an entity’s functional currency.
 Once determined, the functional currency is not changed unless there is a change
in those underlying transactions, events, and conditions.
 .

Functional currency
Functional currency is the currency of the primary economic environment in which the
entity operates
The primary economic environment is normally the environment in which the entity
primarily generates and expends cash

The currency that mainly influences:

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

Functional currency
Flowchart
Primary indicators identify a functional currency

YES
This is the functional currency

ON

YES
Considering the secondary indicators, together with the This is the functional currency
primary indicators, identify a functional currency

ON

Judgement, priority for primary indicators

 Example 1
determining the functional currency

Which currency is Ethiopia Charity A’s functional

currency?
Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5)
another (specify)
Ethiopia Charity A conducts all of its activities in Ethiopia
exclusively in ETB.
It has no international affiliations.
 Example 2
determining the functional currency

Which currency is Ethiopia Charity B’s functional currency?

Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5) another (specify)
Ethiopia Charity B:
 has no international affiliations
 conducts all of its charitable activities in Ethiopia
 all of its revenue is in the form of USD denominated grants (non-
exchange transactions) from a US Charity.
Because the US Charity stipulates a condition of its grants to Charity B that
at least 60% the funds must spent in USD denominated transactions with
US corporations and US citizens, the majority of Charity B’s expenditures
are USD denominated. The remaining expenditures are in ETB.
 Example 3
determining the functional currency

Which currency is Ethiopia Charity C’s functional currency?

Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5) another
(specify)
Ethiopia Charity C has no international affiliations. It conducts all
of its charitable activities in Ethiopia and all of its expenditures are
in ETB.
However, all of its revenue is in the form of GBP denominated
grants (non-exchange transactions) from a UK charity.
 Application guidance
source: paragraphs 13 of IPSAS 4

Additional factors for determining whether a foreign operation’s functional currency is

the same as the reporting entity that has the foreign operation as its controlled entity,
branch, associate, or joint arrangement):
(a) Whether the activities of the foreign operation are carried out as an extension of the
reporting entity, rather than with significant autonomy.
(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.
 Example 1
determining the functional currency of a foreign operation

Which currency is Ethiopian Branch Charity’s functional currency?

Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5) another (specify)
American Charity has Ethiopian Branch Charity (EBC) that conduct
activities in Ethiopia on behalf of American Charity.
EBC conducts its activities substantially in USD (the functional
currency of American Charity). For example, EBC staff are paid in
USD and receive only a small ETB allowance.
EBC’s purchases of supplies and equipment are largely obtained via
American Charity, with purchases in ETB being kept to a minimum.
 Example 2
Determining the functional currency of a foreign operation

Which currency is Ethiopian Campus A’s functional currency?

Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5) another (specify)
Ethiopian Campus A (established by British University) operates under the
management and direction of Ethiopian Campus A.
Ethiopian Campus A conducts its activities substantially in GBP (the functional
currency of British University). For example, Ethiopian Campus student fees
are charged in GBP and staff salaries are GBP denominated.
Ethiopian Campus A purchases of supplies and equipment are largely obtained
via British University, with purchases in ETB being kept to a minimum.
 Example 3
determining the functional currency of a foreign operation

Which currency is Ethiopian Campus B’s functional currency?

Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5) another (specify)
Ethiopian Campus B (established through a collaboration between a German University and the Ethiopian
Government) operates under the management and direction of the Ethiopian Campus.
The functional currency of German University is the Euro. The main contributions of the German
University to Ethiopian Campus B are in the form of the transfer of academic and administrative
skills and branding.
Ethiopian Campus B conducts its activities almost exclusively in ETB. For example, Ethiopian Campus
student fees are charged in ETB and staff salaries are ETB denominated. Ethiopian Campus B is
funded primarily by ETB grants and low-interest loans both from the Ethiopian Government.
Ethiopian Campus B purchases of supplies and equipment from Ethiopian suppliers denominated
in ETB.
 Why determining functional currency matters!

 Functional currency is the entity’s measurement currency

 a foreign currency transaction is recorded, on initial
recognition in the functional currency (paragraph 24 of
IPSAS 4)
 at the end of each reporting period foreign currency
(paragraph 27 of IPSAS 4):
▪ Monetary items are translated using the closing rate
▪ Non-monetary items measured at historical cost are translated
at historic rates
▪ Non-monetary items measured at fair value of translated at the
rate on the date fair value was measured (usually the closing rate)
 Example 4
determining the functional currency of a foreign operation

Which currency is International Charity’s Ethiopian Operation’s functional currency?

Choose one of: 1) ETB; 2) USD; 3) GBP; 4) Euro; or 5) another (specify)
International Charity established a separate charity in Ethiopia. Although USD is the functional
currency of the Geneva head office operations of International Charity, it has many operations in
other countries with other functional currencies.
International Charity’s Ethiopian Charity’s:
 international and Ethiopian fund raising activities are supported by International Charity
and raise cash in USD, Euro, GBP and ETB in near equal proportions.
 staff are paid in the currency of the country in which they mainly operate. While 80% of its
staff operate in Ethiopia, the country wage rate differentials results in only 30% of staff costs
being incurred in ETB. The remaining staff costs relate to fund raising personnel that operate
in the US, Eurozone countries and the UK.
 has no borrowings. Its purchases of supplies and equipment are, in almost equal
proportions, denominated in ETB, USD and Euros.
Foreign currency transactions: Initial Recognition

 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.
Foreign currency transactions: 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 financial performance and financial
position into the presentation currency.
Translation
 Foreign currency translation, as distinct from conversion,
does not involve the act of exchanging one currency for
another.
 Translation is required at the end of an accounting period
when an entity still holds assets or liabilities in its
statement of financial position which were obtained or
incurred in a foreign currency.
Reporting at Subsequent Reporting
Dates
The following rules apply at each subsequent year end.
(a) Report foreign currency monetary items using the closing
rate
(b) Report non-monetary items (eg non-current assets,
inventories) which are carried at historical cost in a foreign
currency using the exchange rate at the date of the
transaction (historical rate)
(c) Report non-monetary items which are carried at fair
value in a foreign currency using the exchange rates that
existed when the values were measured.
 Recognition of Exchange Differences
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 recognized in surplus or deficit in the
period in which they arise.
Disclosure
The entity shall disclose:

(a) The amount of exchange differences recognized in surplus or

deficit except for those arising on financial instruments measured at fair value through
surplus or deficit in accordance with the relevant international or national accounting
standards dealing with the recognition and measurement of financial instruments; and

(b) Net exchange differences classified in a separate component of net assets/equity,

and a reconciliation of the amount of such exchange differences at the beginning and
end of the period.

(C) When the presentation currency is different from the functional

currency, that fact shall be stated, together with disclosure of the
functional currency and the reason for using a different presentation
currency.
Summary

Done
Objectives
 Understand the concept of a functional currency in
general purpose financial information;
 Understand how to determine the functional currency;
and
 Understand some of the main judgements made setting
in determining the functional currency.
 Describe how a foreign currency transaction shall be
recorded initially and subsequently.
 Describe the disclosure requirements according to IPSAS 4
THANK YOU