IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 21 The Effects of Changes in
Foreign Exchange Rates
Prahallad Chandra Das FCMA
Assistant Professor
Dept. of Accounting & Information Systems
Jatiya Kabi Kazi Nazrul Islam University
Trishal, Mymensingh-2220
Connolly – International Financial Accounting and Reporting – 4th Edition
Overview of IAS-21
• IAS 21 The Effects of Changes in Foreign Exchange
Rates outlines how to account for foreign currency
transactions and operations in financial statements, and
also how to translate financial statements into a
presentation currency. An entity is required to determine
a functional currency (for each of its operations if
necessary) based on the primary economic environment in
which it operates and generally records foreign currency
transactions using the spot conversion rate to that
functional currency on the date of the transaction.
• IAS 21 was reissued in December 2003 and applies to
annual periods beginning on or after 1 January 2005.
Connolly – International Financial Accounting and Reporting – 4th Edition
31.1 INTRODUCTION
• Exchange rates effect competitiveness
• A strong / weak currency impacts on exports and imports
• There is arguably no one best position – it depends on the
nature of your business
• Businesses that deal in a foreign currency are exposed to
risks
• IAS 21 The Effects of Changes in Foreign Exchange Rates
• IAS 29 Financial Reporting in Hyperinflationary Economies
Connolly – International Financial Accounting and Reporting – 4th Edition
IAS 21 The Effects of Changes in Foreign Exchange Rates
Objective and Scope
• The objective of IAS 21 is to prescribe how to include
foreign currency transactions and foreign operations in
the financial statements of an entity and how to translate
financial statements into a presentation currency. [IAS
21.1] The principal issues are which exchange rate(s) to
use and how to report the effects of changes in exchange
rates in the financial statements. [IAS 21.2]
Connolly – International Financial Accounting and Reporting – 4th Edition
Key definitions
• Functional Currency
The currency of the primary economic environment in which the
enterprise operates.
• Presentation Currency
The currency in which an enterprise presents its financial statements.
• Exchange Difference
This is the difference resulting from translating one currency into another
currency at different exchange rates.
• Monetary and Non Monetary Items
Monetary items are assets/liabilities held to be received/paid in fixed or
determinable amounts. Examples include deferred tax, pensions and
provisions. The feature of a non-monetary item is the absence of a right
to receive a fixed or determinable amount of money (this includes
prepayments, goodwill, intangible assets, inventory and property).
Connolly – International Financial Accounting and Reporting – 4th Edition
Key definitions
• Closing Rate
This is the spot exchange rate at the reporting date.
• Spot Exchange Rate
The exchange rate for immediate delivery.
• Exchange Rate
The ratio of exchange for two currencies.
• Foreign operations
a subsidiary, associate, joint venture, or branch whose activities are based
in a country or currency other than that of the reporting entity.
Connolly – International Financial Accounting and Reporting – 4th Edition
Determining the functional currency
• The functional currency is the currency of the primary
economic environment in which the entity operates and it
is normally the currency in which the entity primarily
generates and expends cash.
• IAS-21 provides primary and secondary indicators for
use in the determination of an entity’s functional currency,
as summarized below.
• Primary Indicators:
• The currency that mainly influences sales prices for
goods and services(often the currency in which prices are
denominated and settled).
Connolly – International Financial Accounting and Reporting – 4th Edition
Determining the functional currency
• The currency of the country whose competitive forces
and regulations mainly determine the sales prices of its
goods and services; and
• The currency that mainly influences labour, material and
other costs of providing goods or services(often the
currency in which prices are denominated and settled).
• Secondary Indicators:
• The currency in which funds from financing activities
(raising loans and issuing equity) are generated; and
• The currency in which receipts from operating activities
are usually retained.
Connolly – International Financial Accounting and Reporting – 4th Edition
31.2 Foreign Currency Transactions
•
Initial Recognition
 Each transaction should be translated using the ER(Exchange rate) on the date
the transaction occurred, or if stable, an average rate
 If certain transactions are to be settled at a specified rate, or are covered by a
matching forward contract, then the use ‘contracted rate’
•

Subsequent measurement
A foreign currency transaction may give rise to assets or liabilities that are
denominated in a foreign currency. These assets and liabilities will need to be
translated into the entity’s functional currency at each reporting date. How they
will be translated depends on whether the assets and liabilities are
monetary or non-monetary items.
Connolly – International Financial Accounting and Reporting – 4th Edition
31.2 Foreign Currency Transactions
•
Monetary items: The essential feature of a monetary item, as the definition implies, is the
right to receive(or an obligation to deliver) a fixed or determinable number of units of currency.
Exemples:
 Cash and bank balances
 Trade receivables an payables
 Loan receivables an payables
 Foreign currency bonds held as available for sale
 Foreign currency bonds held to maturity
 Pensions and other employee benefits to be paid in cash
 Provisions that are to be settled in cash
 Cash dividends that are recognised as a liability
 A contract to receive (or deliver
Connolly – International Financial Accounting and Reporting – 4th Edition
31.2 Foreign Currency Transactions
•
Non-Monetary items
A Non-monetary item does not give the right to receive(or an obligation to deliver)
a fixed or determinable number of units of currency. Exemples:
 Amounts prepaid for goods and services
 Goodwill
 Intangible assets
 PPE
 Provisions to be settled by the delivery of a non- monetary asset
 Equity instruments that are held as available for sale financial assets
 Equity instruments in subsidiaries, associates or joint ventures
Connolly – International Financial Accounting and Reporting – 4th Edition
• Reporting at Subsequent Reporting Dates
 Monetary items at closing ER (e.g. trade receivables
and payables)
 Non-monetary items measured at HC are not retranslated at the reporting date (e.g. non-current assets
and inventory)
 Non-monetary items measured at foreign currency fair
value are re-translated at each date of fair value
measurement
Connolly – International Financial Accounting and Reporting – 4th Edition
Recognition of exchange differences
• Those arising on settlement of monetary items should be expensed in
the period they arise
• Where a gain/loss on a non-monetary item is recognised directly in
equity any exchange component of that gain/loss should be recognised
directly in equity
• Conversely when a gain/loss on a non-monetary item is recognised in
profit or loss, any exchange component of that gain/loss should be
recognised in profit or loss.
• If a transaction is settled before the end of a reporting, then:
(i)
record the foreign currency transaction in the functional currency at
the spot exchange rate at the date of the transaction (an average rate for
a period may be used if exchange rates do not fluctuate significantly);
(ii) record the settlement at the exchange rate at the date of settlement;
(iii)
recognise the exchange difference (i.e. (i) minus (ii) in arriving at
operating profit in the statement of comprehensive income).
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.1: Transactions settled at the reporting date
Blue Limited, whose year end is 31 December, buys goods
from a foreign company for 180,000 Ricos on 31 July 2013. The
transaction is settled on 31 October 2013.
Exchange rates:
31 July 2013
€1 = 1.5 Ricos
31 October 2013
€1 = 1.6 Ricos
Requirement
Show the journal entries to record the above transaction.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.1: Transactions settled at the reporting date
Initial recognition:
Dr
SPLOCI – P/L – purchases
Cr
SFP – trade payables
€120,000
€120,000
Being initial recognition of goods purchased on credit (180,000
Ricos / 1.5)
At settlement:
Dr
SFP – trade Payables
Cr
SPLOCI – P/L – Fx Gain (e.g. CoS)
Cr
SFP – Cash
€120,000
€7,500
€112,500
Being settlement and recognition of exchange difference
Connolly – International Financial Accounting and Reporting – 4th Edition
Transactions not settled at the reporting date
If a transaction is not settled before the end of a reporting,
then:
(i) record the transaction (in the functional currency) at the
spot exchange rate at the date of the transaction;
(ii)
retranslate any monetary items;
(iii) recognise any exchange difference in arriving at profit or
loss in SPLOCI.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.2: Transactions not settled at the reporting date
Top Limited buys goods from a foreign company for 500,000
Zicos on 31 October 2012. The transaction was not settled at
31 December 2012, the company’s year end.
Exchange rates:
31 October 2012
€1 = 1.6 Zicos
31 December 2012
€1 = 1.75 Zicos
Requirement
Show the journal entries to record the above transaction.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.2: Transactions not settled at the reporting date
Initial recognition:
Dr
SPLOCI – P/L – purchases
Cr
SFP – trade payables
€312,500
€312,500
Being initial recognition of goods purchased on credit (500,000
Zicos / 1.6)
At the reporting date:
Dr
SFP – trade payables
Cr
SPLOCI – P/L – Fx Gain
€26,786
€26,786
Being translation of payable at reporting date and recognition of
exchange difference
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.3: Purchase of a non-monetary item
A company purchased a property on 1 January 2013 for 20,000 DM (when
€1 = 4DM), with the account being settled on 1 March 2013 when the
exchange rate was 20,000 DM = €5,500. If the company’s year end is after 1
March 2013, then this transaction should be recorded as follows:
At 1 January 2013:
Dr
SFP – property
Cr
SFP – payables
€5,000
€5,000
Being initial recognition of property
At 1 March 2013:
Dr
SPLOCI – P/L – Fx Loss
€500
Dr
SFP – payables
€5,000
Cr
Bank
€5,500
Being settlement of liability and recognition of exchange difference
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.3: Purchase of a non-monetary item
However, if the company’s year end is 31 January 2013, and
at 31 January 2013 20,000 DM = €4,900, then:
At 31 January 2013:
Dr
SFP – payables
Cr
SPLOCI – P/L – exchange gain
31 March 2013:
Dr
SFP – payables
Dr
SPLOCI – P/L - exchange loss
Cr
SFP – bank
€100
€100
€4,900
€600
€5,500
Connolly – International Financial Accounting and Reporting – 4th Edition
31.3 FOREIGN CURRENCY TRANSLATION
• Should follow normal consolidation procedures (See Chapters
•
•
26-28).
IAS 27 permits the use of different reporting dates as long as they
are no more than three months apart and adjustments are made
for the effects of any significant transactions between those
dates. In such cases, the exchange rate to adopt is that at the
reporting date of the foreign operation.
IAS 21 shows how to translate FS into a presentation currency
(i.e. the currency in which the FS are presented. This contrasts
with the functional currency, which is the currency of the
primary economic environment in which the (foreign) entity
operates. Depending upon the relationship between the parent
and the subsidiary companies, the presentation currency and the
functional currency may or may not be the same.
Connolly – International Financial Accounting and Reporting – 4th Edition
Normal consolidation procedures
• Eliminate IC balances
• Need to translate I/C monetary balances
• Goodwill treated as asset of foreign operation and
translated at CR
Connolly – International Financial Accounting and Reporting – 4th Edition
Presentation currency = Functional currency
SAME FUNCTIONAL CURRENCY:
i.e. Foreign trade conducted as a direct extension of investing company
Decision depends upon:
• Extent to which foreign cash flows have a direct impact upon those of
the investing company
• Extent to which the functioning of the enterprise is dependent directly
upon the investing company
• Currency in which the majority of the trading transactions are
denominated
• Major currency to which the operation is exposed
Specific circumstances:
• Acts as a selling agent
• Merely a producer/manufacturer
• Located overseas for tax or exchange control reasons
Connolly – International Financial Accounting and Reporting – 4th Edition
Presentation currency = Functional currency
The translation mechanics are:
• Non-monetary assets (e.g. PPE and inventory) translated at
historical rate (Cost or Revaluation)
• Monetary assets and liabilities (e.g. receivables and payables)
translated at CR
• OSC (Opening Share Capital) and pre-acquisition reserves at
historic rate (i.e. ‘acquisition rate’)
• Post-acquisition reserves are a balancing figure
• SPLOCI translated using ER ruling at the dates the amounts
recorded in the financial statements were established (e.g.
Depreciation - Historic Rate)
All other items - Average Rate
• If available, use rates specific to opening and closing inventory
• Exchange difference included in PBT in the SPLOCI – P/L
Connolly – International Financial Accounting and Reporting – 4th Edition
Presentation currency ≠ Functional currency
Indicators are:
• Investment based on net worth of foreign entity
• May be partly financed by local currency loans
• Day-to-day operations of foreign entity are not dependent
on holding company’s currency
• Net investment will remain until business is liquidated or
disposed
Connolly – International Financial Accounting and Reporting – 4th Edition
Presentation currency ≠ Functional currency
The translation mechanics are:
• Assets & liabilities translated at the year-end rate (i.e. CR)
• OSC and pre-acquisition reserves at historic rate (i.e.
‘acquisition rate’)
• Post-acquisition reserves are a balancing figure
• Compare difference between closing reserves and opening
reserves with translated retained earnings to obtain exchange
difference
• Exchange differences taken directly to reserves (separate
component)
• SPLOCI translated using AR
• Exchange difference will arise from:
 Retranslating the opening NA at CR
 Translating SPLOCI at AR and SFP at CR
Connolly – International Financial Accounting and Reporting – 4th Edition
Foreign exchange differences
Presentation Currency = Functional Currency:
•Exchange differences should be recognised in the SPLOCI – P/L.
Presentation Currency ≠ Functional Currency (Presentation Currency
Method):
•All exchange differences should be recognised in equity as a separate
component (through OCI).
•
Foreign exchange differences arise from:
1.
Translating income and expenses at the transaction rate and
assets/liabilities at the CR;
2.
Translating opening net assets at an exchange rate different from that
previously reported;
3.
As any goodwill and fair value adjustments should be treated as assets and
liabilities of the foreign operation, they therefore must be expressed in the
functional currency of the foreign operation and translated at the CR.
If a foreign operation is not 100% owned by the parent company, then
exchange differences should be allocated to NCI.
Connolly – International Financial Accounting and Reporting – 4th Edition
Disposal of foreign entity
Cumulative exchange differences should be recognised as
income or expenses in the same period as the gain or loss
on disposal is recognised
Connolly – International Financial Accounting and Reporting – 4th Edition
Disclosure
1. The amount of exchange differences included in arriving at profit or loss in the
SPLOCI except those arising from IAS 39;
2. Net exchange differences classified as a component of equity and a
reconciliation of opening and closing equity at start and end of the year;
3. When the presentation currency is different from the functional currency, that
fact should be disclosed as well as disclosure of the functional currency and the
reason for using a different presentation currency;
4. When there is a change in the functional currency of either the reporting entity or
a significant foreign operation, that fact and reason for the change should be
disclosed;
5. When an entity presents its financial statements in a currency different from its
functional currency, it should describe the statements as complying with IFRSs
only if they comply with all of the requirements of each applicable standard and
SIC.
Where the requirements listed at item 5. above are not met an entity should:
• clearly identify the information as supplementary;
• disclose the currency in which the supplementary information is displayed;
• disclose the entity’s functional currency and method of translation used to
determine the supplementary information.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 31.4: Translation of a
foreign subsidiary
FUNCTIONAL CURRENCY # PRESENTATION CURRENCY
Quickbuck Limited
$
ER
€
Revenue
544,275
4
136,069
Cost of sales
(145,000)
4
(36,250)
Gross profit
399,275
Depreciation
(30,000)
4
(7,500)
Other expenses
(271,050)
4
(67,762)
1. SPLOCI TRANSLATED USING AR
PBT
98,225
Income tax expense
(24,275)
PAT
73,950
OCI: FX losses
99,819
24,557
4
(6,069)
18,488
(W5(b))
(3,198)
15,290
Connolly – International Financial Accounting and Reporting – 4th Edition
2. A & L TRANSLATED USING CR
3. OSC TRANSLATED USING HR
4. RE AS BALANCING FIGURE
$
ER
€
PPE
270,000
5
54,000
Inventory
48,525
5
9,705
Receivables
45,500
5
9,100
Bank and cash
9,475
5
1,895
373,500
74,700
Ordinary share capital
75,000
3
25,000
RE & FC translation reserve (should be shown separately)
70,450
Balance (W6)
4,090
Loan
90,000
5
18,000
Payables
103,775
5
20,755
Taxation
24,275
5
4,855
Proposed dividends
10,000
5
2,000
373,500
Connolly – International Financial Accounting and Reporting – 4th Edition
74,700
$
ER
€
Ordinary share capital [No change]
75,000
3
25,000
Retained earnings [$70,450 - $53,950]
16,500
(Balance)
5,500
91,500
3
30,500
91,500
5
18,300
5. CALCULATE FX DIFFERENCE
(a) Opening NA at OR [Prior year CR]
Opening NA at CR
12,200
(b) Translate RE [SPLOCI at AR v SFP at CR)
PAT [See SPLOCI]
73,950
4
18,488
Dividends paid [Per Q]
(10,000)
4
(2,500)
Dividends proposed
(10,000)
5
(2,000)
RE per SPLOCI [mainly at AR]
53,950
RE per SFP [at CR]
53,950
13,988
5
(10,790)
Taken through OCI [W1 €18,488 - €3,198 = €15,290]
3,198
(c) TOTAL FX LOSS (Separate component of equity)
15,398
Connolly – International Financial Accounting and Reporting – 4th Edition
€
6. MOVEMENT ON RETAINED EARNINGS
Opening RE at 1 January 2012
(See w5a)
5,500
Retained profit for year
(See w5b)
13,988
19,488
FX loss (to be presented separately)
(See w5c)
(15,398)
Closing RE at 31 December 2012
(See w4)
4,090
Connolly – International Financial Accounting and Reporting – 4th Edition
FUNCTIONAL CURRENCY = PRESENTATION CURRENCY
Quickbuck Limited
1. TRANSLATE SFP
Non monetary at HR
Monetary A&L at CR
$
ER
€
PPE
270,000
2.5
108,000
Inventory
48,525
4.8
10,109
Receivables
45,500
5
9,100
Bank and cash
9,475
5
1,895
373,500
129,104
Ordinary share capital
75,000
3
25,000
Retained earnings
70,450
(Balance)
58,494
Loan
90,000
5
18,000
Payables
103,775
5
20,755
Taxation
24,275
5
4,855
Proposed dividends
10,000
5
2,000
373,500
Connolly – International Financial Accounting and Reporting – 4th Edition
129,104
FUNCTIONAL CURRENCY = PRESENTATION CURRENCY
2. SPLOCI TRANSLATED USING ER RULING AT DATES
AMOUNTS RECORDED IN FS
$
ER
€
Revenue
544,275
4
136,069
Opening inventory
Purchases
Closing inventory
Cost of sales
41,000
152,525
(48,525)
145,000
3
4
4.8
13,667
38,131
(10,109)
41,689
Gross profit
399,275
Depreciation
(30,000)
2.5
(12,000)
Other expenses
(271,050)
4
(67,762)
(W3(b))
28,945
FX gain
-
PBT
98,225
Income tax expense
(24,275)
PAT
73,950
Connolly – International Financial Accounting and Reporting – 4th Edition
94,380
43,563
4
(6,069)
37,494
3. CALCULATE EXCHANGE DIFFERENCE
$
ER
€
Ordinary share capital
75,000
3
25,000
Retained earnings [$70,450 - $53,950]
16,500
(Balance)
25,500
(a) Translate opening SFP
91,500
50,500
PPE
300,000
2.5
120,000
Inventory
41,000
3
13,667
(249,500)
3
(83,167)
Net monetary liabilities (to balance)
91,500
50,500
(b)
Opening RE (see above)
25,500
+ profit for year (PAT €8,549 – divs. Paid €2,500 – divs. Prop €2,000)
4,049
Closing RE per SFP
(58,494)
FX gain (include in SPLOCI – P/L)
28,945
Connolly – International Financial Accounting and Reporting – 4th Edition