HKAS 21 Effects of
Changes in Foreign
Exchange Rates
Date: November 1, 2008
Content
1.
2.
3.
4.
5.
Objective and scope of HKAS 21
Functional currency
Translation foreign currency transactions
Disclosure
Examples
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1. Objective of HKAS 21

The objective of HKAS 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

The principal issues are
- which exchange rates to use and
- how to report the effects of changes in exchange rates in the
financial statements.
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1. Scope of HKAS 21
HKAS 21 shall be applied:
a) in accounting for transactions and balances in foreign
currencies, except for those derivatives transactions and
balances that are within the scope of HKAS 39
b) in translating the results and financial position of
foreign operations that are included in the financial
statements of the entity by consolidation, proportionate
consolidation or the equity method; and
c) in translating an entity’s results and financial position
into a presentation currency.
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1. Basic Terms

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.
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2. Functional currency

Functional currency = The currency of the primary economic
environment in which the entity operates
Determine the functional currency:
 Primary indicator: Currency influence sales price or cost.
 Other indicators: Currency of financing funds, receipt from operating
activities, portion of foreign operation activities, cash flows, currency
which the receipts are retained, etc
 If indicators are mixed or not obvious: Management judgement on
which currency represented most faithfully.
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2. Functional currency


once determined, the functional currency is not changed unless
there is a change in those underlying transactions events and
conditions
hyperinflationary economy
restate financial statement in accordance with HKAS 29
Examples:
HK Co, sales denominated in USD, expenses paid in HKD =>USD
HK Head office, branch in UK, most sales in GBP => GBP
e.g. Standard Chartered Bank =>are presented in US dollars, which is
the Group’s functional and presentation currency
e.g. HSBC =>Functional currency are measured using the currency
which the entity operates, presented in US dollars,
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2. Functional Currency -Recognition

Initial Recognition
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 B/S date
Monetary item ⇒ translated at closing rate
Non-monetary item ⇒ historical cost (rate at date of transaction)
Non-monetary item measured at fair value ⇒ rate at date when fair
value was determined
Non-monetary item measured at other amount ⇒ rate at date when
other amount was determined (e.g. NRV, Impairment)
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2. Functional Currency -Recognition

Monetary items are units of currency held and assets and liabilities
to be received or paid in a fixed or determinable number of units of
currency.
– Pensions and other employee benefits to be paid in cash
– Provisions that are to be settled in cash
Closing rate
– Cash dividends that are recognised as a liability

Non-monetary items includes:
– Amounts prepaid for goods and services
– Prepaid rent
– Goodwill and intangible assets
– Inventories
Historical rate
– Property, plant and equipment
– Provisions that are to be settled by a non-monetary asset
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2. Functional Currency -Recognition

Exchange rates:
Closing rate -> rate at b/s date
Historical rate -> rate at transaction
Average rate -> average rate within a period
Spot rate -> rate for immediate delivery (i.e. at transaction)
Web site for searching exchange rates: www.oanda.com
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2.Functional currency - Exchange difference

Monetary Items: (e.g. Accounts receivable)
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 ⇒ recognised in profit or loss,
except for those form part of net investment in a foreign operation

Non-monetary items: (e.g. PPE)
When a gain or loss on a non-monetary item is recognised directly in
equity ⇒ any exchange component of that gain or loss shall be
recognised directly in equity
When a gain or loss on a nonmonetary item is recognised in profit or
loss ⇒ any exchange component of that gain or loss shall be
recognised in profit or loss
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2.Functional currency - Exchange difference

Exchange differences on a monetary item that is part of a net
investment in a foreign operation
(e.g. long term loan that is not plan to be settled in the
foreseeable future):
Separate financial statements
– are recognised in the income statement of the separate
financial statements.
Consolidated financial statements
– In consolidated financial statements these exchange
differences are recognised in the foreign exchange reserve in
shareholders’ equity.
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3.Presentation currency

Presentation currency is the currency in which the financial
statements are presented.

Functional currency different from the presentation currency are
translated into the presentation currency as follows:
i) assets and liabilities ⇒ translated at the closing rate at B/S date
ii) income and expenses (P/L) ⇒ translated at average exchange
rates (unless this average is not a reasonable approximation); and
iii) all resulting exchange differences are recognized as a separate
component of equity.
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3.Translation of foreign operation

Goodwill arising on acquisition
• 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.
– shall be expressed in the functional currency of the foreign
operation and
– shall be translated at the closing rate

On disposal of foreign operation:
- the translation reserve is recognise to P/L
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4. Disclosure

SIGNIFICANT ACCOUNTING POLICIES
Foreign currencies
(a) Functional and presentation currency
Items included in the accounts of the Company are measured using the
currency of the primary economic environment in which the Company
operates (“the functional currency”). The financial statements are
presented in Hong Kong dollars (“HKD”), which is the functional currency
and the presentation currency of the Company.
(b) Transactions and balances
Foreign currency transactions are translated into the functional currency
using the exchange rates prevailing at the dates of transactions. Foreign
exchange gains and losses resulting from the settlement of such
transactions and from the translation at year-end exchange rates of
monetary assets and liabilities denominated in foreign currencies are
recognised in the income statement.
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
SIGNIFICANT ACCOUNTING POLICIES
(c)
Group companies (For consolidated account only)
The results and financial position of all the group entities (none of which has the
currency of a hyperinflationary economy) that have a functional currency different
from the presentation currency are translated into the presentation currency as
follows:
(i) assets and liabilities for each balance sheet presented are translated at the closing
rate at the date of that balance sheet;
(ii) income and expenses for each income statement are translated at average
exchange rates (unless the average is not a reasonable approximation of the
cumulative effect of the rates prevailing on the transaction dates, in which case
income and expenses are translated at the dates of the transactions); and
(iii) all resulting exchange differences are recognised as a separate component of
equity.
On consolidation, exchange differences arising from the translation of the net
investment in foreign entities, and of borrowings and other currency instruments
designated as hedges of such investments, are taken to equity. When a foreign
operation is sold, such exchange differences are recognised in the income statement
as part of the gain or loss on sale.
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4. Disclosure

Disclose:
- exchange difference recognised in P/L
- exchange difference in equity
- the functional currency, and reason for using different presentation
currency (if any)
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5. Example

Recognition of exchange difference in equity
Property purchased at GBP300k when exchange rate is GBP1 = HK$12
Dr. PPE
HK$3,600k
Cr. Bank
HK$3,600k
One year later, the property revaluated to GBP 330k, exchange rate is
GBP1 = HK$13
Dr. PPE
HK$360k
Cr. Revaluation reserve
HK$360k
Dr. PPE (330k *(13-12))
Cr. Revaluation reserve
HK$330k
HK$330k
(exchange difference booked in equity, if the item is recognized directly in equity)
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5. Example

Part of net investment
UK Holding co lent GBP100 to a HK subsidiary at rate HK$1 = GBP12
(i.e. HK subsidiary’s AP is HK$1,200)
At year end, the rate is HK$1 = GBP13
⇒ At company level, HK subsidiary need to revaluate its AP
Dr. P/L – exchange loss
Cr. AP
HK$100
HK$100
At consolidation , the exchange difference will reclassify to exchange
reserve:
Dr. Exchange reserve [$100/13]
GBP7.69
Cr. P/L – echange loss
GBP7.69
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5. Translating foreign subsidiaries





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Sales – third parties
Sales – interco
COS
Interco expense
Other expense
Dividend – inter co
Avg rate
Historical rate
Avg rate
Historical rate
Avg rate
Historical rate
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5. Translating foreign subsidiaries

Non Monetary Assets
PPE, Stock
Closing rate

Monetary Assets / Liabilities
AR, Cash, AP, Loan
Closing rate

Shareholders fund
Share capital
Pre-acq reserve
Current year profit
Translation reserve
Pre-acq rate (Historical)
Pre-acq rate (Historical)
(per calculation: avg & historical)
(Balancing figure)
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THE END

This presentation only covers the basic items in HKAS 21. You are
recommended to attend the training courses organised by the
HKICPA.
(c) Morison Heng 2008