IAS 21The effects of changes in Foreign Echange rates

1. Accounting issues

1.1 Introduction

A company may engage in foreign currency operations in two ways:

• By entering directly into transactions which are denominated in foreign currencies;
• By conducting foreign operations through a foreign entity (subsidiary, associate or joint venture).

Resultant transactions and balances must be translated into the functional currency of the entity for inclusion in financial statements.

1.2 Key Issues

1. Which exchange rate should be used for translation of the transaction or balance?
2. How to treat any exchange difference that arises – should they be taken to the income statement or equity?

1.3 Objectives

1. To report results which reflect impact of exchange rates on cash flows.
2. To fairly present the results of management’s actions.

1.4 Key Definitions

1. Functional currency is the primary economic environment in which the entity operates.
2. Presentation currency is the currency in which the financial statements are presented.
3. Closing rate is the spot exchange rate at the balance sheet date.
4. Foreign currency is a currency other than the functional currency of the entity.
5. Net investment in a foreign entity is the amount of the reporting entity currency.
• Monetary items include trade receivables, cash, trade payables and loans.
• Non monetary items comprise non current assets, investments and inventory.

2.Functional and Presentation currency

2.1 Functional Currency

• The functional currency of an entry will be dictated by the primary economic environment in which the entity operates.

• An entity should consider the following in determining its functional currency:

1. the currency that mainly influences the selling price of goods or services (and currency of the country whose regulations mainly determine the selling price of goods and services):
2. the currency in which monies from operating activities are kept.

• Other factors to be considered in determining the functional currency of a foreign operation and whether that currency is the reporting entity include:

• Whether activities are carried out as an extension of the reporting entity or with a significant degree of autonomy by the foreign operations;
• Whether transactions between the reporting entity and foreign operation are a high percentage of total transaction;
• Whether cash flows of the foreign operation impact directly on the cash flows of the reporting entity
• Whether the foreign operation is dependent upon the reporting entity to help service current and future debt obligations.

• If the functional currency is not obvious management must use their judgment in identifying the currency that most faithfully represents the economic effects of the underlying transactions.
• Once a functional currency has been identified it should only be changed if there is a change to the economic climate in which it was initially identified.

2.2 Presentation currency

• The financial statement of a foreign operation is translated into the presentation currency of the parent entity.
• Assets and liabilities are translated, at each balance sheet date, at the clsing exchange rate.
• Income and expenses are translated using exchange rates when the transaction occurred.
• The parent’s share of any exchange difference will be included as a separate component of equity, and recycled thorough profit and loss when the foreign operation is disposed.

3. Individual entities

3.1 Accounting treatment –basic transactions

3.1.1 Initial recognition

• Initially a foreign currency transaction is recorded in an entity’s functional currency using the spot exchange rate on the date of the transaction.
• Exchange difference arising on settlement of a foreign currency transaction in the same reporting period are recognised in profit and loss for the period.

3.1.2Subsequent recognition

• At each balance sheet date, any foreign currency monetary item is re-translated using the closing exchange rate.
• Exchange difference arising on re-translation of a foreign currency balance is recognised in profit and loss for the period.
• Non –monetary items measured at historical cost are translated at the exchange rate at the date of the transaction.
• Non-monetary items measured at fair value are translated using the exchange rate when the fair value was determined.

3.2 Exceptions to the basic rules

3.2.1 Net investment in a foreign currency

1. An entity may have a monetary item that is receivable from or payable to a foreign operation.
2. Such monetary items where settlement is neither planned nor likely to occur in the foreseeable future is in substance part of a ‘net investment in the operation’.
3. Exchange difference on such items shall be included in profit and loss in the separate financial statements of the reporting entity or foreign operations.

4 Disclosures

4.1 Exchange differences

1. The amount of exchange differences included in profit or loss for the period.
2. Net exchange difference classified in equity as a separate component of equity, and a reconciliation of the amount of such exchange difference at the beginning and end of the period.
3. When presentation currency is different to the functional currency, that fact shall be stated along with the the functional currency is and the reason for using a different reporting currency.
4. Any changes in functional currency, and the reasons for the change.