IAS 21 “THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES”
DEFINITION:
1. Functional currency: The currency of the primary economic environment in which the entity operates.
2. Foreign currency: A currency other than the functional currency of the entity.
3. Presentation currency: The currency in which the financial statements are presented.
4. Exchange rate: The ratio of exchange for two currencies.
[Link] difference: The difference resulting from translating a given number of units of one currency into another currency at
different exchange rates.
[Link] rate: The spot exchange rate at the year-end date.
7. Spot exchange rate: The exchange rate for immediate delivery.
8. Monetary items. Units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of
currency.
FUNCTIONAL CURRENCY
This is the currency of the primary economic environment in which entity operates.
FACTORS THAT DETERMINE THE FUNCTIONAL CURRENCY OF AN ENTITY.
IAS 21 states that an entity should consider the following factors in determining its functional currency:
a) The currency that mainly influences sales prices for goods and services (often the currency in which prices are denominated and settled)
(b) The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services
(c) 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)
Sometimes the functional currency of an entity is not immediately obvious. Management must then exercise judgement and may also need
to consider:
(a) The currency in which funds from financing activities (raising loans and issuing equity) are generated
(b) The currency in which receipts from operating activities are usually retained in which it operates.
TRANSLATION OF FOREIGN CURRENCY TRANSACTIONS
Initial Recognition: IAS 21 states that a foreign currency transaction should be recorded, on initial recognition in the functional
currency, by applying the exchange rate between the reporting currency and the foreign currency at the date of the transaction
(Spot rate) to the foreign currency amount.
Subsequent recognition: It is important to distinguish between monetary and non-monetary items. Monetary items involve the
right to receive or the obligation to deliver a fixed or determinable amount of currency. This would include receivables, payables, loans
etc. Non-monetary items would be items such as non-current assets and inventories.
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).
TREATMENT OF EXCHANGE DIFFERENCES ON TRANSLATION OF MONETARY ITEMS
Generally, all exchange differences arising from translation should be recognized immediately in the statement of profit or loss. This
means that exchange gain will be recognized as income which exchange losses will be recognized as expense (i.e. Losses) in the
SOPL.
However, the following exchange differences should not be recognized in the SOPL:
1. Exchange difference arising from the translation of a foreign operation or a foreign subsidiary for the purpose of consolidation
should be recognized in the other comprehensive income (OCI).
[Link] difference on monetary items that qualifies as hedging instrument in a cash flow hedge.
3. Exchange difference arising from foreign currency borrowings to be capitalized to the extent that they are regarded as an
adjustment to interest costs.
TRANSLATION OF FINANCIAL STATEMENTS OF A FOREIGN SUBSIDIARY
. Assets & Liabilities – Closing rate.
. Income and expenses – Translate at transaction date (or Average rate)
. Equity – Historical rate.
HOW TO TRANSLATE FOREIGN CURRENCY TO FUNCTIONAL CURRENCY
a. Where the exchange rate is expressed in one unit of foreign currency: Whenever this is the case, it means we multiply using
applicable relevant exchange rate. This is generally called “Direct Quote”
b. Where the exchange rate is expressed in one unit of the functional currency: Whenever this is the case, it means we will
divide using applicable relevant exchange rate. This is generally called “Indirect Quote”
RECOGNITION OF EXCHANGE DIFFERENCE
Exchange differences occur when there is a change in the exchange rate between the transaction date and the date of
settlement of monetary items arising from a foreign currency transaction.
Exchange differences arising on the settlement of monetary items (receivables, payables, loans, cash in a foreign currency) or on
translating an entity's monetary items at rates different from those at which they were translated initially, or reported in
previous financial statements, should be recognized in profit or loss in the period in which they arise.
There are two situations to consider:
(a) The transaction is settled in the same period as that in which it occurred: all the exchange difference is recognized in that
period.
(b) The transaction is settled in a subsequent accounting period: the exchange difference recognized in each intervening period
up to the period of settlement is determined by the change in exchange rates during that period.
