CA Nirmal Ghorawat's Blog

Indian Chartered Accountant

IAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

OBJECTIVE To prescribe

◦      How to include Foreign Currency Transactions and Foreign Operations in the Financial Statements of the entity and

◦      How to Translate Financial Statements into a presentation currency.
SCOPE
  • Foreign Currency Transactions
    • Accounting for Transactions and Balances in Foreign Currencies.
    • Exception: Derivative Transactions and Balances (including Hedge Accounting) within the Scope of IAS 39
  • Foreign Operations
    • Translating the Financial Statements of FOREIGN OPERATIONS included in the FS of entity by Consolidation, Proportionate Consolidation or the Equity Method.
  • Presentation of FS in Foreign Currency
    • Translating an Entity’s FS into a Presentation Currency
FUNCTIONAL CURRENCY Currency of the ‘Primary Economic Environment’ in which the Entity operates.

Primary Economic Environment is normally the one in which the Entity PRIMARILY GENERATES AND EXPENDS CASH.

—  PRIMARY INDICATORS

◦      The Currency that determines the Sales prices of its goods and services and Operating Costs.

—  SECONDARY INDICATORS

◦      Currency of Generation of Funds from Financing Activities – Issue of Debt and Equity Instruments.

◦      Currency of Retention of Receipts from Operating Activities

—  ADDITIONAL INDICATORS (Only for Foreign Operations)

◦      Autonomy – Activities of Foreign Operation are Extension of the Reporting Entity or carried with a Significant Degree of Autonomy.

◦      Volume of Transactions with the Reporting Entity

◦      Impact of Cash Flows of Foreign Operation on the Reporting Entity.

◦      Ability to service Debt Obligations without resort to Reporting Entity.

When Indicators are mixed and Functional Currency is not obvious, MANAGEMENT uses its JUDGEMENT.
CHANGE IN FUNCTIONAL CURRENCY —  Used CONSISTENTLY

—  is not changed unless there is a Change in Underlying Transactions,  Events and Conditions (PRIMARY ECONOMIC ENVIRONMENT)

—  Change is accounted for PROSPECTIVELY.
FOREIGN CURRENCY Currency other than ‘functional currency’.
INITIAL RECOGNITION

(REMEASUREMENT OF FOREIGN CURRENCY TRANSACTIONS INTO FUNCTIONAL CURRENCY)

  • Of FOREIGN CURRENCY TRANSACTION
  • In FUNCTIONAL CURRENCY
  • By applying SPOT EXCHANGE RATE

(b/w Functional Currency & Foreign Currency)

  • At the Date of Transaction

v   Average Rate is permitted, if the exchange rates don’t fluctuate significantly.
SUBSEQUENT MEASUREMENT OF FOREIGN CURRENCY TRANSACTIONS AND TRANSLATION OF FOREIGN OPERATIONS WITH DIFFERENT FUNCTIONAL CURRENCY Items Translation Rate Recognition of Exchange Differences on Settlement or Translation
Monetary Items Closing Rate on Balance Sheet Date To Profit or Loss #
Non-Monetary Items at Historical Cost Rate as at Date of Transaction Equity : If Gain or Loss is recognized in Equity.

PL : If Gain or Loss is recognized in PL.
Non-Monetary Items at Fair Value Rate as at Date of Fair Value Determination
# Exchange differences arising on monetary items that form part of a reporting entity’s net investment in foreign operation shall be recognized, in consolidated financial statements initially as a separate component of equity and recognized in profit or loss on Disposal of the net investment.
TRANSLATION TO PRESENTATION CURRENCY *

(*Except that of an entity whose functional currency is the currency of a hyperinflationary economy.)

 Items Translation Rate Recognition of Exchange Difference
Assets and Liabilities (including Comparatives) Closing Rate on Balance Sheet Date As a Separate Component of Equity.
Income and Expenses

(including Comparatives)

 Exchange Rate at the date of the transaction #
Equity

(including Comparatives)

 Historic Rate or Closing Rate (Management Policy)
#          Average Rate is permitted, if the exchange rates don’t fluctuate significantly.
SUMMARY
  • Determine Functional Currency
  • Re-measurement of Foreign Currency Items into Functional Currency.
  • Translation of Functional Currency to Presentation Currency.

Published by

Nirmal Ghorawat
The author is a fellow member of the Institute of Chartered Accountants of India.

One response to “IAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES”

  1. Dave Landgren Avatar
    Dave Landgren

    I like the helpful information you provide in your articles. I’ll bookmark your blog and check again here regularly. I am quite sure I will learn many new stuff right here! Good luck for the next!

%d bloggers like this: