IAS 21
The Effects of Changes in Foreign Exchange Rates
1Objective and scope
IAS 21 prescribes how to include foreign currency transactions and foreign operations in an entity's financial statements, and how to translate financial statements into a presentation currency. It first requires an entity to determine its functional currency (the currency of the primary economic environment in which it operates), which may differ from the currency it chooses to present its financial statements in.
2Key definitions
3Translation mechanics
Foreign currency transactions
A foreign currency transaction is initially recorded at the spot exchange rate on the transaction date. At each subsequent reporting date, monetary items are retranslated at the closing rate, with the exchange difference recognised in profit or loss. Non-monetary items measured at historical cost are not retranslated; non-monetary items measured at fair value are retranslated at the rate on the date fair value was determined, with the exchange difference following wherever the fair value gain or loss itself is recognised (profit or loss, or OCI).
Translating a foreign operation
| Item | Rate used |
|---|---|
| Assets and liabilities (statement of financial position) | Closing rate at the reporting date |
| Income and expenses (statement of profit or loss) | Exchange rates at the dates of the transactions, or an average rate as a practical approximation |
| Resulting exchange differences | Recognised in other comprehensive income (the foreign currency translation reserve), not profit or loss |
Goodwill and any fair value adjustments arising on the acquisition of a foreign operation are treated as assets and liabilities of that foreign operation, and are therefore translated at the closing rate. On disposal of the foreign operation, the cumulative exchange differences held in the translation reserve are reclassified from OCI to profit or loss.
4Presentation and disclosure
- The amount of exchange differences recognised in profit or loss
- Net exchange differences recognised in other comprehensive income and accumulated in a separate component of equity, with a reconciliation
- When the presentation currency differs from the functional currency, that fact, and the functional currency and reason for using a different presentation currency
5Examinable focus
What KASNEB tests
Distinguishing monetary from non-monetary items when retranslating a foreign currency transaction, and translating a foreign subsidiary's financial statements (closing rate for the statement of financial position, average rate for profit or loss, the balancing exchange difference to OCI) for consolidation purposes, are the two standing question types.