IAS 21

Effects of Changes in Foreign Exchange

rates
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Accounting and Finance, CoBE, AAU. Permission must
be obtained from the Department prior to reproduction
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1. Applicable IFRS

Accounting

and reporting effects of foreign exchange are

addressed by IAS 21 of full IFRS and Section 30 of IFRS for
SMEs.

Objectives of IAS 21
To

prescribe:
How to include (FC)Foreign currency Transaction in
(FS)Financial Statement
How to include Foreign operations in to entity FS
How to translate Financial statements in to presentation
Currency
scope also is in line with objectives.
It does not apply to few issues.
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Definition of Terms
Closing

rate.
Fair value.
Foreign currency.
Monetary items.
Foreign operation.
Functional currency
Foreign currency
Transactions

Exchange rate.
Exchange difference
Presentation currency.
Spot exchange rate
Net investment in a foreign
operation
Conversion
Translation

Recognition of Foreign currency

Transactions

Using spot rate: On initial recognition of foreign currency

transaction and subsequent settlement
Conversion: is appropriate term. It involves either conversion gain or
loss depending on the difference between the exchange rate on the date of
delivery(of item) and date of settlement.
Subsequent reporting:
Translation is appropriate term.
Monetary items: closing rate
Non-monetary items of historical valuation: historical rate
Non-monetary items of fair valuation: rate on the date of valuation

In what conditions do we need such translation?

Conversion and translation.

Discussion
What if you value PPE at cost or recoverable cost and
recoverable cost turned to be value?
What if you value inventory at cost or NRV and NRV turned to
be value?
What if there are several exchange rates on date of
measurement?
What if exchange rate is temporally lacking on the date of
measurement?

Recognition of exchange differences

Differences

on settlement of foreign currency transactions

or translation of monetary/non monetary items.
Are recognized in the period they arise as either profit and
loss or OCI.
Recognition in profit or loss:
Exchange differences arising
on the settlement of monetary items (receivables,
payables, loans, cash in a foreign currency) or

Recognition of exchange differences

on

translating an entity's monetary items at rates

different from those at which they were:
translated initially, or
reported in previous financial statements,
On monetary items held as net investment in foreign
operation when it is reported in separate statements of
the reporting entity or the fin statements of the foreign
operation, as appropriate. In consolidated financial
statement initially as OCI and reclassify to P/L on
disposal of the foreign operation

Recognition of exchange differences

Brain

storming:
When a monetary item is part of a reporting entitys net
investment in a foreign operation, in financial statement of
which entity does a foreign exchange differences arise? If
net investment is:
A.Denominated in functional currency of the reporting entity
B.Denominated in the functional currency of foreign
operation
C.Denominated in the currency other than the functional
currency of either the reporting entity or foreign operation

Recognition of exchange differences

Answer
A. Foreign

Operations separate FS(P/L).

B. Reporting Entitys separate FS(P/L)
C. In Both Reporting Entitys and Foreign Operations separate
FS(P/L)

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Change in functional currency

Change in functional currency
The functional currency of an entity can be changed only if there is a change to
the underlying transactions, events and conditions that are relevant to the entity.
For example, an entity's functional currency may change if there is a change in
the currency that mainly influences the sales price of goods and services.
Prospective application of translation procedures from the date of change;
Translate all items in to new functional currency using the exchange rate on the
date of change
The translated amounts for non-monetary items are treated as historical costs.

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How Functional Currency is determined?

Currency influencing prices:

i.

The currency that mainly influences sales prices for goods and services (often the
currency in which prices are denominated and settled)
The currency of the country whose competitive forces and regulations mainly
determine the sales prices of its goods and services
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)

ii.

iii.

Currency influencing fund flow and depositing:

i.

The currency in which funds from financing activities (raising loans and issuing equity)
are generated
The currency in which receipts from operating activities are usually retained

ii.

How Functional Currency is determined?

i.

ii.
iii.

iv.

Where a parent has a foreign operation (as subsidiary, branch, associate or joint venture) a number of
factors are considered (paragraph 11):
Whether the activities of the foreign operation are carried out as an extension of the parent, rather than
being carried out with a significant degree of autonomy.
Whether transactions with the parent are a high or a low proportion of the foreign operation's activities.
Whether cash flows from the activities of the foreign operation directly affect the cash flows of the
parent and are readily available for remittance to it.
Whether the activities of the foreign operation are financed from its own cash flows or by borrowing
from the parent.
Finally Management judgment

The translation method used has to reflect the economic reality of the relationship between the
reporting entity (the parent) and the foreign operation.

How Functional Currency is determined?

Example
A stand-alone entity (ie not a foreign operation of another entity)
manufactures a product for the local market in country A. Its sales are
denominated in the local currency (LCA). The price of its product in country A is
affected mainly by local supply and demand and regulations. All of the entitys
inputs are sourced in country A and the prices of the inputs are denominated in
LCA and are mainly influenced by economic forces and regulations in country A.
is Local currency functional currency?

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How Functional Currency is determined?

Example
A stand-alone entity extracts a commodity from underground in country A.
The currency of country A is the LCA. Sales of the commodity are denominated
in the local currency of country Z (LCZ). The LCZ sales price of the commodity is
affected by the global supply and demand. Country Z accounts for about 50 per
cent of global demand for the commodity. About 90 per cent of the entitys costs
are for expatriate staff salaries and imported chemicals and specialised
machinery imported from country Z. These costs are denominated and settled in
LCZ. The entitys other costs are incurred and settled in LCA. Is local currency
Functional currency?

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How Functional Currency is determined?

Example
A stand-alone entity (ie not a foreign operation of another entity) based in country A
manufactures a product in country A for export to country B. Labour and raw
materials are relatively inexpensive in country A.
The entitys sales prices are nearly always denominated in LCB (the local currency
of country B) and established predominantly based on prices set by competitive
forces in country B and by country Bs regulations. Customers settle in LCB and
the entity holds its excess cash in LCB, only converting sufficient LCB into LCA
(the local currency of country A) to settle its operating costs as they fall due.
The majority of the entitys borrowings are in LCB. Most costs are paid in LCA.
Specialised machinery is purchased from suppliers in country C. Those
purchases are denominated in LCC (ie the local currency of country C). Such
costs are not significant when compared to the LCA-denominated operating
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costs.

Food For Thought

What will be effect of foreign currency change on L/C execution.
Assume a local customer established an L/C on a local bank for $100, 000 Jan 1,
2001 and the L/C is settled on Jan 28, 2001. Indirect exchange rate to ETB is
ETB 22(Jan 1) and ETB 22.5 (Jan 28).What is the effect of that exchange rate
change on the banks performance and financial liability? What if the rate is
ETB21.5(Jan 28)?
What is the Foreign Exchange Gain/loss?
Effect on balance sheet?

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Case 1. Review Questions

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LO 7

(0.00937-0.00932)*1b/n*0.05*6/12=1250 (loss)
{1billion*5%*6/12}*0.00937=234,250
F. Exchange loss on loan = (.00937-0.00932)*1
billion
Cash payment = 234 250 + 234250 +
(.00937)*1 billion

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US GAAP Vs IFRS
The two have some differences with this respect
1.Translation in consolidated financial statements
IFRS does not require equity accounts to be translated at historical rates.
US GAAP: Equity is required to be translated at historical rates.
IFRS: Management has a policy choice to use either the historical rate or the
closing rate but to be consistently used.
2.Determination of functional currency
Under US GAAP there is no hierarchy of indicators to determine the functional
currency of an entity, whereas a hierarchy exists under IFRS.

Full IFRS Vs IFRS for SMEs

There

is no difference; except that in full IFRS exchange

differences on monetary item that forms part of a net investment
in a foreign operation are reclassified from equity to profit or loss
on disposal of the foreign operation; therefore an SME a different
gain or loss on disposal of a foreign operation.

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Disclosures

Is for proper disclosure to ensure fair and faithful presentation:

An entity shall disclose in statements:

(a) the amount of exchange differences recognized in profit or loss except
for those arising on financial instruments measured at fair value through
profit or loss in accordance with IFRS 9; and
(b)net exchange differences recognized in other comprehensive income
and accumulated in a separate component of equity, and a reconciliation
of the amount of such exchange differences at the beginning and end of
the period

Disclosures

An in entity shall disclose in addition:

When the presentation currency is different from the functional currency,
that fact shall be stated, together with disclosure of the functional
currency and the reason for using a different presentation currency.
When there is a change in the functional currency of either the reporting
entity or a significant foreign operation, that fact and the reason for the
change in functional currency shall be disclosed.
When an entity presents its financial statements in a currency that is
different from its functional currency, it shall describe the financial
statements as complying with IFRSs only if they comply with all the
requirements of IFRSs including the translation method set out .

Disclosures

When an entity displays its financial statements or other financial information

in a currency that is different from either its functional currency or its
presentation currency and the requirements of saying compliant with IFRS are
not meet, it shall:
(a) clearly identify the information as supplementary information to
distinguish it from the information that complies with IFRSs;
(b) disclose the currency in which the supplementary information is
displayed; and
(c) disclose the entitys functional currency and the method of translation
used to determine the supplementary information.