Ê



 
 


By Graham Holt




 


         

    !"  

    !#$ 

  !

The purpose of IAS 21 is to set out how to account for transactions in foreign currencies and
foreign operations.

The standard shows how to translate financial statements into a presentation currency, which is
the currency in which the financial statements are presented. This contrasts with the functional
currency, which is the currency of the primary economic environment in which the entity
operates. Key issues are the exchange rates, which should be used, and where the effects of
changes in exchange rates are recorded in the financial statements.

Functional currency is a concept that was introduced into IAS 21, ?



 





, when it was revised in 2003. The previous version of IAS 21 used a
concept of reporting currency. In revising IAS 21 in 2004, the IASB¶s main aim was to provide
additional guidance on the translation method and determining the functional and presentation
currencies.

The functional currency should be determined by looking at several factors. This currency should
be the one in which the entity normally generates and spends cash, and that in which transactions
are normally denominated. All transactions in currencies other than the functional currency are
treated as transactions in foreign currencies.

The entity¶s functional currency reflects the transactions, events and conditions under which the
entity conducts its business. Once decided on, the functional currency does not change unless
there is a change in the underlying nature of the transactions and relevant conditions and events.

Foreign currency transactions should initially be recorded at the spot rate of exchange at the date
of the transaction. An approximate rate can be used. Subsequently, at each balance sheet date,
foreign currency monetary amounts should be reported using the closing rate. Non-monetary
items measured at historical cost should be reported using the exchange rate at the date of the
transaction. Non-monetary items carried at fair value, however, should be reported at the rate
that existed when the fair values were determined.

c
Œxchange differences arising on monetary items are reported in profit or loss in the period, with
one exception. The exception is that exchange differences arising on monetary items that form
part of the reporting entity¶s net investment in a foreign operation are recognised in the group
financial statements, within a separate component of equity. They are recognised in profit or loss
on disposal of the net investment. If a gain or loss on a non-monetary item is recognised in
equity (for example, property, plant and equipment revalued under IAS 16), any foreign
exchange gain or loss element is also recognised in equity.

 

 
 



An entity can present its financial statements in any currency. If the presentation currency differs
from the functional currency, the financial statements are retranslated into the presentation
currency. If the financial statements of the entity are not in the functional currency of a
hyperinflationary economy, then they are translated into the presentation currency as follows:

‘ Assets and liabilities (including any goodwill arising on the acquisition and any fair value
adjustment) are translated at the closing spot rate at the date of that balance sheet
‘ Income statements are translated at the spot rate at the date of the transactions (average
rates are allowed if there is no great fluctuation in the exchange rates)
‘ All exchange differences are recognised in a separate component of equity.

At the entity level, management should determine the functional currency of the entity based on
the requirements of IAS 21.

An entity does not have a choice of functional currency. All currencies, other than the functional
one, are treated as foreign currencies. An entity¶s management may choose a different currency
from its functional one ± the presentation currency ± in which to present financial statements.

At the group level, various entities within a multinational group will often have different
functional currencies. The functional currency is identified at entity level for each group entity.
Œach group entity translates its results and financial position into the presentation currency of the
reporting entity.

Normal consolidation procedures are followed for the preparation of the consolidated financial
statements, once all the consolidated entities have prepared their financial information in the
appropriate presentation currency.

     

When preparing group accounts, the financial statements of a foreign subsidiary should be
translated into the presentation currency as set out above. Any goodwill and fair value
adjustments are treated as assets and liabilities of the foreign entity, and therefore retranslated at
each balance sheet date at the closing spot rate.

Y
Œxchange differences on intra-group items are recognised in profit or loss, unless they are a
result of the retranslation of an entity¶s net investment in a foreign operation when it is classified
as equity.

Dividends paid in a foreign currency by a subsidiary to its parent firm may lead to exchange
differences in the parent¶s financial statements. They will not be eliminated on consolidation, but
recognised in profit or loss. When a foreign operation is disposed of, the cumulative amount of
the exchange differences in equity relating to that foreign operation is recognised in profit or loss
when the gain or loss on disposal is recognised.

 
 

The notion of a group functional currency does not exist under IFRS; functional currency is
purely an individual entity or business operation-based concept. This has resulted in IAS 21
becoming one of the more complex standards for firms converting to IFRS.

In addition, many multinational groups have found the process time-consuming and challenging,
particularly when considering non-trading group entities where the standard¶s emphasis on
external factors suggests that the functional currency of corporate subsidiaries might well be that
of the parent, regardless of their country of incorporation or the currency in which their
transactions are denominated.

Œntities applying IFRS need to remember that the assessment of functional currency is a key step
when considering any change in the group structure or when implementing any new hedging or
tax strategies. Furthermore, should the activities of the entity within the group change for any
reason, the determination of the functional currency of that entity should be reconsidered to
identify the changes required. Management must take care to document the approach followed in
the determination of functional currency for each entity within the group, using a consistent
methodology across all cases, particularly when an exercise of judgment is required.



An entity, with the dollar as its functional currency, purchases plant from a foreign entity for
¼18m on 31 May 2008 when the exchange rate was ¼2 to $1. The entity also sells goods to a
foreign customer for ¼10.5m on 30 September 2008, when the exchange rate was ¼1.75 to $1. At
the entity¶s year end of 31 December 2008, both amounts are still outstanding and have not been
paid. The closing exchange rate was ¼1.5 to $1.

The accounting for the items for the period ending 31 December 2008 would be as follows:

The entity records the plant and liability at $9m at 31 May 2008. At the year-end, the amount has
not been paid. Thus using the closing rate of exchange, the amount payable would be retranslated
at $12m, which would give an exchange loss of $3m in profit or loss. The asset remains at $9m
before depreciation.

Ñ
The entity will record a sale and trade receivable of $6m. At the year-end, the trade receivable
would be stated at $7m, which would give an exchange gain of $1m that would be reported in
profit or loss. IAS 21 does not specify where exchange gains and losses should be shown in the
statement of comprehensive income.



An entity has a 100%-owned foreign subsidiary, which has a carrying value at a cost of $25m. It
sells the subsidiary on 31 December 2008 for ¼45m. As at 31 December 2008, the credit balance
on the exchange reserve, which relates to this subsidiary, was $6m. The functional currency of
the entity is the dollar and the exchange rate on 31 December 2008 is $1 to ¼1.5. The net asset
value of the subsidiary at the date of disposal was $28m.

The subsidiary is sold for $45m divided by 1.5 million, therefore $30m. In the parent entity¶s
accounts a gain of $5m will be shown. In the group financial statements, the cumulative
exchange gain in reserves will be transferred to profit or loss, together with the gain on disposal.
The gain on disposal is $30m minus $28m, therefore $2m, which is the difference between the
sale proceeds and the net asset value of the subsidiary. To this is added the exchange reserve
balance of $6m to give a total gain of $8m, which will be included in the group statement of
comprehensive income.

6

 
 

 

  


 
 
 







 
 
  
 

‘ âiew the multiple choice questions