Objective of IAS 21

The objective of IAS 21 is to prescribe how to include foreign currency transactions and foreign operations in the financial statements of an entity and how to translate financial statements into a presentation currency. The principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in the financial statements.

Key Definitions [IAS 21.8]

Functional currency: The currency of the primary economic environment in which the entity operates. The term 'functional currency' is used in the 2003 revision of IAS 21 in place of 'measurement currency' but with essentially the same meaning. Presentation currency: The currency in which financial statements are presented.

Exchange difference: The difference resulting from translating a given number of units of one currency into another currency at different exchange rates.

Foreign operation: A subsidiary, associate, joint venture, or branch whose activities are based in a country other than that of the reporting enterprise.

Basic Steps for Translating Foreign Currency Amounts into the Functional Currency

Steps apply to a stand-alone entity, an entity with foreign operations (such as a parent with foreign subsidiaries), or a foreign operation (such as a foreign subsidiary or branch).

1. The reporting entity determines its functional currency

2. The entity translates all foreign currency items into its functional currency

3. The entity reports the effects of such translation in accordance with paragraphs 20-37 and 50.

Foreign Currency Transactions

A foreign currency transaction should be recorded initially at the rate of exchange at the date of the transaction (use of averages is permitted if they are a reasonable approximation of actual). [IAS 21.21-22]

At each subsequent balance sheet date: [IAS 21.23]

• Foreign currency monetary amounts should be reported using the closing rate.
• Non-monetary items carried at historical cost should be reported using the exchange rate at the date of the transaction.
• Non-monetary items carried at fair value should be reported at the rate that existed when the fair values were determined.

Exchange differences arising when monetary items are settled or when monetary items are translated at rates different from those at which they were translated when initially recognised or in previous financial statements are reported in profit or loss in the period, with one exception. [IAS 21.28] 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 consolidated financial statements that include the foreign operation, in a separate component of equity; they will be recognised in profit or loss on disposal of the net investment. [IAS 21.32]

If a gain or loss on a non-monetary item is recognised directly in equity (for example, a property revaluation under IAS 16), any foreign exchange component of that gain or loss is also recognised directly in equity. [IAS 21.30]

Prior to the 2003 revision of IAS 21, an exchange loss on foreign currency debt used to finance the acquisition of an asset could be added to the carrying amount of the asset if the loss resulted from a severe devaluation of a currency against which there was no practical means of hedging. That option was eliminated in the 2003 revision.

Translation from the Functional Currency to the Presentation Currency

The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy are translated into a different presentation currency using the following procedures: [IAS 21.39]

• assets and liabilities for each balance sheet presented (including comparatives) are translated at the closing rate at the date of that balance sheet. This would include any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation are treated as part of the assets and liabilities of the foreign operation [IAS 21.47];
• income and expenses for each income statement (including comparatives) are translated at exchange rates at the dates of the transactions; and
• all resulting exchange differences are recognised as a separate component of equity.

Special rules apply for translating the results and financial position of an entity whose functional currency is the currency of a hyperinflationary economy into a different presentation currency. [IAS 21.42-43]

Disposal of a Foreign Operation

When a foreign operation is disposed of, the cumulative amount of the exchange differences deferred in the separate component of equity relating to that foreign operation shall be recognised in profit or loss when the gain or loss on disposal is recognised. [IAS 21.48]

Where the foreign entity reports in the currency of a hyperinflationary economy, the financial statements of the foreign entity should be restated as required by IAS 29, Financial Reporting in Hyperinflationary Economies, before translation into the reporting currency. [IAS 21.36]

The requirements of IAS 21 regarding transactions and translation of financial statements should be strictly applied in the changeover of the national currencies of participating Member States of the European Union to the Euro - monetary assets and liabilities should continue to be translated the closing rate, cumulative exchange differences should remain in equity and exchange differences resulting from the translation of liabilities denominated in participating currencies should not be included in the carrying amount of related assets. [SIC 7]

Disclosure

• The amount of exchange differences recognised in profit or loss (excluding differences arising on financial instruments measured at fair value through profit or loss in accordance with IAS 39). [IAS 21.52]
• Net exchange differences classified in a separate component of equity, and a reconciliation of the amount of such exchange differences at the beginning and end of the period. [IAS 21.52]
• When the presentation currency is different from the functional currency, disclose that fact together with the functional currency and the reason for using a different presentation currency. [IAS 21.53]
• A change in the functional currency of either the reporting entity or a significant foreign operation and the reason therefor. [IAS 21.54]

When an entity presents its financial statements in a currency that is different from its functional currency, it may describe those financial statements as complying with IFRS only if they comply with all the requirements of each applicable Standard (including IAS 21) and each applicable Interpretation. [IAS 21.55]

Convenience Translations

Sometimes, 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 simply by translating all amounts at end-of-period exchange rates. This is sometimes called a convenience translation. A result of making a convenience translation is that the resulting financial information does not comply with all IFRS, particularly IAS 21. In this case, the following disclosures are required: [IAS 21.57]

• Clearly identify the information as supplementary information to distinguish it from the information that complies with IFRS.
• Disclose the currency in which the supplementary information is displayed.
• Disclose the entity's functional currency and the method of translation used to determine the supplementary information.

Discussion at the IASB's June 2005 Meeting: Net Investment in a Foreign Operation – Paragraph 32 of IAS 21

The Board discussed whether different accounting treatments should apply to exchange differences on monetary items denominated in different currencies. The Board also discussed whether funding provided to a foreign operation by a group entity that is not the reporting entity may be considered to be part of the reporting entity's net investment in that foreign operation in the context of paragraph 32 of IAS 21.

The Board agreed that the intention should be to treat third-currency denominated monetary items that form a part of the net investment in a foreign operation similar to when the monetary item is denominated in the functional currency of either the reporting entity or the foreign operation.

The staff proposed to delete paragraph 33 of IAS 21 in order to remove the inconsistency. However the Board indicated a preference to delete only the last two sentences of that paragraph and include additional guidance. The sentences that may be deleted are as follows:

The Board agreed that the ability to account for exchange differences in equity as provided for by paragraph 32 of IAS 21 should only be available where the lender is in a control relationship (i.e. parent or subsidiary lends to a foreign operation). Monetary amounts outstanding between fellow subsidiaries would qualify for equity treatment, but this would not extend to trade receivables or trade payables. The Staff proposed amending paragraph 15 of IAS 21 as follows:

Some Board members expressed concern whether the above amendment is not sufficiently restrictive to limit its application to a situation where the lender is in a control relationship.

IASB Approves Minor Amendment to IAS 21 – Net Investment in a Foreign Operation

At its November 2005 meeting, the IASB approved certain amendments to IAS 21 that had been proposed in Draft Technical Correction (DTC) 1 Proposed Amendments to IAS 21 The Effects of Changes in Foreign Exchange Rates – Net Investment in a Foreign Operation. However, the Board also decided not to pursue further Technical Corrections but, instead, to adopt editorial corrections as fast-track amendments. The IAS 21 amendment was issued 15 December 2005.

The amendment responds to concerns expressed by the IASB's constituents earlier this year that IAS 21 as amended in December 2003 required different accounting depending on the currency in which a monetary item was denominated where such an item was regarded as part of an entity's investment in a foreign operation. Secondly, IAS 21 was not clear on whether any member of a consolidated group could enter into the monetary transaction with the foreign operation. In response to those concerns, the IASB reviewed IAS 21 and reached the following decisions, which are reflected in the amendment:

• As regards a monetary item that forms part of an entity's investment in a foreign operation, the IASB concluded that the accounting treatment in consolidated financial statements should not be dependent on the currency of the monetary item.
• Also, the accounting should not depend on which entity within the group conducts a transaction with the foreign operation.