Financial Reporting

Dealing with Foreign Exchange Transactions

In this article, Steve Collings discusses the method used to deal with foreign exchange transactions under the prescribed standard, IAS 21.

Students dealing with financial reporting papers will often come across issues relating to the buying and selling of goods and services to other entities who are located in overseas locations – such transactions will often give rise to translation differences.  The objective of IAS 21 ‘The Effects of Changes in Foreign Exchange Rates’ is to prescribe how an entity, who carries on foreign activities will account for the changes in foreign exchange rates.

Functional Currency

The first thing an entity is required to do is to determine the ‘functional ‘currency of the entity.  The functional currency is the currency of the primary economic environment in which it operates (e.g. dollars).  In determining the functional currency, an entity is required to consider the following factors:

·         The currency that mainly influences sales prices for goods and services (this will often be the currency in which sales prices for its goods and services are denominated and settled); and

·         Of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.

In addition, an entity will normally consider the currency that mainly influences labour, material and other costs of providing goods or services.

Foreign Currency Transactions

Foreign currency transactions should be recorded initially in the functional currency by using the exchange rate at the date of the transaction.

At the end of the reporting period, an entity should translate foreign currency monetary items of assets and liabilities using the closing rate method at the reporting date.  Non-monetary items should be translated using the exchange rate at the date of the transaction.

Non-monetary items that are measured using fair values in a foreign currency should be translated using the exchange rates at the date when the fair value was determined.

Any exchange differences on translation are recognised in profit or loss in the period in which they arise.

Exchange differences that arise on a monetary item that forms part of an entity’s net investment in a foreign operation must be recognised in profit or loss in the separate financial statements of the reporting entity or the individual financial statements of the foreign operation, as appropriate.  In the consolidated financial statements, exchange differences are recognised initially in other comprehensive income and reclassified from equity to profit or loss on disposal of the net investment.

Presentation of Information Where the Functional Currency is Different from the Presentational Currency

Where an entity’s presentational currency differs from its functional currency, then it should translate its results and financial position into the presentational currency.

About the Author

Steve Collings FMAAT ACCA DipIFRS is the audit and technical manager for LWA Ltd and a partner in AccountancyStudents.co.uk as well as a freelance technical author.  He is the author of ‘The Core Aspects of IFRS and IAS’ from which this article has been extracted and lectures on financial and reporting issues.

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