IAS 21: Accounting for Foreign Currency Exchange Rate Changes
The objective of IAS 21, The Effects of Changes in Exchange Rates, is to prescribe how foreign currency transactions and foreign operations are incorporated into an entity's financial statements, and how to convert the financial statements to the presentation currency.
The main problems that arise are determining the appropriate exchange rate(s) to use and how to report the effects of changes in exchange rates within the financial statements.
Key Definitions in IAS 21
Functional Currency
Functional currency is the currency of the primary economic environment in which the entity operates. This environment is normally the one in which the entity generates and uses cash.
Foreign Currency and Spot Exchange Rate
- Foreign currency (or currency) is any currency different from the entity's functional currency.
- A Spot exchange rate is the rate of exchange used in transactions requiring immediate delivery.
Exchange Difference
An exchange difference (or change) is the resulting difference from translating a given number of units of one currency into another currency using different exchange rates.
Net Investment in a Foreign Operation
Net investment in a foreign operation is the amount corresponding to the participation of the entity presenting its financial statements in the net assets of that foreign business.
Foreign Operation (Business Abroad)
A foreign operation (or business abroad) is any subsidiary, associate, joint venture, branch, or agency of the reporting entity whose activities are based or conducted in a country or currency other than that of the reporting entity.
Treatment of Goodwill and Fair Value Adjustments
Both the goodwill arising on the acquisition of a foreign operation and fair value adjustments to the carrying amount of assets and liabilities resulting from the acquisition of a foreign operation should be treated as assets and liabilities of the foreign operation.
Translation Procedures for Hyperinflationary Economies
The results and financial position of an entity whose functional currency corresponds to a hyperinflationary economy are translated into a different presentation currency using the following procedures:
- All amounts (i.e., assets, liabilities, equity items, income, and expenses, including comparative figures) must be converted using the closing exchange rate for the most recent balance sheet date, except when:
- The amounts are being converted to the currency of a hyperinflationary economy. In this specific case, the comparative figures are those that were presented as current year amounts in the financial statements of the preceding period. These amounts are not adjusted for subsequent changes that have occurred in the level of prices or exchange rates.