This is the short summary of IAS 21 The Effects of Changes in Foreign Exchange Rates.
In today's world, the entities carry out their foreign activities in 2 ways: 1. They have some transactions in foreign currencies, or
2. They Have a foreign operation.
An entity can also decide to present its financial statements in some foreign currency other than their own.
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.
Functional currency is the currency of the primary economic environment in which the entity operates. It is the own entity's currency and all other currencies are "foreign currencies".
The primary economic environment is normally the one in which the entity primarily generates and expends the cash, but more factors needed to be considered, such as the currency in which the sales prices are denominated, etc.
Presentation currency is the currency in which the financial statements are presented.
How to report transactions in FUNCTIONAL CURRENCY
Initially, all foreign currency transactions shall be translated to functional currency by applying the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.
Subsequently, at the end of each reporting period, you should translate:
• All monetary items in foreign currency using the closing rate;
• All non-monetary items measured in terms of historical cost using the exchange rate at the date of transaction (historical rate);
• All non-monetary items measured at fair value using the exchange rate at the date when the fair value was measured.
All exchange rate differences shall be recognized in profit or loss with some exceptions.
How to translate financial statements into a PRESENTATION CURRENCY
When an entity's functional currency is NOT the currency of a hyperinflationary economy, then an entity should translate:
• All assets and liabilities for each statement of financial position presented (including comparatives) using the closing rate at the date of that statement of financial position.
• All income and expenses and other comprehensive income items (including comparatives) using the exchange rates at the date of transactions.
All resulting exchange differences shall be recognized in other comprehensive income as a separate component of equity.
For more information and other IFRS materials, please visit http://www.ifrsbox.com
Hi. I think there is a slight contradiction in your translation of currency. You mentioned in the first case that monetary item are translated using closing rate; while non monetary items are translated using historical rates. You then mentioned in the second case that assets and liabilities are translated using closing rate. However there are non monetary components included in the assets (property, plant, & equipment). Do we use the historical rate as in the first case, or closing rate as in the second case for PPE (Property, plant and equipment)?
Thanks for the video too
Hi Faisal, I think you are putting 2 issues together. "The first case" as you named it is the translation of foreign currency transactions (i.e. individual transactions) into your own functional currency. "The second case" is the translation of your whole financial statements into ANY presentation currency. I strongly recommend visiting my website - it is nicely explained in my articles with examples. Have a nice day! S.
Thanks for the explanation. I request your help to clarify one point - In case of goods receipt, the exchange rate is used on the date of Goods Receipt and post provision entry (Debit Expenses and Credit Provision account). Later, when we book Invoice, should we consider the exchange rate on the date of booking of Invoice (or) should we consider the same exchange rate as per Goods Receipt? The entry would be (Debit Provision Account and Credit Vendor Account). In case of any price difference, the expenses account would be either debited (or) credited. Kindly clarify what exchange rate needs to be used for booking Invoice (Accounts Payable) - as per the IAS 21? Thank you very much for your support.
When you're going from foreign currency to functional currency, use temporal method, When you're going from your current Financial Statements Functional Currency to a presentation currency of your choice, use Current
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