IAS 21 Foreign Exchange Rates PDF

IAS 21 The effects of changes in foreign exchange rates Definitions Closing rate is the spot exchange rate at the end of the reporting period. Exchange difference is the difference resulting from translating a given number of units of one currency into another currency at differe...

IAS 21 The effects of changes in foreign exchange rates Definitions Closing rate is the spot exchange rate at the end of the reporting period. Exchange difference is the difference resulting from translating a given number of units of one currency into another currency at different exchange rates. Foreign currency is a currency other than the functional currency of the entity. Functional currency is the currency of the primary economic environment in which the entity operates. Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency. Presentation currency is the currency in which the financial statements are presented. Functional Currency The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash. An entity considers the following factors in determining its functional currency: i. 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); ii. The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services. iii. The currency that mainly influences labour, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled). Functional Currency (Cont’d) The following factors may also provide evidence of an entity’s functional currency: i. the currency in which funds from financing activities (ie: issuing debt and equity instruments) are generated. ii. the currency in which receipts from operating activities are usually retained. Initial recognition (Conversion) A foreign currency transaction is a transaction that is denominated or requires settlement in a foreign currency, including transactions arising when an entity: a. buys or sells goods or services whose price is denominated in a foreign currency; b. borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency; or c. otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency. A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction. Example: Initial recognition (Conversion) Suppose a local company buys a large consignment of goods from a supplier in Germany. The order is placed on 1 May and the agreed price is €124,250. At the time of delivery, the rate of foreign exchange was €3.50 to $1. The local company would record the amount owed in its books as follows: Dr: Inventory 35,500 (124,250/3.5) Cr: A/P 35,500 In case the exchange rate in the date of payment has been changed to €3.55 to 1$ Dr: A/P 35,500 Cr: Cash 35,000 (124,250/3.55) Cr: Profit on conversion (I/S) 500 Reporting at the ends of subsequent reporting periods (Translation) Translation; is required at the end of an accounting period when a company still holds assets or liabilities in its statement of financial position which were obtained or incurred in a foreign currency. The accounting treating treatment differs, whether: The functional currency is the presentation currency. The functional currency in NOT the presentation currency. Translation : Functional currency is the presentation currency Monetary items → translated using the closing rate Non-Monetary items & it’s related accounts → translated using the historical rate. The difference → P&L, except if the account gain or loss itself is treated in OCI. Translation Example : Functional currency is the presentation currency European company X purchased goods from American company Y in December N. The total amount of the invoice amounts to $10,000. The exchange rate at the time the goods were received is $1.30= € 1. The invoice would be recognized in X's accounts as follows: Dr: Inventory €7,692 (10,000/1.30) Cr: A/P - Supplier Y (B/S) € 7,692 (10,000/1.30) On 31 December N, the goods were still in inventory and supplier Y still had not settled payment. The exchange rate was $1.32 = € 1. Dr: A/P- Supplier Y (B/S) €117 (10,000/1.32) – (10,000/1.30) Cr: Foreign exchange gain (P&L) € 117 Translation : Functional currency is NOT the presentation currency P & L statement accounts → translated using the weighted average rate. Assets and liabilities → translated using the closing rate. The difference → recognised in other comprehensive income. Thank You