International accounting standard 21 sets some rules which help us in reporting foreign currencies in the financial statements. All these rules are collectively compiled in IAS 21.
The objective of IAS 21
The objective of IAS 21 is to make a set of rules for those activities in an organisation which involves foreign currency transactions. It is specially designed for those organisations in which foreign operations are involved.
Major terms used in IAS 21
- Functional Currency
- Presentation Currency
- Foreign Operations
- Exchange Difference
- Historical Rate/Spot Rate
- Closing Rate
- Average Rate
Functional currency: A currency in which the majority of the entity’s transactions take place, most of the economic activities operate in this currency.
How to identify functional currency:
- Look for the currency which is influencing sale price of goods and services
- The currency of a country which can increase or decrease the sale price by its competitive forces and regulations.
- And lastly, which has a great impact on the input cost of goods and services.
Entity’s functional currency once decided can not be changesd unless a major change occurs in the nature of transaction, events or regulations.
Presentation currency: A currency in which entity’s financial statements (FS) are presented.
Foreign operations: Operations of an entity or its subsidiary(s) taking place in a country other than its home country.
Exchange difference: Differences in monetary terms that occur due to difference in exchange rates.
Historical/Spot rate: Currency Rate at the time of transaction
Closing rate: a rate at the reporting date of financial statements.
Average rate: average rate throughout accounting period of an entity.
Initial transactions
Initial transactions should be recorded at historic or spot rate or they can also be recorded on the average rate if the rate does not fluctuate significantly through out the period.
Settled transactions
Settled transactions are those transactions which occur during the accounting period. it can be payment or receipt, both. These transactions will be recorded at their historic rate on that particular date. It can be different from initial transactions, difference of exchange rate can be occur, and the difference will be justified in statement of profit or loss as gain/loss.
Unsettled transaction
There can be a number of different transactions that can be unsettled at the date of reporting such as outstanding assets or liabilities on the statement of financial positions.
- If the transaction occurs in monetary items, it should be retranslated at the closing rate.
- If the transactions occur in non-monetory items it should remain at the historic rate.
There is a possibility of arising exchange difference in retranslating the monetary items, the difference will be transferred in the statement of profit and loss as gain/loss.
Treatment of foreign operations:
If a company has a foreign subsidiary, it will definitely have foreign operations. Subsidiary’s goodwill or fair value adjustments will be treated as assets or liabilities of the foreign entity that is why it will be retranslated in the statement of financial position at the closing spot rate.
Exchange differences will be treated as gains/losses in the statement of profit and loss. But if they occur as a result of the parent’s net investments, it will be considered as equity.
Dividends paid to the parent company by its subsidiary can also lead to exchange difference, it will also be recognized as gain/loss.
