Foreign currency (IAS 21)
1 Functional currency
Currency of the primary economic environment in which the entity operates. This is deemed to be where the entity generates and expends cash.
Management should consider the following factors in determining the functional currency:
The currency that dominates the determination of the sales prices
The currency that most influences operating costs
The currency in which an entity’s finances are denominated is also considered.
If an entity has transactions that are denominated in a currency other than its functional currency then the amount will need to be translated into the functional currency before it is recorded within the general ledger.
1.1 Individual company accounts
Record the transaction at the exchange rate in place on the date the transaction occurs.
Monetary assets and liabilities are retranslated using the closing rate at the reporting date, with any gains or losses going through profit or loss.
Non-monetary assets and liabilities are not retranslated at the reporting date, unless carried at fair value, whereby translate at the rate when fair value was established.
Note: No specific guidance is given as to where any exchange differences are recorded within profit or loss. The general accepted practice is:
Trading transaction – operating costs
Financing transaction – financing costs
Exchange differences on monetary items belong in profit or loss, not other comprehensive income — a frequent error where a bond or loan is involved. Decide first whether the instrument is an asset or a liability to this entity, and whether it is monetary at all: a non-monetary asset is not retranslated at the closing rate.
2 Group accounts
If a group has a subsidiary company that is located overseas, that subsidiary will have a different functional currency to the rest of the group. Before consolidation of the subsidiary its results will need to be correctly stated in its functional currency. Once this has been done the results can then be translated into the presentational currency of the group and consolidated.
2.1 Group SFP
Translate all the assets and liabilities of the subsidiary @ closing rate (CR)
Goodwill working in overseas currency and translate at the closing rate
Calculate the exchange differences in the subsidiary.
Rate | $m | |
Non-current assets | @CR | X |
Current assets | @CR | X |
Non-current liabilities | @CR | (X) |
Current liabilities | @CR | (X) |
Net assets | X | |
Equity share capital | @HR | X |
Reserves | ||
Pre-acquisition | @HR | X |
Post-acquisition | (β) | X |
Equity | X |
2.2 Group P/L and OCI
Translate all the income and expenses of the subsidiary @ average rate (AR)
2.3 Gain or loss on translation of the overseas subsidiary
The subsidiary’s financial statements are translated using different exchange rates, being the opening and closing rate for net assets and average rate for profit or loss items. This gives rise to exchange gains or losses each year as we translate the subsidiary at year-end.
$m | |||
Opening net assets | |||
@ OR | X | ||
@ CR | X | ||
X | |||
Profit for the year | |||
@ AR | X | ||
@ CR | X | ||
X | |||
Goodwill | |||
@ OR | X | ||
@ CR | X | ||
X | |||
Translation gain/loss | X |
Any gains or losses on translation of the overseas subsidiary are recognised in other comprehensive income.
2.4 Disposal of foreign subsidiary
Note that, on disposal of a foreign subsidiary, the cumulative exchange differences previously recognised in OCI are recycled to the profit and loss account. The exchange differences are now said to be ‘realised’. For example, if the exchange differences were gains, the journal would be as follows:
Dr OCI (cumulative exchange differences) X
Cr Profit and loss account X
Relevant examiner articles on the ACCA (students) website:
IAS 21 – Does it need amending?
Topic explainer video: Foreign operations