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IAS 21


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IAS 21

  1. 1. IAS 21: The Effects of Changes in Foreign Exchange Rates Roshankumar S
  2. 2. Scope:This standard deals with: Accounting for transactions and balances in foreign currencies; Translating the results and financial position of foreign operations, included in financial statements of the entity by consolidation, proportionate consolidation or the equity method; Translating entity’s results and financial position into a presentation currency.This standard does not deal with: Derivative transactions in foreign currencies and balances that are within the scope of IAS 39: Financial Instruments: Recognition and Measurement. Hedge accounting including the hedging of a net investment in foreign operation. The presentation of cash flows arising from transactions in foreign currency, or with the translation of cash flows of a foreign operation.Foreign CurrencyA foreign currency is the currency other than the functional currency of the entity.Functional CurrencyThe functional currency of an entity is the currency of the primary economicenvironment in which that entity operates.Primary economic environment in which an entity operates is normally the one inwhich it primarily generates and expends cash.Factors to determine functional currency: 1. Primary Evidence: a. This factor is related to entity’s sales. An entity considers the currency i. In which the sales prices of the goods and services are denominated and settled. If the currency that mainly influences sales prices is different, then this is considered. (e.g. US dollar is considered for crude oil sales, even if sales are denominated in a different currency) ii. Of the country whose competitive forces and regulations mainly determine the sales price of its goods and services. In general this is viewed as which is the main driver for price changes. (e.g. a local supermarkets price changes are driven by local competition. This is not true for international airlines.) b. This factor is related to operating
  3. 3. An entity considers the currency in which labour, material and other costs of providing goods or services are denominated and settled. (or the currency that mainly influences such costs, if different) In general labour cost would be linked to the currency of the country in which it operates, while material and other costs would be driven by the currency of the country in which the suppliers operate. 2. Secondary Evidence: a. Financing Activities An entity considers the currency in which the funds from financing activities are generated. b. Retention of operating income An entity considers the currency in which the receipts from operating activities are usually retained. This is the currency in which the entity maintains the excess working capital cash balance (i.e. in general it would be the local currency or a hard currency such as US dollar or Euro)Foreign OperationA foreign operation is an entity: Is a subsidiary, associate, joint venture or branch of a reporting entity, and Has activities that are based or conducted in a country or currency other than those of reporting entity.The functional currency is determined separately for individual entities. in case offoreign operation to find out functional currency four factors in addition to primaryand secondary factors shall be considered. These factors are Whether its activities are carried out as an extension of the reporting entity or with significant autonomy. If the activities are carried out as an extension then this provides evidence that its functional currency should be same as that of reporting entity. Whether its transactions with the reporting entity are a high or low proportion of its activities. If it is high proportion of its activities then this provides evidence that its functional currency may be the same as that of reporting entity. Whether the cash flows of the foreign operation directly affect the cash flows of the reporting entity and are available for remittance to it. If it is so then this provides evidence that its functional currency may be the same as that of reporting entity. Whether the cash flows of the foreign operation are sufficient to service debt obligation without the assistance from the reporting entity. If cash
  4. 4. are not sufficient then this provides evidence that its functional currency may be the same as that of reporting entity.None of these criteria should be looked at in isolation but as a whole.Presentation CurrencyThe currency in which the financial statements are presented is defined aspresentation currency. Unlike the functional currency the presentation currency canbe any currency of choice. If the presentation currency differs from functionalcurrency, the results and the financial position have to be translated into presentationcurrency. Presentation currency does not change the way in which the underlyingitems are measured but selection of wrong functional currency could affect themeasurement of items.A foreign currency transaction is the one that is denominated or requires settlementin a foreign currency. An entity must convert the foreign currency item into itsfunctional currency for recording in its books of accounts. Once recorded exchangedifferences will arise.Monetary itemsMonetary items are units of currency held and assets and liabilities to be received orpaid in fixed or determinable amounts of units of currency.Deferred tax, provisions to be settled in cash (e.g. accrued wages), debt security ismonetary item. Deferred income is not a monetary item.Initial RecognitionThe foreign currency transactions are recorded in functional currency by applying tothe foreign currency amount the spot exchange rate between the functional currencyand the foreign currency at the date of the transaction.For practical reasons, a rate that approximates the actual rate at the transaction dateis often used on initial recognition. This will be average rate for the period and will beused for all foreign currency transactions in that period. However, if exchangefluctuates significantly then use of average rates is inappropriate.Reporting at the end of subsequent reporting periodAt the end of each reporting period the foreign currency monetary items aretranslated using closing rate.At the end of each reporting period, non-monetary items that are measured in termsof historical cost in a foreign currency are translated using exchange rate at thedate of the
  5. 5. At the end of each reporting period, non-monetary items that are measured at fairvalue in a foreign currency are translated using the exchange rates at the date whenthe value was determined.When several exchange rates are available the rate to be used is that: At which the future cash flows represented by the transaction or balance could have been settled, if Those cash flows had occurred at measurement date.If the exchangeability between two currencies is temporarily blocked, the firstsubsequent rate at which exchanges could be made is used.Exchange differences on Monetary itemsExchange differences arise from: The settlement of monetary items at a subsequent date to initial recognition; and Remeasuring an entity’s monetary items at rates different from those at which they were initially recordedSuch exchange differences must be recognised as income or expenses in the periodin which they arise.Exception:Exchange difference are recognised directly in other comprehensive income in theconsolidated financial statements, if they arise on a monetary item that forms part ofa reporting entity’s net investment in a foreign operation denominated in thefunctional currency of either the parent or the foreign operation.Exchange differences on Non-Monetary itemsWhen the gain or loss on a non-monetary item is recognised in profit or loss, anyexchange component of that gain or loss is also recognised in the profit or loss.When the gain or loss on a non-monetary item is recognised directly in othercomprehensive income, any exchange component of that gain or loss is alsorecognised directly in other comprehensive income.Translation into Presentation currencyIf the presentation currency is different from the functional currency then the resultsand the financial position of an entity must be translated into the presentationcurrency as
  6. 6. For each statement of financial position presented (including comparatives), assets and liabilities are translated at the closing rate at the date of the statement of financial position. For each statement of comprehensive income or separate statement of comprehensive income presented (including comparatives), income and expenses are translated at exchange rates at the transaction dates (an average rate for a period may be used unless rate fluctuates significantly). Equity items are translated at the rate on the date of acquisition. All resulting exchange differences are recognised in other comprehensive income. These exchange differences are not recognised in income or expenses for the period because the changes in the exchanges in the exchange rates have little or no direct effect on the present or future cash flows from entity’s operation. This is for translation into presentation currency and not for initial recognition into functional currency.Intra-group transactionAn intragroup monetary item (short or long term) cannot be eliminated against thecorresponding intragroup asset/liability without showing exchange differences in theconsolidated financial statements. In the consolidated financial statements, theexchange differences stay as income or expenses unless they arise on a monetaryitem forming part of reporting entity’s net investment in a foreign operation. Whiletranslating the exchange gain or loss on such transaction use the average rate.Goodwill and fair value transactionAny goodwill arising on the acquisition of foreign operation and any fair valueadjustments to the carrying amount of assets and liabilities arising on the acquisitionof foreign operation are treated as: Assets and liabilities of the foreign operation; and Translated at the closing rate.Disposal of foreign operationOn disposal of a foreign operation the cumulative translation amount of exchangedifferences (CTD) that: Have been recognised in other comprehensive income and accumulated in a separate component of equity, and Which relate to that foreign operationAre reclassified from equity to profit or loss when the gains or loss on disposal
  7. 7. In case of partial disposal all the accumulated translation reserves will be reclassifiedinto profit or loss.When the carrying amount of a foreign operation is above its recoverable amount, awrite-down is required (e.g. evidenced by operating losses or impairment of assets).Such write down does not constitute any kind of disposal, so no part of the deferredforeign exchange gain or loss is recognised as income or