i have prepared this short lecture of Foreign currency which is an important area due to the fact that most of companies are becoming increasingly international.
– Determine an entity’s foreign currency
– Distinguish between an entity’s functional and presentational currency
– Account for foreign currency transactions and exchange differences
- Translate an entity’s financial statements into a presentation currency
• IAS 21 The Effects of Changes in Foreign Exchange Rates
Some of the definitions from this standard (IAS 21)
• Presentational currency: the currency in which the financial statements are presented
• Foreign currency: a currency other than the functional currency of the entity
Definition according to IAS 21 - The currency of the primary economic environment in which the entity operates.
To determine its functional currency an entity must consider the following factors:
a. The currency that mainly influences sales prices for its goods and services
b. The currency of the country whose competitive forces and regulations determine sales prices
c. The currency that mainly influences the costs of providing goods and services
d. Currency in which receipts from operating activities are usually retained.
e. The currency in which funds from financing activities are generated e.g. Loans and share issue
f. The currency in which receipts from operating activities are usually retained.
NB: If the evidence provided by all these factors is mixed, then
1. Management should use its judgment
2. The entity’s functional currency reflects
- The transactions
- The events
- The conditions
under which the entity conducts its business
Once decided on, the functional currency does not change unless there is a change in the underlying nature of the 3 factors above
Foreign Currency Transaction
• A transaction that is denominated or requires settlement in a foreign currency.
– Buy or sell goods or services at prices denominated in a foreign currency
– Borrow or lend funds with amounts payable (receivable) in a foreign currency
– Acquire or dispose of assets or incur or settle liabilities in a foreign currency.
Recognition of The Foreign Currency Transaction
• Initial recognition:
– This should be at the spot (exchange)rate
– The Spot Exchange Rate is ‘the exchange rate for immediate delivery’
– Subsequent recognition:
This will depend on whether the item is a monetary or non-monetary item and whether it is carried at historical cost (HC) or at fair value (FV).
Reporting foreign Currency Transaction
At the end of each reporting period:
• Monetary items should be translated using the closing rate (spot rate at the end of the reporting period)
• Non-monetary items carried at HC should be translated using the original exchange rate
Non-monetary items carried at FV should be translated using the exchange rate at the date the fair value was determined
Definition According to IAS 21 - An entity that is a subsidiary, associate, joint venture or branch of a reporting entity.
• The activities of this foreign entity are based or conducted in a country or currency other than those of the reporting entity.
• The exchange of one currency for another currency
• Conversion is required in the case of foreign currency transactions
• The expression of one currency in terms of another currency (usually, the functional currency of the reporting entity)
Foreign Currency differences
Exchange differences arise where;
• A given number of units of one currency are translated into another currency at different exchange rates
• Monetary Items:
• Recognise as income (expense) in period
• Non-Monetary Items:
• Recognise gain or loss in income statement or as other comprehensive income as appropriate
Translation to Presentation currency
At the end of each reporting period:
• Statement of Financial Position
– Assets and liabilities are translated at the closing rate
• Statement of Comprehensive Income
– Income and expenses are translated at the exchange rates which applied on the dates of the transactions. (In practice, an average rate is used for this purpose)