a presentation currency

Functional Currency vs Presentation Currency

Determining a company's functional currency is crucial, yet complex. Most would agree that navigating functional vs presentation currency can be confusing.

This article will clearly define functional and presentation currency, providing easy-to-understand examples and outlining straightforward translation procedures per IFRS guidelines.

You'll learn the key differences between functional and presentation currency, how to accurately determine a company's functional currency using primary indicators and secondary factors, and understand the impact currency choice has on financial statement analysis.

Introduction to Functional vs Presentation Currency

The functional currency refers to the primary currency used in a company's operations, while the presentation currency is the currency used to report the company's financial statements. There are some key differences between these two concepts:

Defining Functional Currency IFRS and Presentation Currency

Functional currency is the currency of the primary economic environment in which an entity operates. It reflects the underlying transactions, events, and conditions under which the entity conducts its business.

Presentation currency is the currency in which an entity presents its financial statements. Companies can choose to present their financials in a currency different from their functional currency.

For example, a French company doing most of its business in the Eurozone would likely have the Euro as its functional currency. However, it may present its financial statements in US dollars to make it easier for potential American investors to understand.

Exploring Functional Currency vs Presentation Currency Examples

Here are some examples to illustrate the difference:

A Canadian company that operates mainly in Canada and conducts transactions in Canadian dollars (CAD) would have CAD as its functional currency . If it presents financial statements in CAD, then CAD would also be its presentation currency .

An American company with operations across Europe and Asia that mostly transacts in British Pounds (GBP) would likely have GBP as its functional currency . However, it may present statements in US dollars (USD) for easier investor understanding, making USD its presentation currency .

A multinational company headquartered in Japan but transacting primarily in USD may use USD as its functional currency and JPY as its presentation currency for reporting purposes in its home country.

Significance of Functional Currency vs Local Currency

Choosing an appropriate functional currency is important for accurate financial reporting in international business. Using a non-functional local currency can distort financial statements during currency translation and not portray the true financial situation. On the other hand, the presentation currency can be tailored for investor convenience without impacting the underlying transactions.

What is the difference between functional currency and presentation currency?

The key difference between functional currency and presentation currency relates to which currency is used for measurement and reporting purposes in financial statements.

Functional Currency

The functional currency is the primary currency used by an entity to generate revenues, incur expenses, and operate day-to-day business activities. It is the currency of the primary economic environment in which an entity operates.

Some key indicators for determining an entity's functional currency include:

• The currency that mainly influences sales prices for goods and services
• The currency of the country whose competitive forces and regulations mainly determine the sales prices
• The currency that mainly influences labor, material, and other costs of providing goods or services

Presentation Currency

The presentation currency is the currency in which an entity presents its financial statements. Companies with foreign operations often translate functional currency financial statements into a presentation currency for consolidation purposes.

For example, a French company with a Euro functional currency may translate its financial statements into US Dollars for presentation if it has substantial operations in the United States or its investors are primarily US-based.

Key Differences

The main differences between functional and presentation currencies:

• Purpose - Functional currency reflects day-to-day business operations, while presentation currency is used for financial reporting.
• Determination - Functional currency depends on the primary economic environment, presentation currency is a choice based on user needs.
• Translation - Transactions in non-functional currencies require translation, presentation currencies involve translating entire financial statements.

In summary, the functional currency reflects the practical currency flows of regular business activities, while the presentation currency serves financial statement users and their preferred currency.

What is the difference between transactional currency and functional currency?

Functional currency is the primary currency used in a company's operations, while transactional currency is the currency used for individual transactions. Here are some key differences:

Functional currency reflects the main currency environment in which a company operates. It is usually the currency that mainly influences sales prices, labor, materials and other costs of providing goods or services. Some of the primary indicators for determining functional currency include:

• Currency that mainly influences sales prices
• Currency of the country whose competitive forces and regulations mainly determine sale prices
• Currency that mainly influences labor, materials and other costs
• Currency in which funds from financing activities are generated
• Currency in which receipts from operating activities are usually retained

Transactional currency is the currency used when buying or selling goods, services or assets. It is determined separately for each transaction based on the currency in which the transaction takes place. For example, if a French company purchases materials from a supplier in the U.S., the transactional currency would be USD.

Presentation currency is the currency used to present an entity's financial statements. Companies can choose any currency for financial reporting, regardless of functional currency. Presentation currency does not impact recognition or measurement in the financial statements.

For example, a Canadian company does most of its business in the U.S. Its functional currency is likely USD since that is the primary currency influencing its revenues, expenses, and cash flows. However, it can choose to present its financial statements in CAD as its presentation currency to better report performance to Canadian investors and stakeholders. The choice of presentation currency does not change the underlying recognition or measurement of transactions.

In summary, functional currency depends on a company's primary operating environment, transactional currency is determined separately for each transaction, and presentation currency is an independent choice for financial reporting. Properly distinguishing between these concepts is important from an accounting perspective.

What is an example of a functional currency?

For example, if a US-based multinational oil and gas company that uses the US dollar as its reporting currency maintains a distinct and separable operating subsidiary in Northern Africa that sells all of its oil production in transactions denominated in the US dollar, the US dollar would be the functional currency of that subsidiary.

Some key reasons why the US dollar is the functional currency in this example:

• The subsidiary's oil sales, which are likely the main source of revenue, are all denominated and settled in US dollars. This indicates the US dollar is the main currency influencing sales prices and cash flows.
• As a separable entity dealing almost exclusively in US dollars, the local currency of Northern Africa likely has little direct influence on the subsidiary's operations and transactions.
• The parent company's reporting currency is the US dollar, so maintaining the same functional currency simplifies consolidation and internal reporting.
• Oil is a global commodity typically traded in US dollars on international markets. The local currency likely has little impact on production costs or sales prices.

In summary, the key transactions, events, and conditions that impact this subsidiary's cash flows are primarily denominated in US dollars, making it the most appropriate functional currency based on IFRS guidance. The local currency in Northern Africa has little direct influence.

What is an example of presentation currency?

The subsidiaries use their local currency to prepare their financial statements, whereas the parent company uses USD to prepare its consolidated financial statements. USD, in this case, is called the presentation currency.

Here is an example to illustrate the difference between functional currency and presentation currency:

Consider a company XYZ Inc. that has a subsidiary in the UK. The UK subsidiary conducts all its business and transactions in British Pounds (GBP). So GBP is the functional currency for the UK subsidiary, as it reflects the economic reality of the subsidiary's operations.

However, XYZ Inc. prepares its consolidated financial statements in US dollars (USD). So when the parent company is consolidating the UK subsidiary's financial statements, it has to translate them from GBP to USD using the applicable foreign exchange rates. USD here is simply the presentation currency - it is the currency in which the consolidated financial statements are presented for the benefit of the parent company.

The key difference is:

Functional currency - reflects the underlying transactions, events, and conditions that are relevant to the entity.

Presentation currency - is simply the currency in which the financial statements are presented. It may be different from functional currencies of consolidated entities.

So in this example, GBP is the functional currency (based on UK subsidiary's operations) while USD is the presentation currency (for consolidation purposes at the parent company).

The choice of presentation currency is usually based on factors like investors' location, comparability with industry peers, headquarters location, etc. It does not change the underlying functional currencies used by individual entities for their operations.

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Determining a company's functional currency.

This section outlines the primary and secondary indicators that determine an entity's functional currency under IFRS guidelines.

Primary Indicators of Functional Currency

The currency which mainly influences sales prices and labor, material & other costs is given priority. Also considered is the currency in which funds from financing are generated and retained earnings held.

Some key factors when assessing an entity's functional currency include:

• The currency that mainly influences sales prices for goods and services. This is often the currency in which sales prices for its goods and services are denominated and settled.
• The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
• The currency that mainly influences labor, material and other costs of providing goods or services. This will depend on whether the entity's costs are primarily incurred and settled in a particular currency.

Funds from financing activities and the currency in which retained earnings are held and dividends are paid are also key considerations.

Assessing Secondary Factors

Other factors like the currency in which receipts from operating activities are usually retained and whether transactions with the reporting entity are in this currency.

Some secondary indicators to consider:

• The currency in which funds from financing activities are generated
• The currency in which receipts from operating activities are usually retained
• Whether transactions with the reporting entity are usually in a particular currency

These secondary factors can provide additional context in determining an entity's functional currency, especially when the primary indicators do not clearly identify a single currency.

Functional Currency vs Presentation Currency IFRS Compliance

Under IFRS guidelines, an entity's functional currency is the currency of the primary economic environment in which it operates. This is not necessarily the currency in which the entity presents its financial statements (presentation currency).

When an entity's functional currency differs from its presentation currency, it must translate its financial results into the presentation currency using the relevant foreign exchange rates. This translation process can impact revenues, expenses, assets and liabilities reported in the financial statements.

Compliance with IFRS requires entities to determine functional currency based on the primary economic environment, rather than choice. This ensures the financial statements reflect the underlying transactions, events and conditions relevant to the entity.

Careful determination of functional currency using the IFRS guidelines is important, as it has implications for the recognition, measurement and disclosure of transactions in the financial statements. Getting this right is key for comparability, consistency and transparency under IFRS standards .

Translating Foreign Currency Transactions

Spot rate application for initial recognition.

When a transaction denominated in a foreign currency first occurs, it must be translated into the functional currency by applying the spot exchange rate on the date of the transaction. The functional currency is the primary currency used in the company's operations.

For example, if a US company purchased inventory priced at 100,000 Mexican Pesos when the spot rate was 1 USD = 20 MXN, the initial recognition of the inventory in US dollars would be $5,000 (100,000 MXN / 20 MXN per USD). Using the spot rate at the date of initial transaction allows the foreign currency amount to be accurately translated into the functional currency.

End-of-Period Translation Procedures

At the end of each reporting period, foreign currency monetary items must be translated using the closing rate. The closing rate is the current exchange rate on the last day of the reporting period. This translation creates foreign exchange gains and losses that are recognized in profit or loss.

Non-monetary items measured at historical cost continue to use the same exchange rate as at the date of initial recognition. Only monetary items are retranslated at the end of each reporting period.

For example, using the previous example, if at the end of the reporting period the USD/MXN exchange rate changed to 1 USD = 18 MXN, the 100,000 MXN inventory would now translate to $5,555 USD (100,000 / 18). This difference of $555 is recognized as a foreign exchange gain.

Handling Exchange Rate Fluctuations

Foreign currency transactions can create exchange differences when exchange rates fluctuate over time. These exchange differences occur both on settlement of monetary items as well as at each financial reporting date for outstanding foreign currency monetary items.

For practical purposes, these gains and losses arising from foreign currency transactions are generally recognized as an expense item in profit or loss during the period of change. This helps account for the effect movements in exchange rates have on the financial reporting currency from period to period.

Translating Financial Statements into a Presentation Currency

If a company's presentation currency differs from its functional currency, additional translation is required using appropriate exchange rates in order to present uniform financial statements.

Presentation Currency Example: Assets and Liabilities

For financial reporting purposes, assets and liabilities are translated at the closing rate on the date of the financial statements between the functional and presentation currencies.

For example, if a company's functional currency is the Mexican Peso, but it presents financial statements in US Dollars, all assets and liabilities would be translated into US Dollars using the spot exchange rate on the last day of the reporting period. This allows assets and liabilities to be accurately stated in the presentation currency.

Income and Expense Translation Approach

Income and expenses should be translated using actual exchange rates at the dates of transactions, or an appropriate average rate over the reporting period.

Using the previous example, revenue and expenses originally denominated in Mexican Pesos would be translated into US Dollars by applying the exchange rates in effect on the date those transactions occurred. An average exchange rate for the period can also be used for simplification purposes. This method helps avoid distortion from exchange rate fluctuations.

Equity Items Translation Considerations

Components of equity are translated using the exchange rates at the date those components arose, rather than current closing rates at financial statement date.

For instance, common stock issued in Mexican Pesos would use the historical exchange rate at issuance date when translating the stock value into the US Dollar presentation currency. This prevents equity balances from showing artificial gains/losses due to exchange rate changes after stock issuance.

Impact of Functional vs Presentation Currency on Financial Analysis

Using appropriate functional and presentation currencies impacts key financial statement metrics and ratios used by analysts to assess performance.

Effects on Assets, Liabilities, and Equity

Line items reflecting economic events that occurred over past periods can be materially impacted when translated from functional to presentation currency. For example, if a company conducts most of its business in the Euro but reports in US dollars, fluctuations in the EUR/USD exchange rate can significantly impact the reported values of assets, liabilities, and equity over time.

This can distort period-over-period comparisons and trend analysis if the effects of foreign currency translation are not isolated. Analysts evaluating solvency measures like debt-to-equity ratios must understand how choice of presentation currency influences the values used in their models and ratios.

Trend Analysis and Exchange Rate Distortions

Fluctuations in exchange rates between functional and presentation currencies can distort trends in financial metrics over reporting periods. If revenues are earned in a foreign currency but converted to the presentation currency using current exchange rates each period, growth may appear volatile due purely to currency swings.

Similarly, margin analysis can be obscured when cost of goods sold is recorded in one currency but revenue converted at varying rates each period. Analysts must normalize data by using constant exchange rates before modeling trends.

Influence on Financial Ratios

Ratios involving margin analysis, solvency assessments and other metrics can vary significantly depending on currencies used. If a company conducts most business in its functional currency, converting financial statements to a different presentation currency using current exchange rates can introduce distortion.

For example, a company reporting improving profit margins year-over-year in its functional currency could show declining margins in the presentation currency due to exchange rate changes alone. Evaluating performance should focus on functional currency, with presentation conversion impacts isolated.

Conclusion and Key Takeaways

In summary, properly distinguishing between functional and presentation currencies is vital for accurate IFRS-compliant financial reporting and analysis.

Recap of Functional Currency vs Presentation Currency

The functional currency reflects the underlying economics of a company's operations, while the presentation currency allows for uniform financial statement presentation across a multinational company's subsidiaries. Key differences include:

• Functional currency is the currency of the primary economic environment in which an entity operates. It impacts how transactions are recorded and how assets and liabilities are translated.
• Presentation currency is the currency in which financial statements are presented. It allows standardized reporting across geographies.

Importance of Accurate Functional Currency Determination

Companies must carefully evaluate functional currency based on IFRS guidelines and key indicators such as cash flows, sales prices, financing, and expense settlement currencies. Inaccurate functional currency selection can lead to distorted financial reporting.

Implications for Financial Statement Analysis

Using appropriate functional and presentation currencies significantly impacts trends, ratios, and benchmarks used in financial statement analysis :

• Asset valuation - Translating asset costs into different currencies impacts valuations and depreciation.
• Equity - Foreign currency translation directly flows through to equity on the balance sheet.
• Revenue and margin trends - Top-line growth and profitability metrics are skewed by currency swings. Normalizing currency effects is critical for accurate analysis.

Proper determination and application of functional and presentation currencies as dictated by IFRS is vital for financial reporting quality and cross-border financial analysis.

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What’s a functional and presentation currency under IAS 21?

When preparing financial statement a company must determine its functional and presentation currencies.

The functional currency is the currency of the primary economic environment where the entity operates, in most cases this will be the local currency (e.g. Euro in Ireland, GBP in UK)

When determining the functional currency, an entity should consider the following factors:

Primary factors

• The currency than mainly influences sales prices for goods and services
• The currency of the country whose competitive forces and regulations mainly determine the sales price of goods and services
• The currency that mainly influences labour, material and other costs of providing goods and services.

Secondary factors

• The currency from which issuing debt and equity is generated
• The currency in which receipts from operating activities are usually retained

What’s a presentation currency?

The presentation currency is the currency in which the entity presents its financial statements and this may be different from the functional currency, (e.g. If the entity in question is a foreign owned subsidiary. It may have to present its financial statements in the currency of the parent company, even though that is different from their normal trading currency).

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CPD technical article

01 March 2009

IAS 21 the effects of changes in foreign exchange rates

Multiple-choice questions

Graham Holt

Graham holt explains the importance of exchange rates when it comes to accounting for any transactions carried out in foreign currencies, this article was first published in the march 2009 edition of  accounting and business  magazine., studying this technical article and answering the related questions can count towards your verifiable cpd if you are following the unit route to cpd and the content is relevant to your learning and development needs. one hour of learning equates to one unit of cpd. we'd suggest that you use this as a guide when allocating yourself cpd units..

The purpose of IAS 21 is to set out how to account for transactions in foreign currencies and foreign operations.

The standard shows how to translate financial statements into a presentation currency, which is the currency in which the financial statements are presented. This contrasts with the functional currency, which is the currency of the primary economic environment in which the entity operates.

Key issues are the exchange rates, which should be used, and where the effects of changes in exchange rates are recorded in the financial statements.

Functional currency is a concept that was introduced into IAS 21, The Effects of Changes in Foreign Exchange Rates , when it was revised in 2003. The previous version of IAS 21 used a concept of reporting currency. In revising IAS 21 in 2004, the IASB’s main aim was to provide additional guidance on the translation method and determining the functional and presentation currencies.

The functional currency should be determined by looking at several factors. This currency should be the one in which the entity normally generates and spends cash, and that in which transactions are normally denominated. All transactions in currencies other than the functional currency are treated as transactions in foreign currencies.

The entity’s functional currency reflects the transactions, events and 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 transactions and relevant conditions and events. Foreign currency transactions should initially be recorded at the spot rate of exchange at the date of the transaction. An approximate rate can be used. Subsequently, at each balance sheet date, foreign currency monetary amounts should be reported using the closing rate. Non-monetary items measured at historical cost should be reported using the exchange rate at the date of the transaction. Non-monetary items carried at fair value, however, should be reported at the rate that existed when the fair values were determined.

Exchange differences arising on monetary items are reported in profit or loss in the period, with one exception. The exception is that exchange differences arising on monetary items that form part of the reporting entity’s net investment in a foreign operation are recognised in the group financial statements, within a separate component of equity. They are recognised in profit or loss on disposal of the net investment. If a gain or loss on a non-monetary item is recognised in equity (for example, property, plant and equipment revalued under IAS 16), any foreign exchange gain or loss element is also recognised in equity.

Presentation currency and functional currency

An entity can present its financial statements in any currency. If the presentation currency differs from the functional currency, the financial statements are retranslated into the presentation currency. If the financial statements of the entity are not in the functional currency of a hyperinflationary economy, then they are translated into the presentation currency as follows:

• Assets and liabilities (including any goodwill arising on the acquisition and any fair value adjustment) are translated at the closing spot rate at the date of that balance sheet
• Income statements are translated at the spot rate at the date of the transactions (average rates are allowed if there is no great fluctuation in the exchange rates)
• All exchange differences are recognised in a separate component of equity.

At the entity level, management should determine the functional currency of the entity based on the requirements of IAS 21.

An entity does not have a choice of functional currency. All currencies, other than the functional one, are treated as foreign currencies. An entity’s management may choose a different currency from its functional one – the presentation currency – in which to present financial statements.

At the group level, various entities within a multinational group will often have different functional currencies. The functional currency is identified at entity level for each group entity. Each group entity translates its results and financial position into the presentation currency of the reporting entity.

Normal consolidation procedures are followed for the preparation of the consolidated financial statements, once all the consolidated entities have prepared their financial information in the appropriate presentation currency.

Translation of a foreign operation

When preparing group accounts, the financial statements of a foreign subsidiary should be translated into the presentation currency as set out above. Any goodwill and fair value adjustments are treated as assets and liabilities of the foreign entity, and therefore retranslated at each balance sheet date at the closing spot rate.

Exchange differences on intra-group items are recognised in profit or loss, unless they are a result of the retranslation of an entity’s net investment in a foreign operation when it is classified as equity.

Dividends paid in a foreign currency by a subsidiary to its parent firm may lead to exchange differences in the parent’s financial statements. They will not be eliminated on consolidation, but recognised in profit or loss. When a foreign operation is disposed of, the cumulative amount of the exchange differences in equity relating to that foreign operation is recognised in profit or loss when the gain or loss on disposal is recognised.

The notion of a group functional currency does not exist under IFRS; functional currency is purely an individual entity or business operation-based concept. This has resulted in IAS 21 becoming one of the more complex standards for firms converting to IFRS.

In addition, many multinational groups have found the process time-consuming and challenging, particularly when considering non-trading group entities where the standard’s emphasis on external factors suggests that the functional currency of corporate subsidiaries might well be that of the parent, regardless of their country of incorporation or the currency in which their transactions are denominated.

Entities applying IFRS need to remember that the assessment of functional currency is a key step when considering any change in the group structure or when implementing any new hedging or tax strategies. Furthermore, should the activities of the entity within the group change for any reason, the determination of the functional currency of that entity should be reconsidered to identify the changes required. Management must take care to document the approach followed in the determination of functional currency for each entity within the group, using a consistent methodology across all cases, particularly when an exercise of judgment is required.

Case study 1

An entity, with the dollar as its functional currency, purchases plant from a foreign entity for €18m on 31 May 2008 when the exchange rate was €2 to $1. The entity also sells goods to a foreign customer for €10.5m on 30 September 2008, when the exchange rate was €1.75 to $1. At the entity’s year end of 31 December 2008, both amounts are still outstanding and have not been paid. The closing exchange rate was €1.5 to $1. The accounting for the items for the period ending 31 December 2008 would be as follows:

The entity records the plant and liability at $9m at 31 May 2008. At the year-end, the amount has not been paid. Thus using the closing rate of exchange, the amount payable would be retranslated at $12m, which would give an exchange loss of $3m in profit or loss. The asset remains at $9m before depreciation.

The entity will record a sale and trade receivable of $6m. At the year-end, the trade receivable would be stated at $7m, which would give an exchange gain of $1m that would be reported in profit or loss. IAS 21 does not specify where exchange gains and losses should be shown in the statement of comprehensive income.

Case study 2

An entity has a 100%-owned foreign subsidiary, which has a carrying value at a cost of $25m. It sells the subsidiary on 31 December 2008 for €45m. As at 31 December 2008, the credit balance on the exchange reserve, which relates to this subsidiary, was $6m. The functional currency of the entity is the dollar and the exchange rate on 31 December 2008 is $1 to €1.5. The net asset value of the subsidiary at the date of disposal was $28m.

The subsidiary is sold for $45m divided by 1.5 million, therefore $30m. In the parent entity’s accounts a gain of $5m will be shown. In the group financial statements, the cumulative exchange gain in reserves will be transferred to profit or loss, together with the gain on disposal. The gain on disposal is $30m minus $28m, therefore $2m, which is the difference between the sale proceeds and the net asset value of the subsidiary. To this is added the exchange reserve balance of $6m to give a total gain of $8m, which will be included in the group statement of comprehensive income.

Graham Holt is an ACCA examiner and principal lecturer in accounting and finance at Manchester Metropolitan University Business School

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Annual Reporting

Knowledge base for IFRS Reporting

IAS 21 Presentation currency

Ias 21 the effects of changes in foreign exchange rates, use of a presentation currency other than the functional currency, translation to the presentation currency.

38 An entity may present its financial statements in any currency (or currencies). If the presentation currency differs from the entity’s functional currency , it translates its results and financial position into the presentation currency . For example, when a group contains individual entities with different functional currencies, the results and financial position of each entity are expressed in a common currency so that consolidated financial statements may be presented.

39 The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

• assets and liabilities for each statement of financial position presented (ie including comparatives) shall be translated at the closing rate at the date of that statement of financial position;
• income and expenses for each statement presenting profit or loss and other comprehensive income (ie including comparatives) shall be translated at exchange rates at the dates of the transactions; and
• all resulting exchange differences shall be recognised in other comprehensive income .

40 For practical reasons, a rate that approximates the exchange rates at the dates of the transactions, for example an average rate for the period, is often used to translate income and expense items. However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate.

41 The exchange differences referred to in paragraph 39(c) result from:

• translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate .
• translating the opening net assets at a closing rate that differs from the previous closing rate .

These exchange differences are not recognised in profit or loss because the changes in exchange rates have little or no direct effect on the present and future cash flows from operations. The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation .

When the exchange differences relate to a foreign operation that is consolidated but not wholly-owned, accumulated exchange differences arising from translation and attributable to non-controlling interests are allocated to, and recognised as part of, non-controlling interests in the consolidated statement of financial position.

42 The results and financial position of an entity whose functional currency is the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

• all amounts (ie assets, liabilities, equity items, income and expenses , including comparatives) shall be translated at the closing rate at the date of the most recent statement of financial position, except that
• when amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts shall be those that were presented as current year amounts in the relevant prior year financial statements (ie not adjusted for subsequent changes in the price level or subsequent changes in exchange rates).

43 When an entity’s functional currency is the currency of a hyperinflationary economy, the entity shall restate its financial statements in accordance with IAS 29 before applying the translation method set out in paragraph 42, except for comparative amounts that are translated into a currency of a non-hyperinflationary economy (see paragraph 42(b)).

When the economy ceases to be hyperinflationary and the entity no longer restates its financial statements in accordance with IAS 29, it shall use as the historical costs for translation into the presentation currency the amounts restated to the price level at the date the entity ceased restating its financial statements.

Translation of a foreign operation

44 Paragraphs 45–47, in addition to paragraphs 38–43, apply when the results and financial position of a foreign operation are translated into a presentation currency so that the foreign operation can be included in the financial statements of the reporting entity by consolidation or the equity method .

45 The incorporation of the results and financial position of a foreign operation with those of the reporting entity follows normal consolidation procedures, such as the elimination of intragroup balances and intragroup transactions of a subsidiary (see IFRS 10 Consolidated Financial Statements ).

However, an intragroup monetary asset (or liability ), whether short-term or long-term, cannot be eliminated against the corresponding intragroup liability (or asset) without showing the results of currency fluctuations in the consolidated financial statements . This is because the monetary item represents a commitment to convert one currency into another and exposes the reporting entity to a gain or loss through currency fluctuations.

Accordingly, in the consolidated financial statements of the reporting entity , such an exchange difference is recognised in profit or loss or, if it arises from the circumstances described in paragraph 32, it is recognised in other comprehensive income and accumulated in a separate component of equity until the disposal of the foreign operation .

46 When the financial statements of a foreign operation are as of a date different from that of the reporting entity , the foreign operation often prepares additional statements as of the same date as the reporting entity ’s financial statements.

When this is not done, IFRS 10 allows the use of a different date provided that the difference is no greater than three months and adjustments are made for the effects of any significant transactions or other events that occur between the different dates.

In such a case, the assets and liabilities of the foreign operation are translated at the exchange rate at the end of the reporting period of the foreign operation .

Adjustments are made for significant changes in exchange rates up to the end of the reporting period of the reporting entity in accordance with IFRS 10. The same approach is used in applying the equity method to associates and joint ventures in accordance with IAS 28 (as amended in 2011).

47 Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation shall be treated as assets and liabilities of the foreign operation . Thus they shall be expressed in the functional currency of the foreign operation and shall be translated at the closing rate in accordance with paragraphs 39 and 42.

Disposal or partial disposal of a foreign operation

48 On the disposal of a foreign operation , the cumulative amount of the exchange differences relating to that foreign operation , recognised in other comprehensive income and accumulated in the separate component of equity , shall be reclassified from equity to profit or loss (as a reclassification adjustment) when the gain or loss on disposal is recognised (see IAS 1 Presentation of Financial Statements (as revised in 2007)).

48A In addition to the disposal of an entity’s entire interest in a foreign operation , the following partial disposals are accounted for as disposals:

• when the partial disposal involves the loss of control of a subsidiary that includes a foreign operation , regardless of whether the entity retains a non-controlling interest in its former subsidiary after the partial disposal; and
• when the retained interest after the partial disposal of an interest in a joint arrangement or a partial disposal of an interest in an associate that includes a foreign operation is a financial asset that includes a foreign operation .

48B On disposal of a subsidiary that includes a foreign operation , the cumulative amount of the exchange differences relating to that foreign operation that have been attributed to the non-controlling interests shall be derecognised, but shall not be reclassified to profit or loss .

48C On the partial disposal of a subsidiary that includes a foreign operation , the entity shall re- attribute the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income to the non-controlling interests in that foreign operation .

In any other partial disposal of a foreign operation the entity shall reclassify to profit or loss only the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income .

48D A partial disposal of an entity’s interest in a foreign operation is any reduction in an entity’s ownership interest in a foreign operation , except those reductions in paragraph 48A that are accounted for as disposals.

49 An entity may dispose or partially dispose of its interest in a foreign operation through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity. A write-down of the carrying amount of a foreign operation , either because of its own losses or because of an impairment recognised by the investor, does not constitute a partial disposal. Accordingly, no part of the foreign exchange gain or loss recognised in other comprehensive income is reclassified to profit or loss at the time of a write-down.

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). Individual jurisdictions around the world may require or permit the use of (locally authorised and/or amended) IFRS Standards for all or some publicly listed companies.  The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. The specific status of IFRS Standards should be checked in each individual jurisdiction . Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction .

IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency

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IAS 21 prescribes the accounting for:

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Individual transactions in foreign currencies are initially recorded at the exchange rate prevailing on the date of the transaction. At the date of settlement, cash transferred is recorded at the rate prevailing on the settlement date. Any exchange difference arising is recognised in profit or loss.

The statement of financial position of a foreign operation is translated using the closing rate, being the exchange rate at the reporting date. The statement of profit or loss and other comprehensive income is translated using the exchange rates at the dates of the transactions. Where this is impracticable, an average rate for the year may be used provided that exchange rates do not fluctuate significantly. Exchange differences arising are reported as other comprehensive income.

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Effects of Changes in Foreign Exchange Rates (IAS 21)

Last updated: 13 June 2024

Entities may engage in transactions denominated in foreign currencies. These transactions must be translated into the currency that the company uses to present its financial statements. In addition, a parent company may conduct foreign operations through subsidiaries, associates or joint arrangements. In such cases, the financial statements of these investees need to be translated to the currency used in the consolidated financial statements. Furthermore, an entity may opt to present its financial statements in a currency different from the one used in its economic environment. All these considerations are addressed by IAS 21.

Let’s dive in.

Translating foreign currency transactions

Initial recognition.

Initially, a foreign currency transaction is recognised at the spot exchange rate (i.e., the rate for immediate delivery) between the functional currency and the foreign currency at the date of the transaction (IAS 21.21). A foreign currency transaction is a transaction denominated or requiring settlement in a foreign currency, including transactions arising when an entity (IAS 21.20):

• Buys or sells goods or services priced in a foreign currency,
• Borrows or lends funds with amounts payable or receivable denominated in a foreign currency, or
• Otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.

The transaction date is when the transaction first qualifies for recognition under applicable IFRS standard (IAS 21.22).

IAS 21 permits the use of simplifications in determining the foreign exchange rate, such as using an average rate, as long as exchange rates don’t fluctuate significantly (IAS 21.22). In practice, entities often use the average of monthly rates, as central banks publish these for most currencies.

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Translation at reporting dates

At the end of each reporting period (IAS 21.23):

• Foreign currency monetary items are translated using the closing rate (i.e., the spot exchange rate at the end of the reporting period).
• Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. They are not re-translated using the closing rate.
• Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined.

Specific procedures for translating foreign operations are discussed below.

Monetary and non-monetary items

Monetary items are defined as units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency (IAS 21.8). Common examples of monetary items include trade receivables and payables or loans. Other examples are given in paragraph IAS 21.16.

Non-monetary items lack the right to receive (or the obligation to deliver) a fixed or determinable number of units of currency. Examples of non-monetary items include advance consideration paid or received, goodwill, items of PP&E, intangible assets and inventories (IAS 21.16).

Investments in equity instruments are also non-monetary items (IFRS 9.B5.7.3), but they are measured at fair value and therefore their carrying amount is effectively impacted by foreign exchange movements.

Recognition of exchange differences

As a general rule, exchange differences arising from the settlement or translation of a monetary asset are recognised in P/L (IAS 21.28).

When non-monetary assets are measured at fair value (or revalued amount) in a foreign currency, exchange differences are treated similarly to gains or losses on remeasurement. That is, they can be recognised in other comprehensive income under circumstances specified by other IFRS standards (IAS 21.30-31).

Example: Recognition of exchange differences

Suppose Entity A buys an item of PP&E on 1 January 20X1. Entity A’s functional and presentation currency is the Euro (EUR), but the invoice for the PP&E is for 1,000 US dollars (USD). The EUR/USD exchange rate on 1 January 20X1 is 1.1 (i.e., 1 EUR = 1.1 USD). The invoice is paid on 1 May 20X1 when the EUR/USD rate is 1.2. All calculations used in this example are available for download in an  Excel file .

Entity A would make the following entries in EUR:

As shown, the PP&E item is carried at historical cost and is not subsequently retranslated to reflect exchange rate movements between initial recognition and invoice payment.

Use of multiple exchange rates

When several exchange rates are available, the rate used is the one at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date (IAS 21.26).

Lack of exchangeability

In 2023, the IASB issued amendments to IAS 21 that will require companies to provide more information in their financial statements when a currency cannot be exchanged into another currency, an issue that wasn’t previously covered. The amendments are effective for annual reporting periods beginning from 1 January 2025, with early application permitted. Read more in ​Deloitte’s publication​ .

Advance Consideration (IFRIC 22)

IFRIC Interpretation 22 ‘Foreign Currency Transactions and Advance Consideration’ stipulates that the transaction date for determining the exchange rate used for initial recognition of the related asset, expense, or income is the date an entity first recognises the non-monetary asset or non-monetary liability arising from the payment or receipt of advance consideration (IFRIC 22.8-9).

Exchange differences on borrowings

According to paragraph IAS 23.6(e), borrowing costs may include exchange differences resulting from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Exchange differences on deferred tax

Exchange differences on deferred foreign tax liabilities or assets may be classified as deferred tax expense or income if that presentation is considered to be the most useful to financial statement users (IAS 12.78).

Change in functional currency

A change in functional currency can only occur if there are changes to the underlying transactions, events, and conditions that the functional currency reflects. Any change in functional currency is accounted for prospectively (IAS 21.35-37).

Translating a foreign operation

When an entity within a group uses a different presentation currency from that of the consolidated financial statements, translations are performed using the following procedures as per IAS 21.39:

• Assets, including goodwill and fair value adjustments (IAS 21.47), and liabilities, are translated at the closing rate at the reporting date. This includes comparatives translated using historical rates.
• Income and expenses are translated at exchange rates applicable at the transaction dates. This also includes comparatives translated using historical rates.
• All resulting exchange differences are recognised in other comprehensive income (OCI).

IAS 21.40 allows for simplifications in determining the foreign exchange rate, for example, using an average rate, assuming exchange rates do not significantly fluctuate. In practice, an average rate for each month is most commonly used.

Cumulative translation adjustment (CTA)

Exchange differences referred to in IAS 21.39(c) are commonly identified as either ‘Cumulative Translation Adjustment’ (CTA) or ‘Foreign Currency Translation Reserve’ (FCTR). The two primary sources for CTA, as per IAS 21.41, include:

• Translating income and expenses at the transaction date exchange rates, while assets and liabilities are translated at the closing rate.
• Translating opening assets and liabilities at a closing rate that differs from the opening rate.

CTA is recognised in OCI, presented as a distinct item within equity, and not recycled to P/L until the foreign operation is disposed of. CTA is further divided between controlling and non-controlling interests (IAS 21.41). It is also recognised in OCI for investments accounted for using the equity method (IAS 21.44).

Example: Illustrative translation of a foreign operation

Consider Group A with the Euro as its presentation currency. Entity X, one of Group A’s subsidiaries, uses the US Dollar as its presentation currency. The following EUR/USD exchange rates apply:

• Opening rate at 1 January 20X1: 1.1
• Average rate in 20X1: 1.2
• Closing rate at 31 December 20X1: 1.3

All calculations and tables presented in this example can be downloaded in an Excel file .

Entity X is consolidated to Group A consolidated financial statements as follows:

Entity X stand-alone data

Statement of financial position in USD:

P/L in USD:

Consolidation of Group A

Consolidated statement of financial position in EUR at 1 January 20X1:

Consolidated statement of financial position in EUR at 31 December 20X1:

Consolidated P/L for 20X1 in EUR:

Intragroup balances

Exchange differences on intragroup balances.

Although intragroup balances are eliminated during consolidation, any exchange differences arising from those balances are not. This is because the group is effectively exposed to foreign exchange gains and losses, even on intragroup transactions, including dividend receivables and payables (IAS 21.45).

Goodwill considerations

Goodwill, as previously stated, is considered an asset of a foreign operation and is retranslated at each reporting date. For multinational group acquisitions, goodwill should be allocated to each functional currency level of the acquired foreign operation (IAS 21.BC32).

Net investment in a foreign operation

A net investment in a foreign operation represents the reporting entity’s interest in the net assets of that operation (IAS 21.8). Monetary items receivable from, or payable to, a foreign operation, where settlement is neither planned nor likely to occur in the foreseeable future, are treated as part of the entity’s net investment in that operation (IAS 21.15-15A). Exchange differences arising from such monetary items are recognised in P/L in separate financial statements, but in OCI (as part of CTA) in consolidated financial statements (IAS 21.32-33).

Disposal or partial disposal of a foreign operation

Upon disposing of a foreign operation, the cumulative amount of exchange differences relating to that operation, recognised in OCI and accumulated in the separate component of equity (i.e. CTA), is reclassified from equity to P/L (as a reclassification adjustment ) when the gain or loss on disposal is recognised (IAS 21.48). Furthermore, paragraph IAS 21.48A outlines accounting procedures for partial disposals.

Translation from the currency of a hyperinflationary economy

IAS 21.42-43 provides specific provisions for translating from the currency of a hyperinflationary economy.

Functional and foreign currencies

Defining functional and foreign currencies.

The functional currency is defined as the currency of the primary economic environment in which an entity operates, i.e. primarily generates and spends cash. IAS 21.9-10 details the factors that should be considered in determining an entity’s functional currency.

The foreign currency, as defined by IAS 21.8, is any currency that is different from the entity’s functional currency.

Functional currency of a foreign operation

Identifying the functional currency can be particularly complex when a reporting entity is a foreign operation of another entity and fundamentally an extension of its operations. For instance, a ‘financial’ subsidiary (i.e., a subsidiary primarily holding financial assets or issuing debt) whose core financial assets and liabilities are denominated in the parent’s functional currency may have the same functional currency as the parent, regardless of its operational country. IAS 21.11 outlines additional factors to be considered when determining the functional currency of a foreign operation. If these indicators are mixed, priority is given to the primary indicators described in IAS 21.9.

Use of a presentation currency other than the functional currency

The rules regarding the translation of a foreign operation are equally applicable to the use of a presentation currency that is different from the functional currency.

Presentation in financial statements

IAS 21 does not specify in which part of the income statement foreign exchange differences should be presented. Therefore, entities must develop an accounting policy. The most common approach is to report exchange differences in the same section of the income statement where the original income or expense was (or will be) recognised for the item that subsequently led to exchange differences. For example, exchange differences on trade receivables are presented within operating profit, while exchange differences on debt are presented within finance costs. This method aligns with the one mandated by IFRS 18 .

Cash flows in foreign currency

IAS 21 does not cover the statement of cash flows as it falls under the scope of IAS 7. This includes the presentation of cash flows resulting from transactions in a foreign currency and the translation of cash flows from a foreign operation (IAS 21.7).

The disclosure requirements are provided in IAS 21.51-57.

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IAS 21 The Effects of Changes in Foreign Exchange Rates

These days people use about 180 currencies world wide!

The truth is that  we, people, don’t want to stay isolated.  We love to sell, buy, import, export, trade together and do many other things,  all in foreign currencies!

When you look at the business world, you’ll see that business go global in two ways: they either have individual transactions in foreign currencies, or when they grow bigger, they often set up foreign operations (separate business abroad).

Moreover, the exchange rates change every minute. So how to bring a bit of organization into this currency mix-up? That’s why there is the standard IAS 21 The Effects of Changes in Foreign Exchange Rates.

What is the objective of IAS 21?

The objective of IAS 21 The Effects of Changes in Foreign Exchange Rates is to prescribe:

• How to include foreign currency transactions and foreign operations in the financial statements of an entity; and
• How to translate financial statements into a presentation currency .

In other words, IAS 21 answers 2 basic questions:

• What exchange rates shall we use?
• How to report gains or losses from foreign exchange rates in the financial statements?

Functional vs. Presentation Currency

IAS 21 defines both functional and presentation currency and it’s crucial to understand the difference:

Functional currency is the currency of the primary economic environment in which the entity operates. It is the own entity’s currency and all other currencies are “foreign currencies”.

Presentation currency is the currency in which the financial statements are presented.

In most cases, functional and presentation currencies are the same.

Also, while an entity has only 1 functional currency, it can have 1 or more presentation currencies, if an entity decides to present its financial statements in more currencies.

You also need to realize that an entity can actually choose its presentation currency , but it CANNOT choose its functional currency. The functional currency needs to be determined by assessing several factors.

How to determine functional currency

The most important factor in determining the functional currency is the entity’s primary economic environment in which it operates. In most cases, it will be the country where an entity operates, but this is not necessarily true.

The primary economic environment is normally the one in which the entity primarily generates and expends the cash . The following factors can be considered:

• What currency does mainly influence sales prices for goods and services?
• In what currency are the labor, material and other costs denominated and settled?
• In what currency are funds from financing activities generated (loans, issued equity instruments)?
• And other factors, too.

Sometimes, sales prices, labor and material costs and other items might be denominated in various currencies and therefore, the functional currency is not obvious.

In this case, management must use its judgment to determine the functional currency that most faithfully represents the economic effects of the underlying transactions, events and conditions.

How to report transactions in Functional Currency

Initial recognition.

Initially , all foreign currency transactions shall be translated to functional currency by applying the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.

The date of transaction is the date when the conditions for the initial recognition of an asset or liability are met in line with IFRS.

Subsequent reporting

Subsequently, at the end of each reporting period , you should translate:

• All monetary items in foreign currency using the closing rate ;
• All non-monetary items measured in terms of historical cost using the exchange rate at the date of transaction ( historical rate );
• All non-monetary items measured at fair value using the exchange rate at the date when the fair value was measured.

How to report foreign exchange differences

All exchange rate differences shall be recognized in profit or loss , with the following exceptions:

• Exchange rate gains or losses on non-monetary items are recognized consistently with the recognition of gains or losses on an item itself.For example, when an item is revalued with the changes recognized in other comprehensive income, then also exchange rate component of that gain or loss is recognized in OCI, too.
• In the separate entity’s  or foreign operation’s financial statements: in profit or loss ;
• In the consolidated financial statements: initially in other comprehensive income and subsequently, on disposal of net investment in the foreign operation, they shall be reclassified to profit or loss .

Change in functional currency

When there is a change in a functional currency, then the entity applies the translation procedures related to the new functional currency prospectively from the date of the change.

How to translate financial statements into a Presentation Currency

When an entity presents its financial in the presentation currency different from its functional currency, then the rules depend on whether the entity operates in a non-hyperinflationary economy or not.

Non-hyperinflationary economy

When an entity’s functional currency is NOT the currency of a hyperinflationary economy, then an entity should translate:

• All assets and liabilities for each statement of financial position presented (including comparatives) using the closing rate at the date of that statement of financial position. Here, this rule applies for goodwill and fair value adjustments , too.
• All income and expenses and other comprehensive income items (including comparatives) using the exchange rates at the date of transactions. Standard IAS 21 permits using some period average rates for the practical reasons, but if the exchange rates fluctuate a lot during the reporting period, then the use of averages is not appropriate.

All resulting exchange differences shall be recognized in other comprehensive income as a separate component of equity.

However, when an entity disposes the foreign operation, then the cumulative amount of exchange differences relating to that foreign operation shall be reclassified from equity to profit or loss when the gain or loss on disposal is recognized.

Hyperinflationary economy

When an entity’s functional currency IS the currency of a hyperinflationary economy, then the approach slightly changes:

• The entity’s current year’s financial statements are restated first, as required by IAS 29 Financial Reporting in Hyperinflationary Economies. Comparative figures are used the same as current year’s figures in the financial statements from previous reporting period.
• Only then, the same procedures as described above are applied.

IAS 21 prescribes the number of disclosures, too. Please watch the following video with the summary of IAS 21 here:

Have you ever been unsure what foreign exchange rate to use? Please comment below this video and don’t forget to share it with your friends by clicking HERE. Thank you!

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235 Comments

Thank you dear Silvia for I’m inspired a lot from your lecture.

Inventory & Foreign Exchange Rate. What happened if inventory which was purchased with foreign currency is required to be recorded based on NRV, do we need to record changes in the exchange rates at closing date?

Hi Silvia, thanks for the always helpful articles and videos. I read/watched both this article and the article about translating entities to a presentation currency. If one applies these rules to companies within the same group (eg holding company makes prepayments to a subsidiary who then sells a service back to the holding company where holding company and subsidiary have different functional currencies) does it make sense that one would then end up with an intercompany imbalances between the prepaid asset and prepaid liability and so to “balance” the intercompany elimination entry one would take the imbalance to the FCTR/CTR?

Hi Silvia I am currently doing a research study on this Standard may you kindly assist.

Hi explain how realized and unrealized exchange gain or loss come up.if I have a foreign bank account balance and at the reporting date I translate the closing rate to functional currency will the difference be realized or unrealized

Realized. By the way – IFRS do not know the term “unrealized” FX differences. Once you are required to revalue at some reporting date, these differences are realized because you need to recognize them in your financial statements (through profit or loss).

Good job Silvia. Please how do I reference this your good work

Hi. Thank you for the great article. Question tho – Are there exceptions to the rule which says that exchange difference arising from the conversion of functional to presentation currency should be recorded in OCI?

Hi, In a hyperinflation environment, what will be the appropriate rate to value inventory that were imported . the rate at the date of the LC or the rate at the day of settlement?

Hello Sylvia. How to treat currency exchange effect when the upper edge of currency is frozen per contract? For example i have liability in foreign currency, but no more then 3. How to treat effect when exchange rate becomes 3.2? Could you provide some reference from standards? Also i think that it has to be ifrs 9 issue Thanks in advance

Thank you Silvia for your illustration, I have a question regarding functional currency , if we have a entity that has a functional currency in US Dollar but chose to present financial statements in EUR for stock market, in this case does it need to translate the financial statements using the rules that are applied when translating from foreign operations to presentation currency ? Thanks in advance

Hi Silvia. Thank you for your article. I would like to seek guidance on the settlement of foreign currency translation reserve. I encounter a problem where the company functional currency has cleared to zero balance, but there are still some balances in the forex translation reserve. What are the possible reasons causing the remaining balances in the reserve and how to deal with it? I look forward for your reply, thank you.

Hi Silvia, Thank you for your article. I have one specific question: I have been told like this “Under IAS -21 each company shall prepare separate financial statement on the basis of functional currency and parent shall follow presentation currency in Consolidated FS”

My Query is : I have one Company only. I don’t want to touch Consolidation Part. My Company is in Oman and our functional currency is OMR. But management intends to present the FS in USD as well for the shake of potential investors who prefer to read USD. Or, say for any other purpose. Can we apply IAS 21 Translation of FS from OMR to USD in Case of Standalone FS ?

Hi, How is the industry practice to convert the (1) Stated Capital (2) Retained Earnings Opening Balance ? in the absence of specific guideline in the standard. Would you be able to help me with that ?

I mean when the Financials are converted to another presentation currency ?

Hi Randika, please read this . S.

Dear Silvia,

First of all thank you for all of your articles. I love to read them.

I am writing my thesis and my teacher said that when there was any decrease in equity (like dividend, capital decrease) I should not have translated these transactions with historical rate (the exchange rate at the date of transaction) because the equity should have been decreased like inventory with FIFO or average cost. It is logical, but I have not found any example for that . Do you have maybe an article where it is clearly explained?

Thank you in advance!

Hi Eva, well, there is no guidance on translating the equity items and there are multiple ways of doing it. So perhaps your teacher should explain why she/he thinks that historical cost is the best option. Please try looking here, too. I explained more about translating equity items.

Dear Silvia, Thank you very much for your explanation in the video, it was very helpful, I have a query that I was hoping you could help me, is there a way to calculate the CTD other than by difference or is there a method where we can test if the CTD is determined correctly?

I look forward reading your opinion and response. Thanks in advance!

Hi Silvia, I have a question on this topic. What happens if an entity located in Kenya, with EUR functional currency and KES presentation currency, has bank balances as of the reporting date in the bank accounts in KES? I mean, does the company have to recognize the fx differences to convert first the KES to EUR and then again to translate the EUR to KES because KES is the presentation currency? it would look weird… is it necessary to do it? is it stated anywhere in the IFRS? Thanks in advance. Regards.

Hi, Would a derivative (OTC Forward) be a non-monetary items measured at fair value and therefore use a daily FX rate until it is settled? Would this result in a discrepancy between BS and P&L reporting value? Thanks.

Dear Silvia, Please let me clarify the following situation below: (using fictitious company’s name and numbers including exchange rate for a simple explanation purpose)

I prepare an annual budget of ABC company. It has H/O estimated sales JPY 1000 for Jan, JPY 2000 for Feb, JPY 3000 for March in profit and loss (PL). At the same time, I recognise JPY 1000 for Jan, JPY 3000 (1000+2000) for Feb, and JPY 6000 (1000+2000+3000) as account receivable in Balance Sheet (BS) . As ABC company’s functional & presentational currency is EUR so I translate into EUR. Using average rate let’s say 1EUR=100 YEN, ABC company’s budget sales in PL shows EUR 10 for Jan, EUR 20 for Feb and EUR 30 March. At the same time, using same late average rate as accounting team suggested, (not closing period rate), ABC company’s budget account receivable in BS shows EUR 10 for Jan, EUR 30 for Feb and EUR 60 for March. But I wonder if we use a basic knowledge, when translating items in BS such as account receivable, then we should use closing rate let’s say 1 EUR =110 JPY so it will be EUR 9 for Jan In BS and so on. If I use closing rate then sale figure and account receivable in the same month shows different figures and this is an inconsistency.(sale EUR 10 in PL and Account receivable EUR 9 in BS for Jan)

Could you please give me your advice which rate to use in PL and BS in this case? Thank you for your time in advance.

Hi Silvia, How is profit repatriation from a foreign branch / operation accounted for in the financial statements?

Hi Silvia, I would like to get some clarification on this : –

“For income and expenses and other comprehensive income items (including comparatives) using the exchange rates at the date of transactions.’

i) Let say Company A have a few sales transaction in foreign currency. So during year end closing, Company A would only have recalculate the receivable part ( monetary asset) using the latest foreign exchange rate. For sales revenue that was recognized early in the year using spot exchange rate, no action needed ?

ii) How should the forex gain / loss on receivables be recognized during year end close ? Seems not proper to recognized it directly to P&L as it is still unrealized forex gain / loss ?

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The Effects of Changes in Foreign Exchange Rates

Determining an entity’s functional currency, determining the functional currency of a foreign operation, and dealing with a change in such a currency.

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IAS 21 The Effects of Changes in Foreign Exchange Rates provides guidance to determine the functional currency of an entity under International Financial Reporting Standards (IFRS). The standard also prescribes how to include foreign currency transactions and foreign operations in the financial statements of an entity and how to translate financial statements from the entity’s functional currency into its presentation currency. This factsheet will delve into determining an entity’s functional currency, determining the functional currency of a foreign operation, and dealing with a change in the said functional currency.

Definition and determination of functional currency

The functional currency is the currency in which an entity records and measures its transactions, in other words, the currency in which it maintains its accounting records. It is determined by reference to the currency of the primary economic environment in which that entity operates. To determine the functional currency an entity needs to consider various factors, which IAS 21 splits into 2 categories, that is the primary and the secondary factors.

The primary factors that an entity needs to consider are the following:

• the currency that mainly influences the sales prices for the goods and services, which will often be the currency in which sales prices for its goods and services are denominated and settled; 
• the currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services; and
• the currency that mainly influences labour, material and other costs of providing goods or services, which normally is the currency in which such costs are denominated and settled.

Very often, the application of points (a) and (b) above to gaming entities, does not give a straightforward interpretation of what that gaming entity’s functional currency is. This is because a company with a gaming licence in a specific country, would have the facility to operate in several different jurisdictions , which could result in having revenues denominated in various currencies .

With respect to point (c), the management of the gaming entity would need to look at the location where its labour force is operating, the currency used to settle their respective salaries and any other costs it would be incurring. 

The following secondary factors should also be considered to provide additional evidence of an entity’s functional currency:

• the currency in which funds from financing activities are generated; and
• the currency in which receipts from operating activities are usually retained.

In view of the fact that an analysis of the primary factors may not be definitive in determining the functional currency for a gaming entity, management is required to carry out an assessment taking also into consideration the above-mentioned secondary factors. Management is required to assess the funding obtained by the gaming entity and how the receipts from its operating activities are retained. 

Therefore, to determine the functional currency of an entity management is required to carry out an assessment, taking into consideration the above mentioned primary and secondary indicators, which most faithfully represent the economic effects of the underlying transactions, events and conditions pertaining to the entity. When the above indicators are mixed and therefore do not give a clear indication of the entity’s functional currency, management must exercise its judgement and, especially where gaming entities are concerned, give more weight to the secondary indicators.

Functional currency of a foreign operation

The term ‘foreign operation’ includes subsidiaries, associates, joint ventures or branches of a reporting entity, and which activities are based or conducted in a country or currency other than those of the reporting entity. IAS 21 requires an assessment to determine whether the foreign operation ‘inherits’ the reporting entity’s functional currency, or whether it has a functional currency in its own right. The following additional factors are considered when determining the functional currency, and whether its functional currency is the same as that of the reporting entity:

• Autonomy - Whether the operation is essentially an extension of the reporting entity. 
• Proportion of transactions – Whether the foreign operation’s transactions with the reporting entity constitute a high or low proportion of the operation’s activities.
• Proportion of cash flows – Whether cash flows from the activities of the foreign operation directly affect the cash flows of the reporting entity and are readily available for remittance to it. 
• Debt service – Whether a foreign operation’s cashflow can service its debt obligations without funds being made available by the reporting entity. 

As described above, an entity’s functional currency reflects the underlying transactions, events and conditions that are relevant to it. Hence, once determined, the functional currency does not change unless there is a change in the underlying nature of the transactions and relevant conditions and events. For example, a change in the currency that mainly influences the sales prices of the goods and services following a relocation of a significant component of the entity’s business may led to a change in an entity’s functional currency.

The effect of a change in the functional currency is accounted for prospectively. Therefore, an entity translates all items into the new functional currency using the exchange rate at the date of change. The resulting translated amounts for non-monetary items are treated as their historical cost. Exchange differences arising from the translation of a foreign operation previously recognised in other comprehensive income are not reclassified from equity to profit and loss until the disposal of the operation.

The responsibility to determine the functional currency lies with the entity’s management, yet it is also the responsibility of the auditors to review critically and exercise professional judgement and scepticism, to ensure that the assessment made by management is appropriate and in accordance with IAS 21 principles.

IAS 21 – Determining the functional currency under IFRS.

Accounting challenges can arise as a result of developments in underlying accounting requirements.

Accounting challenges can arise as a result of developments in accounting requirements.

Jonathan Dingli

Partner, Corporate Accounting Advisory Services

KPMG in Malta

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Accounting And Foreign Exchange – What To Look Out For

In the simplest of worlds, there would be one global currency.

In the simplest of companies you work on, most probably the file is organised, the company has no foreign currency exposure, and the client speaks your language.

Today’s article focuses on the main aspects to be on the lookout for when entities are exposed to foreign currencies.

The first distinction to make is that between three terms that tend to be confusing, that is – functional currency, presentation currency and foreign currency:

Functional Currency is the currency of the primary economic environment in which the entity operates.

Any currency in the world which is not the functional currency of an entity is a Foreign Currency

Presentation Currency is the currency in which the financial statements are presented.

Functional Currency

The determination of the functional currency is one of the crucial matters to determine before starting to work on any file. IAS 21 ‘The Effects Of Changes in Foreign Exchange Rates’ guides preparers in relation to how to determine the functional currency.

The primary indicators of the functional currency are the currencies that affect the sales price and costs of an organisation. Since the assessment of the primary indicators may not enable preparers to arrive at a conclusion in relation to which is the functional currency of an entity, the standards provides secondary factors. Such secondary factors include the currency of the entity’s financing activities and the currency in which receipts from operating activities are usually accumulated.

When determining the functional currency of a foreign operation, there are additional factors which are also listed in IAS 21, such as whether the foreign operation is autonomous from the reporting entity, or not.

In any case, the determined functional currency should be the currency in which the books of account are kept. Any other currencies in which the entity deals with are foreign currencies.

Presentation Currency

The presentation currency is the currency in which the financial statements of an entity are presented. This is an accounting policy choice under IAS 21. The entity is free to choose the currency in which to present to its shareholders. In general, the simplest solution would be to present financial statements in the same currency as the functional currency.

However, it’s imperative to stress that the Maltese Companies Act requires that the accounts are presented in the same currency as the share capital. As a result, there isn’t a choice for preparers.

Changes In Functional And Presentation Currency

In the rare eventuality of a change in functional currency, the change is made prospectively, and all figures are converted at the date of the change, including share capital.

Since the choice of the presentation currency is technically an accounting policy choice, it follows that a change in presentation currency is a change in accounting policy. As a result, the change needs to be reflected retrospectively, just like other changes in accounting policy.

Exchange Rate Selection

There are two main sets of rules when selecting exchange rates:

• Rules for booking transactions in foreign currency.
• Rules for other situations.

Transactions In Foreign Currency

Even though the entity has selected its functional currency, the entity may still enter into foreign currency transactions. For instance, a EUR company might purchase goods in USD. Such transactions are foreign currency transactions.

The exchange rate to use for transactions entered into is the rate at the date of the transaction. An average rate for the period is permitted insofar as this doesn’t distort the figures. The complication arises at the reporting date. The entity needs to distinguish between monetary and non-monetary items. Monetary items are those that will result in a settlement in a fixed or determinable number of units of currency (such as cash balances, debtors and creditors) whilst non-monetary items are all other items (such as property, inventory and shares). At the reporting date, all monetary items are translated at the exchange rate of that day, whilst non-monetary items are not retranslated from the historical exchange rate (that is, from the rate at the date of initial recognition).

Differences on transactions are recognised in profit or loss – retranslations result in unrealised exchange movements whilst gains or losses upon settlement result in realised exchange movements.

Other Situations

There are other situations requiring different treatment, whereby assets and liabilities are converted at the closing rates, irrespective of whether they’re monetary or not. Income statement items are converted at actual (or average) rates, just like with transactions in foreign currency. In this case, differences are recognised in the exchange fluctuation reserve.

Such situations include:

• The process of converting from the functional currency of an entity to its presentation currency.
• The process of converting a foreign operation into the presentation currency of the reporting entity.

Should you wish to discuss further our IFRS team would be happy to assist you.

Contact us on  [email protected]

Disclaimer  –  Please note that this article is intended for information purposes only and whilst utmost care has been taken to ensure a correct application and interpretation of IFRS rules, Zampa Debattista shall bear no responsibility legal or otherwise, for misuse.

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Currency Translation: Accounting Methods, Risks, and Examples

Daniel Liberto is a journalist with over 10 years of experience working with publications such as the Financial Times, The Independent, and Investors Chronicle.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

What Is Currency Translation?

Currency translation is the process of converting one currency in terms of another, often in the context of the financial results of a parent company's foreign subsidiaries into its functional currency —the currency of the primary economic environment in which an entity generates and expends cash flows.

For transparency purposes, companies with overseas ventures are, when applicable, required to report their accounting figures in one currency.

Key Takeaways

• Currency translation allows a company with foreign operations or subsidiaries to reconcile all of its financial statements in terms of its local, or functional currency.
• Currency translations use the exchange rate at the end of the reported period for assets and liabilities, the exchange rate on the date that income or an expense was recognized for the income statement, and a historical exchange rate at the date of entry to shareholder equity.
• There are two main methods of currency translation accounting: the current method, for when the subsidiary and parent use the same functional currency; and the temporal method for when they do not.
• Translation risk arises for a company when the exchange rates fluctuate before financial statements have been reconciled. This risk can be hedged with currency derivatives or forex positions.

How Currency Translation Works

Many companies, particularly big ones, are multinational, operating in various regions of the world that use different currencies . If a company sells into a foreign market and then sends payments back home, earnings must be reported in the currency of the place where the majority of cash is primarily earned and spent. Alternatively, in the rare case that a company has a foreign subsidiary , say in Brazil, that does not transfer funds back to the parent company, the functional currency for that subsidiary would be the Brazilian real.

Before a foreign entity's financial statements can translate into the reporting currency, the foreign unit's financial statements must be prepared in accordance with General Accepted Accounting Principles  (GAAP) rules. When that condition is satisfied, the financial statements expressed in the functional currency should use the following exchange rates for translation:

• Assets and Liabilities : The exchange rate between the functional currency and reporting currency at the end of the period.
• Income Statement : The exchange rate on the date that income or an expense was recognized; a weighted average rate during the period is acceptable.
• Shareholder Equity : The historical exchange rate at the date of entry to shareholder equity; the change in retained earnings uses historical exchange rates of each period's income statement.

Gains and losses resulting from currency conversions are recorded in financial statements. The change in foreign currency translation is a component of  accumulated other comprehensive income , presented in a company's consolidated statements of shareholders' equity and carried over to the consolidated balance sheet under shareholders' equity.

If a company has operations abroad that keep books in a foreign currency, it will disclose the above methodology in its  footnotes under "Note 1 - Summary of Significant Accounting Policies" or something substantially similar.

The Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 830, entitled "Foreign Currency Matters," offers a comprehensive guide on the measurement and translation of foreign currency transactions.

Currency Translation Accounting Methods

There are two main accounting standards for handling currency translation.

• The current rate method : A method of foreign currency translation where most items in the financial statements are translated at the current exchange rate. The current rate method is utilized in instances where the subsidiary isn't well integrated with the parent company, and the local currency where the subsidiary operates is the same as its functional currency.
• The temporal method : Also known as the historical method, this technique converts the currency of a foreign subsidiary into the currency of the parent company. The temporal method is used when the local currency of the subsidiary is not the same as the currency of the parent company. Differing exchange rates are used depending on the financial statement item being translated.

Translation Risk

Translation risk is the exchange rate risk associated with companies that deal in foreign currencies and list foreign assets on their balance sheets.

Companies that own  assets  in foreign countries, such as plants and equipment, must convert the value of those assets from the foreign currency to the home country's currency for accounting purposes. In the U.S., this accounting translation is typically done on a quarterly and annual basis. Translation risk results from how much the assets' value fluctuate based on exchange rate movements between the two counties involved.

Multinational corporations with international offices have the greatest exposure to translation risk. However, even companies that don't have offices overseas but sell products internationally are exposed to translation risk. If a company earns revenue in a foreign country, it must convert that revenue into its home or local currency when it reports its financials at the end of the quarter. 

Example of Currency Translation

International sales accounted for 64% of Apple Inc.’s revenue in the quarter ending Dec. 26, 2020. In recent years, a recurring theme for the iPhone maker and other big multinationals has been the adverse impact of a rising U.S. dollar. When the greenback strengthens against other currencies, it subsequently weighs on international financial figures once they are converted into U.S. dollars.

The likes of Apple seek to overcome adverse fluctuations in foreign exchange rates by hedging their exposure to currencies. Foreign exchange (forex) derivatives , such as futures contracts and options, are acquired to enable companies to lock in a currency rate and ensure that it remains the same over a specified period of time.

Constant Currencies

Constant currencies is another term that often crops up in financial statements. Companies with overseas operations often choose to publish reported numbers alongside figures that strip out the effects of exchange rate fluctuations. Investors generally pay a lot of attention to constant currency figures as they recognize that currency movements can mask the true financial performance of a company.

In its fiscal second-quarter ending Nov. 30, 2020, Nike Inc. reported a 9% increase in revenues, adding that sales rose 7% on a constant currency basis.

Financial Accounting Standards Board. " Statement of Financial Accounting, Standards No. 52, Foreign Currency Translation ," Page FAS52-4 and 5. Accessed March 31, 2021.

Financial Accounting Standards Board. " Statement of Financial Accounting, Standards No. 52, Foreign Currency Translation ," Page FAS52-5. Accessed March 31, 2021.

Deloitte. " A Roadmap to Foreign Currency Transactions and Translations ," Page 7. Accessed March 31, 2021.

Financial Accounting Standards Board. " Statement of Financial Accounting, Standards No. 52, Foreign Currency Translation ," Page FAS52-7. Accessed March 31, 2021.

Financial Accounting Standards Board. " Foreign Currency Matters (Topic 830) ." Accessed March 31, 2021.

Apple. " Apple Reports First Quarter Results ." Accessed March 31, 2021.

Nike. " Nike, Inc. Reports Fiscal 2021 Second Quarter Results ." Accessed March 31, 2021.

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Use of a presentation currency other than the functional currency (AASB121_08-15_COMPmar20_07-21)

Use of a presentation currency other than the functional currency, translation to the presentation currency.

An entity may present its financial statements in any currency (or currencies). If the presentation currency differs from the entity’s functional currency, it translates its results and financial position into the presentation currency. For example, when a group contains individual entities with different functional currencies, the results and financial position of each entity are expressed in a common currency so that consolidated financial statements may be presented.

The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

(a) assets and liabilities for each statement of financial position presented (ie including comparatives) shall be translated at the closing rate at the date of that statement of financial position;

(b) income and expenses for each statement presenting profit or loss and other comprehensive income (ie including comparatives) shall be translated at exchange rates at the dates of the transactions; and

(c) all resulting exchange differences shall be recognised in other comprehensive income.

For practical reasons, a rate that approximates the exchange rates at the dates of the transactions, for example an average rate for the period, is often used to translate income and expense items. However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate.

The exchange differences referred to in paragraph 39(c) result from:

(a) translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate.

(b) translating the opening net assets at a closing rate that differs from the previous closing rate.

These exchange differences are not recognised in profit or loss because the changes in exchange rates have little or no direct effect on the present and future cash flows from operations. The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation. When the exchange differences relate to a foreign operation that is consolidated but not wholly-owned, accumulated exchange differences arising from translation and attributable to non-controlling interests are allocated to, and recognised as part of, non-controlling interests in the consolidated statement of financial position.

The results and financial position of an entity whose functional currency is the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

(a) all amounts (ie assets, liabilities, equity items, income and expenses, including comparatives) shall be translated at the closing rate at the date of the most recent statement of financial position, except that

(b) when amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts shall be those that were presented as current year amounts in the relevant prior year financial statements (ie not adjusted for subsequent changes in the price level or subsequent changes in exchange rates).

When an entity’s functional currency is the currency of a hyperinflationary economy, the entity shall restate its financial statements in accordance with AASB 129 before applying the translation method set out in paragraph 42 , except for comparative amounts that are translated into a currency of a non-hyperinflationary economy (see paragraph 42(b) ). When the economy ceases to be hyperinflationary and the entity no longer restates its financial statements in accordance with AASB 129 , it shall use as the historical costs for translation into the presentation currency the amounts restated to the price level at the date the entity ceased restating its financial statements.

Translation of a foreign operation

Paragraphs 45–47 , in addition to paragraphs 38–43 , apply when the results and financial position of a foreign operation are translated into a presentation currency so that the foreign operation can be included in the financial statements of the reporting entity by consolidation or the equity method.

The incorporation of the results and financial position of a foreign operation with those of the reporting entity follows normal consolidation procedures, such as the elimination of intragroup balances and intragroup transactions of a subsidiary (see AASB 10 Consolidated Financial Statements ). However, an intragroup monetary asset (or liability), whether short-term or long-term, cannot be eliminated against the corresponding intragroup liability (or asset) without showing the results of currency fluctuations in the consolidated financial statements. This is because the monetary item represents a commitment to convert one currency into another and exposes the reporting entity to a gain or loss through currency fluctuations. Accordingly, in the consolidated financial statements of the reporting entity, such an exchange difference is recognised in profit or loss or, if it arises from the circumstances described in paragraph 32 , it is recognised in other comprehensive income and accumulated in a separate component of equity until the disposal of the foreign operation.

When the financial statements of a foreign operation are as of a date different from that of the reporting entity, the foreign operation often prepares additional statements as of the same date as the reporting entity’s financial statements. When this is not done, AASB 10 allows the use of a different date provided that the difference is no greater than three months and adjustments are made for the effects of any significant transactions or other events that occur between the different dates. In such a case, the assets and liabilities of the foreign operation are translated at the exchange rate at the end of the reporting period of the foreign operation. Adjustments are made for significant changes in exchange rates up to the end of the reporting period of the reporting entity in accordance with AASB 10 . The same approach is used in applying the equity method to associates and joint ventures in accordance with AASB 128 .

Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation shall be treated as assets and liabilities of the foreign operation. Thus they shall be expressed in the functional currency of the foreign operation and shall be translated at the closing rate in accordance with paragraphs 39 and 42 .

Disposal or partial disposal of a foreign operation

On the disposal of a foreign operation, the cumulative amount of the exchange differences relating to that foreign operation, recognised in other comprehensive income and accumulated in the separate component of equity, shall be reclassified from equity to profit or loss (as a reclassification adjustment) when the gain or loss on disposal is recognised (see AASB 101 Presentation of Financial Statements ).

In addition to the disposal of an entity’s entire interest in a foreign operation, the following partial disposals are accounted for as disposals:

(a) when the partial disposal involves the loss of control of a subsidiary that includes a foreign operation, regardless of whether the entity retains a non-controlling interest in its former subsidiary after the partial disposal; and

(b) when the retained interest after the partial disposal of an interest in a joint arrangement or a partial disposal of an interest in an associate that includes a foreign operation is a financial asset that includes a foreign operation.

On disposal of a subsidiary that includes a foreign operation, the cumulative amount of the exchange differences relating to that foreign operation that have been attributed to the non-controlling interests shall be derecognised, but shall not be reclassified to profit or loss.

On the partial disposal of a subsidiary that includes a foreign operation, the entity shall re-attribute the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income to the non-controlling interests in that foreign operation. In any other partial disposal of a foreign operation the entity shall reclassify to profit or loss only the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income.

A partial disposal of an entity’s interest in a foreign operation is any reduction in an entity’s ownership interest in a foreign operation, except those reductions in paragraph 48A that are accounted for as disposals.

An entity may dispose or partially dispose of its interest in a foreign operation through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity. A write-down of the carrying amount of a foreign operation, either because of its own losses or because of an impairment recognised by the investor, does not constitute a partial disposal. Accordingly, no part of the foreign exchange gain or loss recognised in other comprehensive income is reclassified to profit or loss at the time of a write-down.

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