IAS 21

IAS 21 The Effects of Changes in Foreign Exchange Rates is the standard in International Financial Reporting Standards that deals with foreign currencies in financial statements. It answers two questions: how an entity records transactions and balances that are in a currency other than its own, and how the results and position of a foreign operation are converted so that they can be included in the statements of the reporting group. In both cases it specifies which exchange rate to use and where the resulting differences are reported.

The standard is maintained by the International Accounting Standards Board; the present version was issued in 2003 and applied from 2005. It does not cover foreign currency derivatives or hedge accounting, which fall under IFRS 9, and economies with very high inflation are dealt with in IAS 29.

The central concept is the functional currency: the currency of the primary economic environment in which an entity operates. It is determined by facts, not chosen. The main indicators are the currency that mainly influences sales prices and the currency that mainly influences labour, material and other costs. Secondary indicators are the currency in which financing is raised and in which operating receipts are kept. For a foreign subsidiary, the degree of autonomy from its parent is also considered. Each entity in a group determines its own functional currency, so a group has no single one.

The presentation currency is the currency in which the financial statements are shown. An entity may present in any currency it chooses, which is why some groups report in US dollars or euros although their home currency differs.

A foreign currency transaction is recorded on initial recognition in the functional currency using the spot rate at the date of the transaction; an average rate for a week or month may be used if rates do not move significantly. At each later reporting date, the treatment depends on the type of item.

• Monetary items, such as cash, receivables, payables and loans, are retranslated at the closing rate.
• Non-monetary items measured at historical cost, such as inventory and equipment, remain at the rate on the date of the transaction.
• Non-monetary items measured at fair value are translated at the rate on the date the fair value was measured.

Exchange differences on settling or retranslating monetary items go to profit or loss in the period they arise. When a gain or loss on a non-monetary item is recognised in other comprehensive income, its exchange component is recognised there too.

When a subsidiary, branch, associate or joint arrangement has a functional currency different from the group's presentation currency, its statements are translated as follows. Assets and liabilities are translated at the closing rate at the date of the statement of financial position. Income and expenses are translated at the rates on the dates of the transactions, with an average rate for the period commonly used as an approximation. All resulting differences are recognised in other comprehensive income and accumulated in a separate component of equity, usually called the foreign currency translation reserve.

Goodwill and fair value adjustments arising on the acquisition of a foreign operation are treated as its assets and liabilities and translated at the closing rate. The translation takes place as part of consolidation accounting in preparing consolidated financial statements.

A loan or receivable between a parent and its foreign operation for which settlement is neither planned nor likely in the foreseeable future is, in substance, part of the parent's net investment. Exchange differences on such an item are recognised in profit or loss in the separate statements of the entities concerned, but in the consolidated statements they are recognised in other comprehensive income. On disposal of the foreign operation, the cumulative amount held in equity for that operation is reclassified to profit or loss as part of the gain or loss on disposal.

IFRIC 22 clarifies that when an entity pays or receives consideration in advance in a foreign currency, the rate used for the related asset, expense or income is the rate on the date of the advance. Where the functional currency is that of a hyperinflationary economy, the statements are first restated under IAS 29 and then translated in full at the closing rate.

In August 2023 the Board issued amendments on lack of exchangeability, effective for annual periods beginning on or after 1 January 2025. They set out how to assess whether a currency can be exchanged for another and, when it cannot, how to estimate a spot rate and what to disclose. The issue arises in countries with exchange controls and more than one official rate.

Translation differences can cause large movements in reported equity without any cash effect, and groups with operations in volatile currencies explain them in their notes. Exposure arising from monetary items affects earnings directly and is often managed through hedging with forward contracts. US accounting rules follow a broadly similar model, with differences mainly in the treatment of highly inflationary economies.

• IFRS Foundation