CHAPTER 5

FOREIGN CURRENCY
Objective of IAS 21
The objective of IAS 21 is to produce rules that an entity should follow in the translation of foreign
currency activities.

Definitions
Exchange rates
❖ Historic rate: rate in place at the date the transaction takes place, sometimes referred to as
the spot rate.
❖ Closing rate: rate at the reporting date.
❖ Average rate: average rate throughout the accounting period.

Assets and liabilities

❖ Monetary items: items that can be easily converted into cash, e.g. receivables, payables, loans.
❖ Non-monetary items: items that give no right to receive or deliver cash, e.g. inventory, plant
and machinery.

Currency
 Functional currency: 'the currency of the primary economic environment in which an entity
operates' (IAS 21, para 8). This will usually be the currency in which the majority of an entity's
transactions take place.

IAS 21 says that an entity should consider the following primary factors when determining its
functional currency:
❖ 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 price of goods and services
❖ the currency that mainly influences labour, materials and other costs of providing goods and
services.

If the primary factors are inconclusive then the following secondary factors should also be considered:
❖ the currency in which funds from financing activities are generated
❖ the currency in which receipts from operating activities are retained.

 Presentation currency: 'the currency in which the financial statements are presented' (IAS 21, para
8).

Individual company – Translating transactions

Mechanics of translation

Initial transactions
❖ Translate using the historic rate prevailing at the transaction date.
❖ The average rate can also be used if it does not fluctuate significantly during the accounting
period.

Settled transactions
If a transaction is settled (payment or receipt occurs) during the accounting period:
❖ Translate at the date of payment / receipt using the historic rate prevailing at that date.

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 ❖ As this may be different to the initial transaction an exchange difference may arise, this is
posted to the statement of profit or loss (see Treatment of exchange differences below).

Exercise 1
On 1 April 20X8 Collins Co, a company that uses the dollar ($) as its functional currency, buys goods
from an overseas supplier, who uses Kromits (Kr) as its functional currency. The goods are priced at
Kr54,000. Payment is made 2 months later on 31 May 20X8.

The prevailing exchange rates are:

1 April 20X8 Kr1.80 : $1
31 May 20X8 Kr1.75 : $1

Required: Record the journal entries for these transactions.

Unsettled transactions
❖ If a transaction is still unsettled at the reporting date, there will be an outstanding asset or
liability on the statement of financial position.
❖ If the asset/liability is a monetary item it should be retranslated at the closing rate.
❖ If the asset/liability is a non-monetary item it should remain at the historic rate.
❖ Exchange differences will arise on the retranslation of the monetary items, and these are also
posted to the statement of profit or loss.

Exercise 2
On 1 April 20X8 Collins Co, a company that uses the dollar ($) as its functional currency, buys goods
from an overseas supplier, who uses Kromits (Kr) as its functional currency. The goods are priced at
Kr54,000. Payment is still outstanding at the reporting date of 30 June 20X8.

The prevailing exchange rates are:

1 April 20X8 Kr1.80 : $1
30 June 20X8 Kr1.70 : $1

Required: Record the journal entries for these transactions.

Treatment of exchange differences

❖ If the exchange difference relates to trading transactions it is disclosed within other operating
income/operating expenses.
❖ If the exchange difference relates to non-trading transactions it is disclosed within interest
receivable and similar income/finance costs.

Exercise 2
ABC Co has a year end of 31 December 20X1 and uses the dollar ($) as its functional currency. On
25 October 20X1 ABC Co buys goods from a Swedish supplier for Swedish Krona (SWK) 286,000.
Rates of exchange:

25 October 20X1 $1 = SWK 11.16

16 November 20X1 $1 = SWK 10.87
31 December 20X1 $1 = SWK 11.02

Required:
Show the accounting treatment for the above transactions if:

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 (a) A payment of SWK286,000 is made on 16 November 20X1.

(b) The amount owed remains outstanding at the year-end date.

Non-monetary Items
• Cost model
Non-monetary items that are held at cost are initially translated at the historic rate and carried
forward at this value. They are not retranslated.

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