Jain forex 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! 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? How to translate financial statements into a presentation currency. What exchange rates shall we use?
How to report gains or losses from foreign exchange rates in the financial statements? Functional currency is the currency of the primary economic environment in which the entity operates. Presentation currency is the currency in which the financial statements are presented. In most cases, functional and presentation currencies are the same. It’s a full IFRS learning package with more than 40 hours of private video tutorials, more than 140 IFRS case studies solved in Excel, more than 180 pages of handouts and many bonuses included. If you take action today and subscribe to the IFRS Kit, you’ll get it at discount!
Click here to check it out! 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. What currency does mainly influence sales prices for goods and services? In what currency are the labor, material and other costs denominated and settled? 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. 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.
All non-monetary items measured at fair value using the exchange rate at the date when the fair value was measured. 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 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. Here, this rule applies for goodwill and fair value adjustments, too. 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.