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Foreign currency exchange rate changes (Functional currency (The currency…
Foreign currency exchange rate changes
IAS 21 The effects of changes in foreign exchange rates governs most of the accounting impact of foreign currency exchange rate changes
The purpose of this standard is to prescribe how to account for transactions in foreign currencies and foreign oeprations
The standards explain the applicable exchange rates and the effects of foreign currency exchange rate changes in an entity's financial statements
IAS 21 principally deals with
The translation of foreign currency transactions and balances
The translation of results and financial position of foreign subsidiaries for consolidation purposes
The translation of foreign currency results into the presentation currency
Functional currency
The currency of the primary economic environment in which an entity operates
Usually the environment in which it generates and spends cash
The currency in which its goods and services are denominated and paid for
The current used to pay for labour, material and other costs associated with the provision of goods and services
Also determined by the country where competition and regulations largely determine the selling prices of an entity's goods or services
The currency in which funds are generated from financing activities (currency of an entity's debt instruments / issued equity)
Must determine its functional currency and measure its performance and financial position in that currency. All other currencies are treated as foreign currencies
Cannot change functional currency unless there is a change in circumstances, events or conditions that warrants a change in functional currency
An entity has a free choice over its presentation currency. Where the presentation currency differs from the functional currency, the functional currency should be translated into the presentation currency
Transactions in a foreign currency should be translated into the functional currency at the spot rate of exchange on the date of the transaction. For practical purposes, IAS 21 allows an approximate rate to be used such as the weekly or monthly average rate, provided there have been no significant fluctuations of the currency during the relevant period
Translation of monetary and non monetary items at the balance sheet date
Foreign currency denominated monetary items (units of currency held, assets and liabilities to be received / paid in a fixed or determinable number of units of currency) should be converted at the closing rate of exchange
Non-monetary times valued on a historic cost basis should be converted at the exchange rate on the date the transaction took place (ie historic rate of exchange)
Non-monetary items held at fair value should be converted at the exchange rate prevailing at the most recent valuation date i.e when the fair values were last determined
Recognition of foreign exchange differences
Exchange differences are recognised by one entity in the income statement in the period in which they occur apart from exchange differences on monetary items forming part of a net investment in a foreign operation, which are recognised in the group accounts. The exchange gains or losses are recognised in the income statement upon disposal of the foreign entity
Foreign currency dividends paid to a parent from its foreign subsidiary may result in exchange gains or losses in the financial statements of the parent entity. These exchange different should be recognised in the profit and loss account of the parent entity and should not be reversed out on consolidation
Consolidation of group entities
Entities within a group may have different functional currencies because the functional currency is determined at entity level and not at group level
Each entity within the group should translate its invidiuah results and financial position into the presentation currency of the group so that consolidation may take place in the presentation currency