exchange rate at the date of the 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 recognised in other comprehensive income are not reclassified from
equity to profit or loss until the disposal of the operation (see 6.6 below). [IAS 21.37].
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Example 15.8: Change in functional currency
The management of Entity A has considered the functional currency of the entity to be the euro. However, as a
result of a change in circumstances affecting the operations of the entity, management determines that on 1 January
2019 the functional currency of the entity is now the US dollar. The exchange rate at that date is €1=US$1.20.
Entity A’s statement of financial position at 1 January 2019 in its old functional currency is as follows:
€
Property, plant and equipment 200,000
Current assets
Inventories 10,000
Receivables 20,000
Cash 5,000
35,000
Current liabilities
Payables 15,000
Taxation 3,000
18,000
Net current assets
17,000
217,000
Long-term loans
120,000
97,000
Included within the statement of financial position at 1 January 2019 are the following items:
• Equipment with a cost of €33,000 and a net book value of €16,500. This equipment was originally
purchased for £20,000 in 2013 and has been translated at the rate ruling at the date of purchase of
£1=€1.65.
• Inventories with a cost of €6,000. These were purchased for US$6,000 and have been translated at the
rate ruling at the date of purchase of €1=US$1.00.
• Payables of €5,000 representing the US$6,000 due in respect of the above inventories, translated at the
rate ruling at 1 January 2019.
• Long-term loans of €15,000 representing the outstanding balance of £10,000 on a loan originally taken out
to finance the acquisition of the above equipment, translated at £1=€1.50, the rate ruling at 1 January 2019.
Entity A applies the translational procedures applicable to its new functional currency prospectively from the
date of change. Accordingly, all items in its statement of financial position at 1 January 2019 are translated
at the rate of €1=US$1.20 giving rise to the following amounts:
$
Property, plant and equipment 240,000
Current assets
Inventories 12,000
Receivables 24,000
Cash 6,000
42,000
Current liabilities
Payables 18,000
Taxation 3,600
21,600
Net current assets
20,400
260,400
Long-term loans
144,000
116,400
Foreign
exchange
1133
As far as the equipment that was originally purchased for £20,000 is concerned, the cost and net book value in
terms of Entity A’s new functional currency are US$39,600 and US$19,800 respectively, being €33,000 and
€16,500 translated at €1=US$1.20. Entity A does not go back and translate the £20,000 cost at whatever the
£ sterling/US dollar exchange rate was at the date of purchase and calculate a revised net book value on that basis.
Similarly, the inventories purchased in US dollars are included at $7,200, being €6,000 translated at
€1=US$1.20. This is despite the fact that Entity A knows that the original cost was $6,000.
As far as the payables in respect of the inventories are concerned, these are included at $6,000, being €5,000
translated at €1=US$1.20. This represents the original amount payable in US dollars. However, this is as it
should be since the original payable had been translated into euros at the rate ruling at 1 January 2019 and
has just been translated back into US dollars at the same rate. The impact of the change in functional currency
is that whereas Entity A had recognised an exchange gain of €1,000 while the functional currency was the
euro, no further exchange difference will be recognised in respect of this amount payable. Exchange
differences will now arise from 1 January 2019 on those payables denominated in euros, whereas no such
differences would have arisen on such items prior to that date.
Similarly, the £10,000 amount outstanding on the loan will be included at $18,000, being €15,000 translated
at €1=US$1.20. This is equivalent to the translation of the £10,000 at a rate of £1=US$1.80, being the direct
exchange rate between the two currencies at 1 January 2019. In this case, whereas previously exchange gains
and losses would have been recognised on this loan balance based on movements of the £/€ exchange rate,
as from 1 January 2019 the exchange gains and losses will be recognised based on the £/$ exchange rate.
Often an entity’s circumstances change gradually over time and it may not be possible
to determine a precise date on which the functional currency changes. In these
circumstances an entity will need to apply judgement to determine an appropriate date
from which to apply the change, which might coincide with the beginning or end of an
interim or annual accounting period.
5.6
Books and records not kept in functional currency
Occasionally, an entity may keep its underlying books and records in a currency that is
not its functional currency under IAS 21. For example, it could record its transactions in
terms of the local currency of the country in which it is located, possibly as a result of
local requirements. In these circumstances, at the time the entity prepares its financial
statements all amounts should be converted into the functional currency in accordance
with the requirements of the standard discussed at 5.1 to 5.3 above.9 This process is
intended to produce the same amounts in the functional currency as would have
occurred had the items been recorded initially in the functional currency. For example,
monetary items should be translated into the functional currency using the closing rate,
and non-monetary items that are measured on a historical cost basis should be
translated using the exchange rate at the date of the transaction that resulted in their
recognition which will result in local currency denominated transactions giving rise to
exchange differences. [IAS 21.34].
6
USE OF A PRESENTATION CURRENCY OTHER THAN THE
FUNCTIONAL CURRENCY
An entity may present its financial statements in any currency (or currencies) (see 3
above). If the presentation currency differs from the entity’s functional currency, it needs
to translate 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
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consolidated financial statements may be presented. [IAS 21.38]. There is no concept of a
‘group’ functional currency. Each entity within the group has its own functional currency,
and the results and financial position of each entity have to be translated into the
presentation currency that is used for the consolidated financial statements.
[IAS 21.18].
The requirements of IAS 21 in respect of this translation process are discussed below.
The procedures to be adopted apply not only to the inclusion of foreign subsidiaries in
consolidated financial statements but also to the incorporation of the results of
associates and joint arrangements. [IAS 21.44]. They also apply when the results of a
foreign branch are to be incorporated into the financial statements of an individual
entity or a stand-alone entity preparing financial statements or when an entity preparing
separate financial statements in accordance with IAS 27 presents its financial statements
in a currency other than its functional currency.
In addition to these procedures, IAS 21 has additional provisions that 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. [IAS 21.44]. These additional
provisions are covered at 6.3 to 6.5 below.
6.1
Translation to the presentation currency
Under IAS 21, the method of translation depends on whether the entity’s functional
currency is that of a hyperinflationary economy or not, and if it is, whether it is being
translated into a presentation currency which is that of a hyperinflationary economy or
not. A hyperinflationary economy is defined in IAS 29 – Financial Reporting in
Hyperinflationary Economies (see Chapter 16 at 2.3). The requirements of IAS 21
discussed below can be summarised as follows:
Presentation currency
Non-hyperinflationary
Hyperinflationary
Non-hyperinflationary
functional currency
Assets/liabilities
– current period
Closing rate (current B/S date)
Closing rate (current B/S date)
– comparative period
Closing rate (comparative B/S date)
Closing rate (comparative B/S date)
Equity items
– current period
Not specified
Not specified
– comparative period
Not specified
Not specified
Income/expenses (including those
recognised in other comprehensive
income)
– current period
Actual rates (or appropriate average
Actual rates (or appropriate average
for current period)
for current period)
– comparative period
Actual rates (or appropriate average
Actual rates (or appropriate average
for comparative period)
for comparative period)
Exchange differences
Separate component of equity
Separate component of equity
Foreign
exchange
1135
Hyperinflationary
functional currency
Assets/liabilities
– current period
Closing rate (current B/S date)
Closing rate (current B/S date)
– comparative period
Closing rate (comparative B/S date)
Closing rate (current B/S date)
Equity items
– current period
Closing rate (current B/S date)
Closing rate (current B/S date)
– comparative period
Closing rate (comparative B/S date)
Closing rate (current B/S date)
Income/expenses (including those
recognised in other comprehensive
income)
– current period
Closing rate (current B/S date)
Closing rate (current B/S date)
– comparative period
Closing rate (comparative B/S date)
Closing rate (current B/S date)
Exchange differences
Not specified
Not applicable
6.1.1
Functional currency is not that of a hyperinflationary economy
The results and financial position of an entity whose functional currency is not the
currency of a hyperinflationary economy should be translated into a different
presentation currency using the following procedures: [IAS 21.39]
(a) assets and liabilities for each statement of financial position presented
(i.e. including comparatives) are translated at the closing rate at the reporting date;
(b) income and expenses for each statement of comprehensive income or separate
income statement presented (i.e. including comparatives) are translated at
exchange rates at the dates of the transactions; and
(c) all resulting exchange differences are recognised in other comprehensive income.
For practical reasons, the reporting entity may use a rate that approximates the actual
exchange rate, e.g. an average rate for the period, to translate income and expense items.
However, if exchange rates fluctuate significantly, the use of the average rate for a
period is inappropriate. [IAS 21.40].
As discussed at 5.1.2 above, IFRIC 22 explains how to determine the ‘date of transaction’
for the purposes of an entity recording a foreign currency transaction in its functional
currency, particularly when payments are made or received in advance of the associated
transaction occurring. However, in our view, this guidance does not apply to the
translation of an entity’s results into a presentation currency; instead the date of
transaction for this purpose is the date on which income or expense is recorded in profit
or loss or other comprehensive income of the foreign operation.
A foreign operation may have reclassification adjustments to profit or loss of gains or
losses previously recognised in other comprehensive income, for example as a result of
the application of cash flow hedge accounting. However, IAS 21 does not explicitly
address how these adjustments should be translated into the presentation currency. In
our experience the most commonly applied approach is to regard them as income or
expenses of the foreign operation to be translated at the exchange rate at the date of
reclassification in accordance with paragraph 39(b). For cash flow hedges, this better
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reflects the hedge accounting reported in the foreign operation’s own financial
statements. Nevertheless, some would argue that reclassification adjustments do not
represent income or expenses. Consequently, paragraph 39(b) would not apply and the
reclassification is translated using the historical exchange rates at the dates the original
gains or losses arose. In our view, each of these approaches represents an acceptable
accounting policy choice.
The translational process above makes only limited reference to the translation of
equity items, although the selection of accounting policy for translating reclassification
adjustments is likely to influence whether an entity translates the associated equity
balance in order to prevent a residual amount being left within the reserve. The
treatment of such items is discussed at 6.2 below.
IAS 21 indicates that the exchange differences referred to in item (c) above result from:
[IAS 21.41]
• translating income and expenses at the exchange rates at the dates of the
transactions and assets and liabili
ties at the closing rate. Such exchange differences
arise both on income and expense items recognised in profit or loss and on those
recognised in other comprehensive income; and
• translating the opening net assets at a closing rate that differs from the previous
closing rate.
This is not in fact completely accurate since if the entity has had any transactions with
equity holders that have resulted in a change in the net assets during the period there are
likely to be further exchange differences that need to be recognised to the extent that the
closing rate differs from the rate used to translate the transaction. This will particularly be
the case where a parent has subscribed for further equity shares in a subsidiary.
The reason why these exchange differences are not recognised in profit or loss is
because the changes in exchange rates have little or no direct effect on the present and
future cash flows from operations. [IAS 21.41].
The application of these procedures is illustrated in the following example.
Example 15.9: Translation of a non-hyperinflationary functional currency to a
non-hyperinflationary presentation currency
An Australian entity owns 100% of the share capital of a foreign entity which was set up a number of years
ago when the exchange rate was A$1=FC2. It is consolidating the financial statements of the subsidiary in its
consolidated financial statements for the year ended 31 December 2019. The exchange rate at the year-end is
A$1=FC4 (2018: A$1=FC3). For the purposes of illustration, it is assumed that exchange rates have not
fluctuated significantly and the appropriate weighted average rate for the year was A$1=FC3.5, and that the
currency of the foreign entity is not that of a hyperinflationary economy. The income statement of the
subsidiary for that year and its statement of financial position at the beginning and end of the year in its
functional currency and translated into Australian dollars are as follows:
Foreign
exchange
1137
Income statement
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 224
