Introduction: Ind AS 21 addresses how foreign currency transactions, foreign operations, and financial statements presented in a foreign currency should be included and translated in an entity’s financial statements. It aims to provide guidance on the selection of exchange rates and reporting the effects of changes in these rates.
Foreign Activities: Entities engage in foreign activities through transactions in foreign currencies or foreign operations. The standard outlines the treatment of these activities in financial reporting.
Objective: The primary objective of Ind AS 21 is to prescribe the methodology for incorporating foreign currency transactions and operations into financial statements and translating them into the presentation currency.
Scope and Exclusions:
- Hedge Accounting: Ind AS 21 does not apply to hedge accounting for foreign currency items. Hedge accounting, including for a net investment in a foreign operation, is covered by Ind AS 109.
- Statement of Cash Flows: Ind AS 21 does not apply to the presentation of cash flows arising from foreign currency transactions in the statement of cash flows. The translation of cash flows of a foreign operation is governed by Ind AS 7.
- Long-term Foreign Currency Monetary Items: The standard doesn’t apply to long-term foreign currency monetary items if the entity has opted for the exemption provided in Ind AS 101, paragraph D13AA. In such cases, the entity can continue applying the chosen accounting policy for these items.
Functional Currency:
Definition: Functional currency is the currency of the primary economic environment where the entity operates and generates and expends cash.
Determination Factors:
- Sales Prices: The currency mainly influencing sales prices for goods and services.
- Competitive Forces: The currency of the country whose competitive forces and regulations determine sales prices.
- Costs: The currency mainly influencing labor, material, and other costs of providing goods or services.
- Hyperinflationary Economy: If the functional currency is that of a hyperinflationary economy, financial statements are restated according to Ind AS 29, Financial Reporting in Hyperinflationary Economies.
Reporting Foreign Currency Transactions in the Functional Currency
Foreign Currency Definitions:
- Foreign Currency: Any currency other than the functional currency of the entity.
- Spot Exchange Rate: The exchange rate for immediate delivery.
- Exchange Difference: The difference arising from translating a specific number of units of one currency into another at different exchange rates.
Initial Recognition:
- Recording a Transaction: On initial recognition, a foreign currency transaction is recorded in the functional currency using the spot exchange rate between the functional currency and the foreign currency at the transaction date.
Example: A US-based company (functional currency: USD) buys inventory from a Japanese supplier for JPY 1,000,000. If the spot exchange rate is 1 USD = 110 JPY at the transaction date, the initial recognition in USD is $9,090.91 (1,000,000 JPY / 110 JPY per USD).
End of Reporting Period:
- Translation of Monetary Items: At the end of each reporting period, foreign currency monetary items are translated using the closing rate.
- Non-Monetary Items (Historical Cost): Non-monetary items measured at historical cost in a foreign currency are translated using the exchange rate at the transaction date.
- Non-Monetary Items (Fair Value): Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was measured.
Exchange Differences:
- Recognition in Profit or Loss: Exchange differences arising on settling monetary items or translating them at rates different from the initial recognition shall be recognized in profit or loss in the period of occurrence.
- Net Investment in a Foreign Operation: Exchange differences on a monetary item forming part of the net investment in a foreign operation are recognized in profit or loss in the separate or individual financial statements of the reporting entity.
Other Comprehensive Income:
- Exchange Component in Other Comprehensive Income: Exchange components of gains or losses on non-monetary items recognized in other comprehensive income are also recognized in other comprehensive income.
Change in Functional Currency:
- Prospective Application: If there’s a change in the entity’s functional currency, the new functional currency’s translation procedures are applied prospectively from the date of the change.
Example: A UK-based company changes its functional currency from GBP to EUR. The new procedures are applied for translating financial statements from the date of this change.
Translation to the Presentation Currency/Translation of a Foreign Operation
Introduction: Entities may present financial statements in any currency, and when it differs from the functional currency, results and financial position are translated. This is crucial for stand-alone entities, parents preparing consolidated statements, or parents, investors, or venturers creating separate financial statements.
Translation to Presentation Currency: For entities not in a hyperinflationary economy:
- Balance Sheet Items: Assets and liabilities in each balance sheet, including comparatives, are translated at the closing rate on the balance sheet date.
- Income and Expenses: Income and expenses in each profit and loss statement, including comparatives, are translated at exchange rates on transaction dates.
- Exchange Differences: Resulting exchange differences are recognized in other comprehensive income.
Treatment of Goodwill and Fair Value Adjustments:
- Goodwill: Goodwill from acquiring a foreign operation and fair value adjustments to assets and liabilities are treated as assets and liabilities of the foreign operation.
Disposal of Foreign Operation:
- Reclassification: On disposal of a foreign operation, cumulative exchange differences in other comprehensive income are reclassified from equity to profit or loss.
- Partial Disposal: For partial disposals, the entity re-attributes a proportionate share of cumulative exchange differences to non-controlling interests.
Appendix B – Determination of Transaction Date:
- Exchange Rate Determination: The date of the transaction for initial recognition of related assets, expenses, or income is when the entity initially recognizes the non-monetary asset or liability from advance consideration in a foreign currency.
- Multiple Payments or Receipts: If there are multiple advance payments or receipts, a date of the transaction is determined for each.
Example: If a multinational company, with subsidiaries in different countries, consolidates its financial statements, the results and financial positions of each subsidiary are translated into a common currency for presenting consolidated financial statements.
Conclusion: Ind AS 21 equips entities with the necessary guidance to accurately account for and report on the impact of foreign currency fluctuations in their financial statements. It establishes clear rules for the treatment of foreign currency transactions, the translation of foreign operations, and the presentation of financial statements in a foreign currency. By adhering to these guidelines, entities can ensure consistency and comparability in their financial reporting, providing stakeholders with a true and fair view of the financial impact of foreign exchange movements. As global business activities continue to expand, the relevance of Ind AS 21 in fostering transparency and understanding of foreign currency effects in financial statements becomes increasingly paramount.
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