Foreign currency transactions

• What are foreign currency transactions?
• Initial recognition
• Subsequent measurement
• Disclosure

What are foreign currency transactions?


A foreign currency is any currency other than the functional currency of an entity [IAS21.8(R.05)]. The functional currency is the currency of the primary economic environment in which an entity operates. Foreign currency transactions can arise when an entity (a) buys or sells goods or services whose price is denominated in a foreign currency; (b) borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency; or (c) otherwise acquires or disposes of assets, or incurs or settles liabilities denominated in a foreign currency [IAS21.20(R.05)].

Transactions in any currency other than the entity's functional currency are accounted for as foreign currency transactions .

Initial recognition


Foreign currency transactions are recorded on initial recognition in the functional currency at the transaction rate (the spot exchange rate at the date of the transaction) between the entity's functional currency and the foreign currency [IAS21.21(R.05)].

An average exchange rate may be used for all transactions occurring during a period of say a week or a month, if exchange rates do not fluctuate significantly. However, if exchange rates fluctuate significantly, the use of average rates is inappropriate [IAS21.22(R.05)] .

Monetary intra-group items qualify as an entity's net investment in a foreign operation if their settlement is neither planned nor likely to occur in the foreseeable future [IAS21.15(R.05)] .

Exchange differences arising from intra-group monetary items such as long-term receivables or loans that are part of the net investment in a foreign operation are recognised in the income statement in the separate financial statements of the reporting entity or the individual financial statements of the foreign operation, as appropriate. Exchange differences that arise on foreign currency balances that are part of the net investment are recognised initially in a separate component of equity in the consolidated financial statements if it is denominated in the functional currency of the reporting entity or the foreign operation . These exchange differences are recycled to the income statement on disposal of the net investment [IAS21.32(R.05)]. IAS 21R is expected to be amended soon to lift certain restrictions as to which monetary items could qualify as a net investment in a foreign operation.

Monetary items formally designated as hedging instruments in a cash flow or net investment hedge are accounted for in accordance with specific rules of IAS 39R [IAS39.95-98(R.05)] [IAS39.102(R.05)].

Non-monetary, non-financial items
The translation of non-monetary items depends on whether they are recognised at historical cost or at fair value. Non-monetary items carried at historical cost are translated using the historical exchange rate that existed at the date when the item was recognised [IAS21.23(b)(R.05)]. Non-monetary items that are carried at fair value are recognised using the exchange rate on the date that when the fair values were determined [IAS21.23(c)(R.05)] .

The carrying amount of non-monetary, non-financial items is determined under the relevant standard (that is IAS 2, IAS 16 and IAS 40 respectively) initially in the foreign currency. It is then translated into the entity's functional currency in accordance with IAS 21R [IAS21.24(R.05)] .

Certain non-monetary assets (for example inventory) are measured at the lower of cost or net realisable value. The carrying amount for such assets denominated in a foreign currency is determined by comparing:

	The cost or carrying amount, as appropriate, translated at the exchange rate at the date when the amount was determined; and
	The net realisable value or recoverable amount, as appropriate, translated at the exchange rate at the date when the value was determined.

The effect of this comparison may lead to the recognition of an impairment loss in the entity's functional currency which would not be recognised if the foreign currency was the functional currency or vice versa [IAS21.25(R.05)] .

Financial instruments
Financial instruments can be monetary or non-monetary and may be carried at fair value, cost or amortised cost. Where a financial instrument is denominated in a foreign currency, it is initially recognised at fair value in the foreign currency and translated into the functional currency at the spot rate. The fair value of the financial instrument is usually the same as the fair value of the consideration given in the case of an asset, or received in the case of a liability.

The foreign currency amount of financial instruments carried at amortised cost or cost is translated into the functional currency using either the closing rate (if it is a monetary item) or the historical rate (if it is a non-monetary item) for subsequent measurement. Financial instruments carried at fair value are translated to the functional currency using the closing spot rate.

The entire change in the carrying amount of a non-monetary available-for-sale financial asset, including the effect of changes in foreign currency rates, is reported in equity at the balance sheet date [IAS39.IG.E.3.4(R.05)].

A change in the carrying amount of monetary available-for-sale financial assets on subsequent measurement is analysed between the foreign exchange component and the fair value movement. The foreign exchange component is recognised in profit or loss and the fair value movement is recognised in equity. [IAS39.IG.E.3.2(R.05)] .

The entire change in the carrying amount of financial instruments measured at fair value through profit or loss, including the effect of changes in foreign currency rates, is recognised in profit or loss within fair value differences on subsequent measurement [IAS 21.52(a)(R.05)].

a)	the amount of exchange differences recognised in profit or loss except those arising on financial instruments measured at fair value through profit or loss in accordance with IAS 39R [IAS21.52(a)(R.05)]; and
b)	the net exchange differences classified in a separate component of equity and a reconciliation of the amount of such exchange differences at the beginning and end of the period [IAS21.52(b)(R.05)].