determination would be made as to the functional currency of a particular entity. If local
management has come up with a different analysis of the facts from that of the parent,
it should be discussed to ensure that both parties have considered all the relevant facts
and circumstances and a final determination made.
By documenting the decision about the functional currency of each entity, and the
factors taken into account in making that determination, the reporting entity will be
better placed in the future to determine whether a change in the underlying
transactions, events and conditions relating to that entity warrant a change in its
functional currency.
5
REPORTING FOREIGN CURRENCY TRANSACTIONS IN
THE FUNCTIONAL CURRENCY OF AN ENTITY
Where an entity enters into a transaction denominated in a currency other than its
functional currency then it will have to translate those foreign currency items into its
functional currency and report the effects of such translation. The general requirements
of IAS 21 are as follows.
5.1 Initial
recognition
A foreign currency transaction is a transaction that is denominated or requires
settlement in a foreign currency, including transactions arising when an entity: [IAS 21.20]
(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.
On initial recognition, foreign currency transactions should be translated into the
functional currency using the spot exchange rate between the foreign currency and the
functional currency on the date of the transaction. [IAS 21.21]. The date of a transaction
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is the date on which it first qualifies for recognition in accordance with IFRS. For
convenience, an average rate for a week or month may be used for all foreign currency
transactions occurring during that period, if the exchange rate does not fluctuate
significantly. [IAS 21.22].
5.1.1
Identifying the date of transaction
The date of a transaction is the date on which it first qualifies for recognition in accordance
with IFRS. Although this sounds relatively straightforward, the following example
illustrates the difficulty that can sometimes arise in determining the transaction date:
Example 15.3: Establishing the transaction date (1)
A Belgian entity buys an item of inventory from a Canadian supplier. The dates relating to the transaction,
and the relevant exchange rates, are as follows:
Date Event
€1=C$
14 April 2019
Goods are ordered
1.50
5 May 2019
Goods are shipped from Canada and
1.53
invoice dated that day
7 May 2019
Invoice is received
1.51
10 May 2019
Goods are received
1.54
14 May 2019
Invoice is recorded
1.56
7 June 2019
Invoice is paid
1.60
IAS 2 – Inventories – does not make any reference to the date of initial recognition of inventory. However,
IFRS 9 deals with the initial recognition of financial liabilities. It requires the financial liability to be
recognised when, and only when, the entity becomes a party to the contractual provisions of the instrument.
[IFRS 9.3.1.1]. In discussing firm commitments to purchase goods, it indicates that an entity placing the order
does not recognise the liability at the time of the commitment, but delays recognition until the ordered goods
have been shipped or delivered, [IFRS 9.B3.1.2(b)], normally on the date that the risks and rewards of ownership
are considered to have passed.
Accordingly, it is unlikely that the date the goods are ordered should be used as the date of the transaction.
If the goods are shipped free on board (f.o.b.) then the risks and rewards of ownership are normally considered
to pass on shipment (5 May) and this date should be used. If, however, the goods are not shipped f.o.b. then
the risks and rewards of ownership will often be considered to pass on delivery (10 May) and therefore the
date the goods are received should be treated as the date of the transaction. In practice, the transaction date
will depend on the precise terms of the agreement (which are often based on standardised agreements such
as the Incoterms rules).
The dates on which the invoice is received and is recorded are irrelevant to when the risks and rewards of
ownership pass and therefore should not in principle be considered to be the date of the transaction. In
practice, it may be acceptable that as a matter of administrative convenience that the exchange rate at the date
the invoice is recorded is used, particularly if there is no undue delay in processing the invoice. If this is done
then care should be taken to ensure that the exchange rate used is not significantly different from that ruling
on the ‘true’ date of the transaction.
It is clear from IAS 21 that the date the invoice is paid is not the date of the transaction because if it were then
no exchange differences would arise on unsettled transactions.
In the example above, one of the difficulties in identifying the date of transaction is the
fact that IAS 2 contains little guidance on determining when purchased inventory should
be recognised as an asset. Some standards, particularly those published more recently
such as IFRS 15 – Revenue from Contracts with Customers – contain more detailed
guidance in this respect. Nevertheless, determining the date of transaction may still
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exchange
1119
require the application of judgement and the date that a transaction is recorded in an
entity’s books and records will not necessarily be the same as the date at which it
qualifies for recognition under IFRS. Other situations where this issue is likely to arise
is where an entity is recording a transaction that relates to a period, rather than one
being recognised at a single point in time, as illustrated below:
Example 15.4: Establishing the transaction date (2)
On 30 September 2019 Company A, whose functional currency is the euro, acquires a US dollar bond for
US$8,000 which is measured at amortised cost. The bond carries fixed interest of 5% per annum paid
quarterly, i.e. US$100 per quarter. The exchange rate on acquisition is US$1 to €1.50.
On 31 December 2019, the US dollar has appreciated and the exchange rate is US$1 to €2.00. Interest received
on the bond on 31 December 2019 is US$100 (= €200).
Although the interest might only be recorded on 31 December 2019, the rate on that date is not the spot rate
ruling at the date of the transaction. Since the interest has accrued over the 3 month period, it should be
translated at the spot rates applicable to the accrual of interest during the 3 month period. Accordingly, a
weighted average rate for the 3 month period should be used. Assuming that the appropriate average rate is
US$1 to €1.75 the interest income is €175 (= US$100 × 1.75).
Acc
ordingly, there is also an exchange gain on the interest receivable of €25 (= US$100 × [2.00 – 1.75]) to
be reflected in profit or loss. The journal entry for recording the receipt of the interest on 31 December 2019
is therefore as follows:
€
€
Cash 200
Interest income (profit or loss)
175
Exchange gain (profit or loss)
25
5.1.2
Deposits and other consideration received or paid in advance
An entity might receive (or pay) a deposit in a foreign currency in advance of delivering
(or receiving) goods or services in circumstances where the resulting liability (or asset)
is considered a non-monetary item – see 5.4.1 below. To many it seems clear that in
these circumstances the date of transaction is the date on which the deposit is
recognised. However, historically, some have argued it should be a subsequent date (or
dates) when the goods or services are actually delivered. [IFRIC 22.1-3].
The Interpretations Committee, noting diversity in practice particularly in the
construction industry, published IFRIC 22 in December 2016 addressing this issue. It
explains that, in general, the appropriate application of IAS 21 is to use the exchange rate
at the date the advance payment is recognised, normally the payment date. [IFRIC 22.8]. If
there are multiple payments or receipts in advance, an entity should determine a date of
transaction for each payment or receipt of advance consideration. [IFRIC 22.9].
IFRIC 22 applies to a foreign currency transaction (or part of it) when an entity
recognises a non-monetary asset or non-monetary liability arising from the payment or
receipt of advance consideration before the related asset, expense or income (or part of
it) is recognised. [IFRIC 22.4]. It does not apply when an entity measures the asset, income
or expense arising from the advance payment at fair value or at the fair value of the
consideration paid or received at a date other than the date of initial recognition of the
non-monetary asset or non-monetary liability, for example the measurement of
goodwill when applying IFRS 3 – Business Combinations. [IFRIC 22.5].
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The interpretation need not be applied to income taxes or insurance contracts
(including reinsurance contracts) issued or reinsurance contracts held. [IFRIC 22.6]. In fact,
once IFRS 17 – Insurance Contracts – is applied, a group of insurance contracts is
treated as a monetary item (see Chapter 52 at 7.3) and therefore the interpretation is
unlikely to be relevant. [IFRIC 22.BC8, IFRS 17.30].
The interpretation is effective for periods commencing on or after 1 January 2018. Earlier
application was permitted, but disclosure of this fact would have been required. [IFRIC 22.A1].
On initial application, an entity should apply the requirements either: [IFRIC 22.A2]
(a) retrospectively in accordance with IAS 8 – Accounting Policies, Changes in
Accounting Estimates and Errors; or
(b) prospectively to all assets, expenses and income in the scope of the interpretation
initially recognised on or after:
(i) the beginning of the reporting period in which the entity first applies the
interpretation; or
(ii) the beginning of a prior reporting period presented as comparative
information in the financial statements of the reporting period in which the
entity first applies the interpretation.
An entity applying the interpretation prospectively should apply it to assets, expenses
and income initially recognised on or after the beginning of the first reporting period to
which it is applied (see (b) above) for which the entity has recognised non-monetary
assets or non-monetary liabilities arising from advance consideration before that date.
[IFRIC 22.A3].
5.1.3
Using average rates
Rather than using the actual rate ruling at the date of the transaction ‘an average rate for
a week or month may be used for all foreign currency transactions occurring during that
period’, if the exchange rate does not fluctuate significantly (see 5.1 above). [IAS 21.22].
For entities which engage in a large number of foreign currency transactions it will be
more convenient for them to use an average rate rather than using the exact rate for
each transaction. If an average rate is to be used, what guidance can be given in choosing
and using such a rate?
(a) Length of period
As an average rate should only be used as an approximation of actual rates then care
has to be taken that significant fluctuations in the day-to-day exchange rates do not
arise in the period selected. For this reason the period chosen should not be too long.
We believe that the period should be no longer than one month and where there is
volatility of exchange rates it will be better to set rates on a more frequent basis, say,
a weekly basis, especially where the value of transactions is significant;
(b) Estimate of average rate relevant to date of transaction
The estimation of the appropriate average rate will depend on whether the rate is
to be applied to transactions which have already occurred or to transactions which
will occur after setting the rate. Obviously, if the transactions have already
occurred then the average rate used should relate to the period during which those
transactions occurred; e.g. purchase transactions for the previous week should be
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exchange
1121
translated using the average rate for that week, not an average rate for the week
the invoices are being recorded;
If the rate is being set for the following period the rate selected should be a
reasonable estimate of the expected exchange rate during that period. This could
be done by using the closing rate at the end of the previous period or by using the
actual average rate for the previous period. We would suggest that the former be
used. Whatever means is used to estimate the average rate, the actual rates during
the period should be monitored and if there is a significant move in the exchange
rate away from the average rate then the rate being applied should be revised;
(c) Application
of average rate to type of item
We believe that average rates should be used only as a matter of convenience
where there are a large number of transactions. Even where an average rate is used,
we recommend that the actual rate should be used for large one-off transactions
such as the purchase of a fixed asset or an overseas investment or taking out a
foreign loan. Where the number of foreign currency transactions is small it will
probably not be worthwhile setting and monitoring average rates and therefore
actual rates should be used.
5.1.4
Practical difficulties in determining exchange rates
In most cases determining an exchange rate will be a relatively straightforward exercise,
but this will not always be the case, particularly where there are restrictions on entities
wishing to exchange one currency for another, typically a local currency for a foreign
currency. For example,
• legal restrictions might permit sales of local currency only at an official rate rather
than a rate that reflec
ts more fully market participants’ views of the currency’s
relative value or its underlying economics. Those official rates may or may not be
pegged to another country’s currency, for example the US dollar;
• exchange rates set by governments might vary according to the nature of the
underlying transaction; and
• the volume of currency that can be exchanged through official mechanisms may be
limited by formal or informal restrictions imposed by government, often designed to
help manage the government’s sometimes scarce foreign exchange reserves.
These situations are often encountered in countries that have more of a closed economy
and which may be experiencing a degree of economic strain. High inflation or even
hyperinflation and devaluations can be symptomatic of these situations as can the
development of a ‘black market’ in foreign currencies, the use of which could to some
extent be unlawful. Determining an appropriate exchange rate to use in these
circumstances can be difficult as discussed at 5.1.4.A to 5.1.4.C below.
In more extreme cases of economic strain or hyperinflation a country may eventually
replace its local currency completely or even adopt a third country’s currency as its
own. Examples of the latter include Ecuador and Zimbabwe which have both in recent
times effectively adopted the US dollar as their official currency. In addition to the
underlying economic problems these actions are designed to address they may also go
some way towards addressing some of the associated financial reporting issues.
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It is also important to recognise that economic characteristics such as those mentioned
above are not always associated with difficult economic conditions, e.g. many successful
economies have a currency that to some extent is, or has been, pegged to another
currency or is otherwise linked to a different currency,
5.1.4.A Dual
rates
One of the practical difficulties in translating foreign currency amounts that was
noted above is where there is more than one exchange rate for that particular
currency depending on the nature of the transaction. In some cases the difference
between the exchange rates can be small and therefore it probably does not matter
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 221