Exploring IAS 21 International Accounting Standard: The Effects of Changes in Foreign Exchange Rates
Exploring IAS 21: The Effects of Changes in Foreign Exchange Rates – A Journey Across Currency Borders
Discover IAS 21 Foreign Exchange and how it reflects on measurement and disclosure in financial statements… with practical points and concise examples for correct application. Read more. We will focus here on “how to apply” the standard in reality: choosing the functional currency, recording foreign currency transactions, re-evaluation at the end of the period, and then translating financial statements for foreign operations—with a concise entry example and a checklist to help you close the month without surprises.
- Quick understanding of the scope of IAS 21 Foreign Exchange and what it covers.
- Practical distinction between Functional Currency and Presentation Currency.
- The Golden Rule: Difference between Monetary and Non-Monetary items.
- How exchange rate differences appear in Profit or Loss or Other Comprehensive Income (OCI).
- Journal entry examples + Monthly closing checklist.
1) What is IAS 21 and Why Does it Matter?
The IAS 21 standard regulates how to account for the effects of exchange rate changes when: (1) Your entity carries out transactions in a foreign currency (buying/selling/loans…), or (2) You own/control a foreign operation and need to translate its results.
2) Core IAS 21 Terms (Functional vs Presentation)
Before any entry, IAS 21 requires you to define the Functional Currency—the currency of the primary economic environment.
| Term | Practical Meaning | Why it Matters? |
|---|---|---|
| Functional Currency | The currency of the primary economic environment | Basis for measurement and exchange differences |
| Presentation Currency | The currency in which statements are presented | Differences go to OCI if it differs from Functional |
| Closing Rate | The spot exchange rate at the end of the reporting period | Used for re-evaluating monetary items |
3) Initial Recognition
When a foreign currency transaction occurs, it is recorded using the spot exchange rate at the date of the transaction.
Close Checklist - Excel File
4) Subsequent Measurement
At the end of each reporting period:
- Monetary items: (Cash, receivables, loans) are translated using the closing rate.
- Non-monetary items: (Inventory, Fixed Assets) measured at historical cost are not re-translated.
5) Exchange Differences
Exchange differences arising on the settlement or translation of monetary items are recognized in Profit or Loss.
8) Practical Example
Functional Currency: USD. Purchase of goods for 10,000 EUR on credit. Spot Rate: 1.10. Closing Rate: 1.15.
| Date | Entry | Debit ($) | Credit ($) |
|---|---|---|---|
| Jan 1 | Inventory / Accounts Payable | 11,000 | 11,000 |
| Jan 31 | Exchange Loss / Accounts Payable | 500 | 500 |
10) Operational Tracking Calculator
12) Conclusion
Applying IAS 21 ensures your financial results aren’t distorted by currency volatility. Start by identifying your functional currency and automate your month-end re-evaluations.