Foreign currency transactions according to IAS 21

Business operations often involve foreign currency transactions. These transactions should be accounted for in the domestic currency, which means they must be translated, measured and properly presented. This, in turn, raises a number of questions about domestic and international reporting. The regulations found in International Accounting Standard 21 “The Effects of Changes in Foreign Exchange Rates” offer a helping hand here.​

Concepts used in IAS 21

The discussed Standard employs three concepts in relation to currencies, namely:

• functional currency,
• foreign currency,
• presentation currency.

Functional currency is the currency of the primary economic environment in which the entity operates, i.e. it is usually the currency of the country where it operates. It is possible to choose a different currency as the functional currency, provided that it has a greater impact on the prices of goods and services sold and the costs incurred by the entity; however, it must be documented.

Foreign currency is a currency other than the functional currency, whereas presentation currency is a currency in which financial statements are presented.

IAS 21 also mentions the closing rate, being the spot exchange rate at the end of the reporting period. Depending on the asset to be measured, the spot exchange rate may be the buying or selling rate referred to in the Polish accounting regulations.

How to initially recognise a foreign currency transaction

Foreign currency transactions include, among others, transactions of the purchase or sale of goods and services, the price of which is denominated in a foreign currency and transactions of taking out or granting loans and credits that are payable or receivable in a foreign currency. In accordance with IAS 21, these transactions should be recorded initially in the functional currency after conversion of the foreign currency at the spot exchange rate as at the date of the transaction. Under the standard, an average rate of exchange for a given week or a month can be applied for a given foreign currency for the sake of simplicity, with the proviso that this solution is only correct if there is no great fluctuation in exchange rates.

Balance sheet measurement

In IAS 21, the method of balance sheet measurement of assets and liabilities denominated in foreign currencies depends on whether this is a monetary or a non-monetary item.

Monetary items are cash on hand and in bank accounts, as well as receivables and payables due to be received or paid in a foreign currency, the amount of which either has been or can be determined, whereas non-monetary items are other assets and liabilities. Their chief feature is the absence of the right to receive a fixed or determinable amount of foreign currency.

In order to determine the value of given balance sheet items at a balance sheet date, a relevant rate of exchange must be applied, namely:

• closing rate for monetary items,
• exchange rate at the date of the transaction for non-monetary items carried at historical cost or production cost,
• rate that existed when the fair values were determined for non-monetary items carried at fair value.

What about advance considerations for fixed assets under construction?

In order to obtain fixed assets, certain entities make payments of deposits, prepayments and advances. There is a question whether such payments should be measured as monetary or non-monetary items. In the literature one can find that if payments are considered prepayments or advances, they are classified as non-monetary items and presented in financial statements at the exchange rate as at the date of transaction. However, if these payments are treated as refundable deposits, they can be classified as monetary items measured at the closing rate.

How to recognise exchange differences

According to IAS 21, exchange differences for monetary and non-monetary items should be reported in the profit or loss in the period. In the case of monetary items that form part of the entity’s net investment in a foreign operation, exchange differences should be recognised in the entity’s profit or loss in their financial statements, and in the consolidated financial statements in other comprehensive income.

If a gain or loss on a non-monetary item is recognised directly in equity, any foreign exchange components of this gain or loss should be recognised in equity, as well. The same principle applies to recognising gains or losses in the profit or loss.

Presentation currency

Entities can present their financial statements in any currency. In order to present financial statements in a different currency than the functional currency, the entity must translate the result and financial position to the presentation currency. Assets and liabilities are translated at the closing rate as at the date of the statement of financial position (balance sheet), whereas income and expenses presented in the statement of comprehensive income are translated at exchange rates as at the dates of the transactions (an average rate of exchange is often used). All resulting exchange differences are accumulated in a separate component of equity.

Disclosures in financial statements

The entity discloses the amount of exchange differences reported in profit or loss and net exchange differences accumulated in a separate component of equity, and a reconciliation of the amount of these exchange differences at the beginning and end of the period. When the presentation currency is different from the functional currency, the entity discloses this fact, providing the functional currency and reasons for using a different presentation currency. If the functional currency has been changed, it should be disclosed along with reasons therefor.

If an entity presents its financial statements in a currency that is different from its functional currency, it may describe these financial statements as complying with IFRS only if they comply with all the requirements of each applicable Standard and each applicable Interpretation.

If these requirements are not met, and the entity presents its financial statements or other financial information in a currency that is different from its functional currency and presentation currency, the entity should identify this information as supplementary information in order to distinguish it from the information that complies with IFRS, and disclose the currency in which supplementary information is displayed along with the entity’s functional currency and with the translation method that has been used.

What does the Polish Accounting Act say about this?

In line with the Polish balance sheet law, business transactions denominated in foreign currencies shall be recognised in the books of accounts as at the transaction dates as at the rate of exchange actually applied on that date: only for the sale or purchase of foreign currencies or the settlement of receivables or liabilities (Art. 30 par. 2 item 1 of the Accounting Act). For other transactions, an average exchange rate set by the National Bank of Poland for a given currency as at the day preceding the date of the business transaction shall be applied (Art. 30 par. 2 item 2 of the Accounting Act).

What is more, if the entity decides to apply solutions provided for in NAS 11, then – in line with § 6.18 –  the entity should translate e.g. the aforementioned advances and prepayments for a fixed asset denominated in foreign currencies into the Polish currency only at the time of their transfer. Thus, the entity does not revalue them at the balance sheet date or the purchase date.

Should you have any questions about the reporting of foreign currency transactions, I encourage you to contact RSM Poland experts directly.