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Effects of Changes in Foreign Exchange Rates (IAS 21)

Last updated: 13 June 2024

Entities may engage in transactions denominated in foreign currencies. These transactions must be translated into the currency that the company uses to present its financial statements. In addition, a parent company may conduct foreign operations through subsidiaries, associates or joint arrangements. In such cases, the financial statements of these investees need to be translated to the currency used in the consolidated financial statements. Furthermore, an entity may opt to present its financial statements in a currency different from the one used in its economic environment. All these considerations are addressed by IAS 21.

Let’s dive in.

Translating foreign currency transactions

Initial recognition.

Initially, a foreign currency transaction is recognised at the spot exchange rate (i.e., the rate for immediate delivery) between the functional currency and the foreign currency at the date of the transaction (IAS 21.21). A foreign currency transaction is a transaction denominated or requiring settlement in a foreign currency, including transactions arising when an entity (IAS 21.20):

• Buys or sells goods or services priced in a foreign currency,
• Borrows or lends funds with amounts payable or receivable denominated in a foreign currency, or
• Otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.

The transaction date is when the transaction first qualifies for recognition under applicable IFRS standard (IAS 21.22).

IAS 21 permits the use of simplifications in determining the foreign exchange rate, such as using an average rate, as long as exchange rates don’t fluctuate significantly (IAS 21.22). In practice, entities often use the average of monthly rates, as central banks publish these for most currencies.

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Translation at reporting dates

At the end of each reporting period (IAS 21.23):

• Foreign currency monetary items are translated using the closing rate (i.e., the spot exchange rate at the end of the reporting period).
• Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. They are not re-translated using the closing rate.
• 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 determined.

Specific procedures for translating foreign operations are discussed below.

Monetary and non-monetary items

Monetary items are defined as units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency (IAS 21.8). Common examples of monetary items include trade receivables and payables or loans. Other examples are given in paragraph IAS 21.16.

Non-monetary items lack the right to receive (or the obligation to deliver) a fixed or determinable number of units of currency. Examples of non-monetary items include advance consideration paid or received, goodwill, items of PP&E, intangible assets and inventories (IAS 21.16).

Investments in equity instruments are also non-monetary items (IFRS 9.B5.7.3), but they are measured at fair value and therefore their carrying amount is effectively impacted by foreign exchange movements.

Recognition of exchange differences

As a general rule, exchange differences arising from the settlement or translation of a monetary asset are recognised in P/L (IAS 21.28).

When non-monetary assets are measured at fair value (or revalued amount) in a foreign currency, exchange differences are treated similarly to gains or losses on remeasurement. That is, they can be recognised in other comprehensive income under circumstances specified by other IFRS standards (IAS 21.30-31).

Example: Recognition of exchange differences

Suppose Entity A buys an item of PP&E on 1 January 20X1. Entity A’s functional and presentation currency is the Euro (EUR), but the invoice for the PP&E is for 1,000 US dollars (USD). The EUR/USD exchange rate on 1 January 20X1 is 1.1 (i.e., 1 EUR = 1.1 USD). The invoice is paid on 1 May 20X1 when the EUR/USD rate is 1.2. All calculations used in this example are available for download in an  Excel file .

Entity A would make the following entries in EUR:

As shown, the PP&E item is carried at historical cost and is not subsequently retranslated to reflect exchange rate movements between initial recognition and invoice payment.

Use of multiple exchange rates

When several exchange rates are available, the rate used is the one at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date (IAS 21.26).

Lack of exchangeability

In 2023, the IASB issued amendments to IAS 21 that will require companies to provide more information in their financial statements when a currency cannot be exchanged into another currency, an issue that wasn’t previously covered. The amendments are effective for annual reporting periods beginning from 1 January 2025, with early application permitted. Read more in ​Deloitte’s publication​ .

Advance Consideration (IFRIC 22)

IFRIC Interpretation 22 ‘Foreign Currency Transactions and Advance Consideration’ stipulates that the transaction date for determining the exchange rate used for initial recognition of the related asset, expense, or income is the date an entity first recognises the non-monetary asset or non-monetary liability arising from the payment or receipt of advance consideration (IFRIC 22.8-9).

Exchange differences on borrowings

According to paragraph IAS 23.6(e), borrowing costs may include exchange differences resulting from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Exchange differences on deferred tax

Exchange differences on deferred foreign tax liabilities or assets may be classified as deferred tax expense or income if that presentation is considered to be the most useful to financial statement users (IAS 12.78).

Change in functional currency

A change in functional currency can only occur if there are changes to the underlying transactions, events, and conditions that the functional currency reflects. Any change in functional currency is accounted for prospectively (IAS 21.35-37).

Translating a foreign operation

When an entity within a group uses a different presentation currency from that of the consolidated financial statements, translations are performed using the following procedures as per IAS 21.39:

• Assets, including goodwill and fair value adjustments (IAS 21.47), and liabilities, are translated at the closing rate at the reporting date. This includes comparatives translated using historical rates.
• Income and expenses are translated at exchange rates applicable at the transaction dates. This also includes comparatives translated using historical rates.
• All resulting exchange differences are recognised in other comprehensive income (OCI).

IAS 21.40 allows for simplifications in determining the foreign exchange rate, for example, using an average rate, assuming exchange rates do not significantly fluctuate. In practice, an average rate for each month is most commonly used.

Cumulative translation adjustment (CTA)

Exchange differences referred to in IAS 21.39(c) are commonly identified as either ‘Cumulative Translation Adjustment’ (CTA) or ‘Foreign Currency Translation Reserve’ (FCTR). The two primary sources for CTA, as per IAS 21.41, include:

• Translating income and expenses at the transaction date exchange rates, while assets and liabilities are translated at the closing rate.
• Translating opening assets and liabilities at a closing rate that differs from the opening rate.

CTA is recognised in OCI, presented as a distinct item within equity, and not recycled to P/L until the foreign operation is disposed of. CTA is further divided between controlling and non-controlling interests (IAS 21.41). It is also recognised in OCI for investments accounted for using the equity method (IAS 21.44).

Example: Illustrative translation of a foreign operation

Consider Group A with the Euro as its presentation currency. Entity X, one of Group A’s subsidiaries, uses the US Dollar as its presentation currency. The following EUR/USD exchange rates apply:

• Opening rate at 1 January 20X1: 1.1
• Average rate in 20X1: 1.2
• Closing rate at 31 December 20X1: 1.3

All calculations and tables presented in this example can be downloaded in an Excel file .

Entity X is consolidated to Group A consolidated financial statements as follows:

Entity X stand-alone data

Statement of financial position in USD:

P/L in USD:

Consolidation of Group A

Consolidated statement of financial position in EUR at 1 January 20X1:

Consolidated statement of financial position in EUR at 31 December 20X1:

Consolidated P/L for 20X1 in EUR:

Intragroup balances

Exchange differences on intragroup balances.

Although intragroup balances are eliminated during consolidation, any exchange differences arising from those balances are not. This is because the group is effectively exposed to foreign exchange gains and losses, even on intragroup transactions, including dividend receivables and payables (IAS 21.45).

Goodwill considerations

Goodwill, as previously stated, is considered an asset of a foreign operation and is retranslated at each reporting date. For multinational group acquisitions, goodwill should be allocated to each functional currency level of the acquired foreign operation (IAS 21.BC32).

Net investment in a foreign operation

A net investment in a foreign operation represents the reporting entity’s interest in the net assets of that operation (IAS 21.8). Monetary items receivable from, or payable to, a foreign operation, where settlement is neither planned nor likely to occur in the foreseeable future, are treated as part of the entity’s net investment in that operation (IAS 21.15-15A). Exchange differences arising from such monetary items are recognised in P/L in separate financial statements, but in OCI (as part of CTA) in consolidated financial statements (IAS 21.32-33).

Disposal or partial disposal of a foreign operation

Upon disposing of a foreign operation, the cumulative amount of exchange differences relating to that operation, recognised in OCI and accumulated in the separate component of equity (i.e. CTA), is reclassified from equity to P/L (as a reclassification adjustment ) when the gain or loss on disposal is recognised (IAS 21.48). Furthermore, paragraph IAS 21.48A outlines accounting procedures for partial disposals.

Translation from the currency of a hyperinflationary economy

IAS 21.42-43 provides specific provisions for translating from the currency of a hyperinflationary economy.

Functional and foreign currencies

Defining functional and foreign currencies.

The functional currency is defined as the currency of the primary economic environment in which an entity operates, i.e. primarily generates and spends cash. IAS 21.9-10 details the factors that should be considered in determining an entity’s functional currency.

The foreign currency, as defined by IAS 21.8, is any currency that is different from the entity’s functional currency.

Functional currency of a foreign operation

Identifying the functional currency can be particularly complex when a reporting entity is a foreign operation of another entity and fundamentally an extension of its operations. For instance, a ‘financial’ subsidiary (i.e., a subsidiary primarily holding financial assets or issuing debt) whose core financial assets and liabilities are denominated in the parent’s functional currency may have the same functional currency as the parent, regardless of its operational country. IAS 21.11 outlines additional factors to be considered when determining the functional currency of a foreign operation. If these indicators are mixed, priority is given to the primary indicators described in IAS 21.9.

Use of a presentation currency other than the functional currency

The rules regarding the translation of a foreign operation are equally applicable to the use of a presentation currency that is different from the functional currency.

Presentation in financial statements

IAS 21 does not specify in which part of the income statement foreign exchange differences should be presented. Therefore, entities must develop an accounting policy. The most common approach is to report exchange differences in the same section of the income statement where the original income or expense was (or will be) recognised for the item that subsequently led to exchange differences. For example, exchange differences on trade receivables are presented within operating profit, while exchange differences on debt are presented within finance costs. This method aligns with the one mandated by IFRS 18 .

Cash flows in foreign currency

IAS 21 does not cover the statement of cash flows as it falls under the scope of IAS 7. This includes the presentation of cash flows resulting from transactions in a foreign currency and the translation of cash flows from a foreign operation (IAS 21.7).

The disclosure requirements are provided in IAS 21.51-57.

© 2018-2024 Marek Muc

The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). You can access full versions of IFRS Standards at shop.ifrs.org. IFRScommunity.com is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org.

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CPD technical article

01 March 2009

IAS 21 the effects of changes in foreign exchange rates

Multiple-choice questions

Graham Holt

Graham holt explains the importance of exchange rates when it comes to accounting for any transactions carried out in foreign currencies, this article was first published in the march 2009 edition of  accounting and business  magazine., studying this technical article and answering the related questions can count towards your verifiable cpd if you are following the unit route to cpd and the content is relevant to your learning and development needs. one hour of learning equates to one unit of cpd. we'd suggest that you use this as a guide when allocating yourself cpd units..

The purpose of IAS 21 is to set out how to account for transactions in foreign currencies and foreign operations.

The standard shows how to translate financial statements into a presentation currency, which is the currency in which the financial statements are presented. This contrasts with the functional currency, which is the currency of the primary economic environment in which the entity operates.

Key issues are the exchange rates, which should be used, and where the effects of changes in exchange rates are recorded in the financial statements.

Functional currency is a concept that was introduced into IAS 21, The Effects of Changes in Foreign Exchange Rates , when it was revised in 2003. The previous version of IAS 21 used a concept of reporting currency. In revising IAS 21 in 2004, the IASB’s main aim was to provide additional guidance on the translation method and determining the functional and presentation currencies.

The functional currency should be determined by looking at several factors. This currency should be the one in which the entity normally generates and spends cash, and that in which transactions are normally denominated. All transactions in currencies other than the functional currency are treated as transactions in foreign currencies.

The entity’s functional currency reflects the transactions, events and conditions under which the entity conducts its business. Once decided on, the functional currency does not change unless there is a change in the underlying nature of the transactions and relevant conditions and events. Foreign currency transactions should initially be recorded at the spot rate of exchange at the date of the transaction. An approximate rate can be used. Subsequently, at each balance sheet date, foreign currency monetary amounts should be reported using the closing rate. Non-monetary items measured at historical cost should be reported using the exchange rate at the date of the transaction. Non-monetary items carried at fair value, however, should be reported at the rate that existed when the fair values were determined.

Exchange differences arising on monetary items are reported in profit or loss in the period, with one exception. The exception is that exchange differences arising on monetary items that form part of the reporting entity’s net investment in a foreign operation are recognised in the group financial statements, within a separate component of equity. They are recognised in profit or loss on disposal of the net investment. If a gain or loss on a non-monetary item is recognised in equity (for example, property, plant and equipment revalued under IAS 16), any foreign exchange gain or loss element is also recognised in equity.

Presentation currency and functional currency

An entity can present its financial statements in any currency. If the presentation currency differs from the functional currency, the financial statements are retranslated into the presentation currency. If the financial statements of the entity are not in the functional currency of a hyperinflationary economy, then they are translated into the presentation currency as follows:

• Assets and liabilities (including any goodwill arising on the acquisition and any fair value adjustment) are translated at the closing spot rate at the date of that balance sheet
• Income statements are translated at the spot rate at the date of the transactions (average rates are allowed if there is no great fluctuation in the exchange rates)
• All exchange differences are recognised in a separate component of equity.

At the entity level, management should determine the functional currency of the entity based on the requirements of IAS 21.

An entity does not have a choice of functional currency. All currencies, other than the functional one, are treated as foreign currencies. An entity’s management may choose a different currency from its functional one – the presentation currency – in which to present financial statements.

At the group level, various entities within a multinational group will often have different functional currencies. The functional currency is identified at entity level for each group entity. Each group entity translates its results and financial position into the presentation currency of the reporting entity.

Normal consolidation procedures are followed for the preparation of the consolidated financial statements, once all the consolidated entities have prepared their financial information in the appropriate presentation currency.

Translation of a foreign operation

When preparing group accounts, the financial statements of a foreign subsidiary should be translated into the presentation currency as set out above. Any goodwill and fair value adjustments are treated as assets and liabilities of the foreign entity, and therefore retranslated at each balance sheet date at the closing spot rate.

Exchange differences on intra-group items are recognised in profit or loss, unless they are a result of the retranslation of an entity’s net investment in a foreign operation when it is classified as equity.

Dividends paid in a foreign currency by a subsidiary to its parent firm may lead to exchange differences in the parent’s financial statements. They will not be eliminated on consolidation, but recognised in profit or loss. When a foreign operation is disposed of, the cumulative amount of the exchange differences in equity relating to that foreign operation is recognised in profit or loss when the gain or loss on disposal is recognised.

The notion of a group functional currency does not exist under IFRS; functional currency is purely an individual entity or business operation-based concept. This has resulted in IAS 21 becoming one of the more complex standards for firms converting to IFRS.

In addition, many multinational groups have found the process time-consuming and challenging, particularly when considering non-trading group entities where the standard’s emphasis on external factors suggests that the functional currency of corporate subsidiaries might well be that of the parent, regardless of their country of incorporation or the currency in which their transactions are denominated.

Entities applying IFRS need to remember that the assessment of functional currency is a key step when considering any change in the group structure or when implementing any new hedging or tax strategies. Furthermore, should the activities of the entity within the group change for any reason, the determination of the functional currency of that entity should be reconsidered to identify the changes required. Management must take care to document the approach followed in the determination of functional currency for each entity within the group, using a consistent methodology across all cases, particularly when an exercise of judgment is required.

Case study 1

An entity, with the dollar as its functional currency, purchases plant from a foreign entity for €18m on 31 May 2008 when the exchange rate was €2 to $1. The entity also sells goods to a foreign customer for €10.5m on 30 September 2008, when the exchange rate was €1.75 to $1. At the entity’s year end of 31 December 2008, both amounts are still outstanding and have not been paid. The closing exchange rate was €1.5 to $1. The accounting for the items for the period ending 31 December 2008 would be as follows:

The entity records the plant and liability at $9m at 31 May 2008. At the year-end, the amount has not been paid. Thus using the closing rate of exchange, the amount payable would be retranslated at $12m, which would give an exchange loss of $3m in profit or loss. The asset remains at $9m before depreciation.

The entity will record a sale and trade receivable of $6m. At the year-end, the trade receivable would be stated at $7m, which would give an exchange gain of $1m that would be reported in profit or loss. IAS 21 does not specify where exchange gains and losses should be shown in the statement of comprehensive income.

Case study 2

An entity has a 100%-owned foreign subsidiary, which has a carrying value at a cost of $25m. It sells the subsidiary on 31 December 2008 for €45m. As at 31 December 2008, the credit balance on the exchange reserve, which relates to this subsidiary, was $6m. The functional currency of the entity is the dollar and the exchange rate on 31 December 2008 is $1 to €1.5. The net asset value of the subsidiary at the date of disposal was $28m.

The subsidiary is sold for $45m divided by 1.5 million, therefore $30m. In the parent entity’s accounts a gain of $5m will be shown. In the group financial statements, the cumulative exchange gain in reserves will be transferred to profit or loss, together with the gain on disposal. The gain on disposal is $30m minus $28m, therefore $2m, which is the difference between the sale proceeds and the net asset value of the subsidiary. To this is added the exchange reserve balance of $6m to give a total gain of $8m, which will be included in the group statement of comprehensive income.

Graham Holt is an ACCA examiner and principal lecturer in accounting and finance at Manchester Metropolitan University Business School

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Annual Reporting

Knowledge base for IFRS Reporting

IAS 21 Presentation currency

Ias 21 the effects of changes in foreign exchange rates, use of a presentation currency other than the functional currency, translation to the presentation currency.

38 An entity may present its financial statements in any currency (or currencies). If the presentation currency differs from the entity’s functional currency , it translates its results and financial position into the presentation currency . For example, when a group contains individual entities with different functional currencies, the results and financial position of each entity are expressed in a common currency so that consolidated financial statements may be presented.

39 The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

• assets and liabilities for each statement of financial position presented (ie including comparatives) shall be translated at the closing rate at the date of that statement of financial position;
• income and expenses for each statement presenting profit or loss and other comprehensive income (ie including comparatives) shall be translated at exchange rates at the dates of the transactions; and
• all resulting exchange differences shall be recognised in other comprehensive income .

40 For practical reasons, a rate that approximates the exchange rates at the dates of the transactions, for example an average rate for the period, is often used to translate income and expense items. However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate.

41 The exchange differences referred to in paragraph 39(c) result from:

• translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate .
• translating the opening net assets at a closing rate that differs from the previous closing rate .

These exchange differences are not recognised in profit or loss because the changes in exchange rates have little or no direct effect on the present and future cash flows from operations. The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation .

When the exchange differences relate to a foreign operation that is consolidated but not wholly-owned, accumulated exchange differences arising from translation and attributable to non-controlling interests are allocated to, and recognised as part of, non-controlling interests in the consolidated statement of financial position.

42 The results and financial position of an entity whose functional currency is the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures:

• all amounts (ie assets, liabilities, equity items, income and expenses , including comparatives) shall be translated at the closing rate at the date of the most recent statement of financial position, except that
• when amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts shall be those that were presented as current year amounts in the relevant prior year financial statements (ie not adjusted for subsequent changes in the price level or subsequent changes in exchange rates).

43 When an entity’s functional currency is the currency of a hyperinflationary economy, the entity shall restate its financial statements in accordance with IAS 29 before applying the translation method set out in paragraph 42, except for comparative amounts that are translated into a currency of a non-hyperinflationary economy (see paragraph 42(b)).

When the economy ceases to be hyperinflationary and the entity no longer restates its financial statements in accordance with IAS 29, it shall use as the historical costs for translation into the presentation currency the amounts restated to the price level at the date the entity ceased restating its financial statements.

Translation of a foreign operation

44 Paragraphs 45–47, in addition to paragraphs 38–43, apply when the results and financial position of a foreign operation are translated into a presentation currency so that the foreign operation can be included in the financial statements of the reporting entity by consolidation or the equity method .

45 The incorporation of the results and financial position of a foreign operation with those of the reporting entity follows normal consolidation procedures, such as the elimination of intragroup balances and intragroup transactions of a subsidiary (see IFRS 10 Consolidated Financial Statements ).

However, an intragroup monetary asset (or liability ), whether short-term or long-term, cannot be eliminated against the corresponding intragroup liability (or asset) without showing the results of currency fluctuations in the consolidated financial statements . This is because the monetary item represents a commitment to convert one currency into another and exposes the reporting entity to a gain or loss through currency fluctuations.

Accordingly, in the consolidated financial statements of the reporting entity , such an exchange difference is recognised in profit or loss or, if it arises from the circumstances described in paragraph 32, it is recognised in other comprehensive income and accumulated in a separate component of equity until the disposal of the foreign operation .

46 When the financial statements of a foreign operation are as of a date different from that of the reporting entity , the foreign operation often prepares additional statements as of the same date as the reporting entity ’s financial statements.

When this is not done, IFRS 10 allows the use of a different date provided that the difference is no greater than three months and adjustments are made for the effects of any significant transactions or other events that occur between the different dates.

In such a case, the assets and liabilities of the foreign operation are translated at the exchange rate at the end of the reporting period of the foreign operation .

Adjustments are made for significant changes in exchange rates up to the end of the reporting period of the reporting entity in accordance with IFRS 10. The same approach is used in applying the equity method to associates and joint ventures in accordance with IAS 28 (as amended in 2011).

47 Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation shall be treated as assets and liabilities of the foreign operation . Thus they shall be expressed in the functional currency of the foreign operation and shall be translated at the closing rate in accordance with paragraphs 39 and 42.

Disposal or partial disposal of a foreign operation

48 On the disposal of a foreign operation , the cumulative amount of the exchange differences relating to that foreign operation , recognised in other comprehensive income and accumulated in the separate component of equity , shall be reclassified from equity to profit or loss (as a reclassification adjustment) when the gain or loss on disposal is recognised (see IAS 1 Presentation of Financial Statements (as revised in 2007)).

48A In addition to the disposal of an entity’s entire interest in a foreign operation , the following partial disposals are accounted for as disposals:

• when the partial disposal involves the loss of control of a subsidiary that includes a foreign operation , regardless of whether the entity retains a non-controlling interest in its former subsidiary after the partial disposal; and
• when the retained interest after the partial disposal of an interest in a joint arrangement or a partial disposal of an interest in an associate that includes a foreign operation is a financial asset that includes a foreign operation .

48B On disposal of a subsidiary that includes a foreign operation , the cumulative amount of the exchange differences relating to that foreign operation that have been attributed to the non-controlling interests shall be derecognised, but shall not be reclassified to profit or loss .

48C On the partial disposal of a subsidiary that includes a foreign operation , the entity shall re- attribute the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income to the non-controlling interests in that foreign operation .

In any other partial disposal of a foreign operation the entity shall reclassify to profit or loss only the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income .

48D A partial disposal of an entity’s interest in a foreign operation is any reduction in an entity’s ownership interest in a foreign operation , except those reductions in paragraph 48A that are accounted for as disposals.

49 An entity may dispose or partially dispose of its interest in a foreign operation through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity. A write-down of the carrying amount of a foreign operation , either because of its own losses or because of an impairment recognised by the investor, does not constitute a partial disposal. Accordingly, no part of the foreign exchange gain or loss recognised in other comprehensive income is reclassified to profit or loss at the time of a write-down.

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). Individual jurisdictions around the world may require or permit the use of (locally authorised and/or amended) IFRS Standards for all or some publicly listed companies.  The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. The specific status of IFRS Standards should be checked in each individual jurisdiction . Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction .

IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency IAS 21 Presentation currency

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Current Rate Method and Temporal Method of Translation

Translation refers to converting the functional currency into the parent’s presentation currency. The procedures specified by IFRS and US GAAP for translating foreign currency financial statements essentially require the use of either the current rate method or the temporal method . The suitable method for an individual foreign entity depends on the functional currency of the entity.

According to IASB, the management should take into account the following factors when deciding on the functional currency:

• The currency that impacts the sales prices of goods and services.
• The currency that influences the company’s operational costs.
• The currency from which funds are generated.
• The currency of the country whose forces and regulations mainly determine the sale price of goods.
• The currency in which receivables from operating activities are retained.

The Current Rate Method

The current rate method applies when a foreign entity has a functional currency that is different from the parent’s presentation currency. The parent translates the foreign entity’s financial statements, which are recorded in the subsidiary’s functional currency, into the parent company’s presentation currency.

Consider a Germany-based food company, ABC Ltd., that owns 10% of a Mexican company, XYZ Ltd. ABC primarily uses the euro as the presentation currency, and it does not control XYZ’s operations. XYZ is self-sustaining and much delinked from ABC. Therefore, XYZ uses its local currency, the Mexican Peso (MXN), as its functional currency. The current rate method is applicable in this case to translate XYZ’s assets and liabilities from Mexican Pesos, the functional currency, to ABC’s presentation currency, the euro.

How It Works

Each income statement element, i.e., revenues, and expenses, is translated at the average exchange rate during the reporting period. On the other hand, all balance sheet items are translated at the current exchange rate on the balance sheet date. Shareholder’s equity, mostly made up of common stock and dividends, is translated at the historical exchange rate . This will be the rate in effect when the assets are acquired.

Cumulative translation adjustment is a translation gain/loss caused by foreign currency exchange rate fluctuation. It is recognized under the shareholder’s equity on the balance sheet and is required to keep the translated balance sheet balanced. Balance sheet exposure to the foreign currency exchange rate is equal to the net asset (equity) position of the subsidiary.

$$ \text{Net assets (Equity) = Total assets – Total Liabilities = Equity} $$

If the local currency appreciates against the parent’s presentation currency, the exposure is positive and will result in a gain in the cumulative translation adjustment.

The Temporal Method

This translation method is applicable when the subsidiary’s functional currency is the same as the parent’s presentation currency. The local currency deviates from the functional and the presentation currencies. Re-measurement refers to the translation of the local currency to a foreign currency using the temporal method.

Under this method, assets and liabilities are classified as either monetary or non-monetary . Monetary assets and liabilities are items that are settled in cash, which include cash, receivables, payables, and debt. Non-monetary assets and liabilities are not settled in cash. They include inventory, fixed assets, intangible assets, and unearned revenue.

For example, Pearson is a hypothetical company based in Canada, and it uses Canadian Dollars (CAD) as its presentation currency. Pearson owns 100% of ACK, a company based in India, and so it controls ACK’s operation decisions. Since ACK is well integrated with the parent, it will use Canadian Dollars as its functional currency. As Pearson’s presentation currency is similar to ACK’s functional currency, it will use the temporal method to translate ACK’s assets and liabilities.

Monetary assets and liabilities, such as accounts payable, cash, and accounts receivable, are translated at the current (end-of-period) rates under both the temporal and the current rate method is used. However, non-monetary assets and liabilities such as inventory, fixed assets, and intangible assets are translated at the historical exchange rate . The historical exchange rate can be taken as the rate on the date on which the assets were acquired or purchased. Common stock and dividends are also translated at the historical exchange rate .

Expenses related to non-monetary assets, such as the cost of goods and services (COGS) and depreciation, are translated at the historical exchange rate. Revenue and other expenses are translated using the average exchange rate . It is crucial to note that the historical rate differs based on the inventory costing method used.

Under US GAAP, re-measurement refers to the process of translating foreign currency financial statements of a foreign operation that has the parent’s presentation currency as its functional currency. A temporal method is applied here. Re-measurement gain/loss is reported on the income statement . If the local currency appreciates relative to the presentation currency, the result will be a re-measurement gain and vice versa.

The balance sheet exposure associated with the temporal method is equal to the foreign subsidiary’s net monetary asset position.

$$ \text{Net monetary asset position = Net monetary assets – Net monetary liabilities} $$

Example: Determining the Appropriate Translation Method in Various Scenarios

H Ltd is based in Belgium and complies with International Financial Reporting Standards (IFRS). H used EUR100 million of its cash and borrowed an equal amount to open a subsidiary in Switzerland. The funds were converted into Swiss Franc (CHF) on 31 December 2016 at an exchange rate of EUR1.00 = CHF1.10 and used to purchase CHF 90 million in fixed assets and CHF 10 million of inventories. An analyst wants to explore various scenarios to determine the potential impact on H Ltd.’s consolidated financial statements. No further information is available, and all other economic factors in Belgium are held constant. It is believed that the euro will appreciate against the Swiss Franc for the foreseeable future.

If the euro is chosen as the Switzerland subsidiary’s functional currency, H Ltd. will translate its fixed assets using the rate at which the assets were purchased . The temporal method must be used when the parent’s currency is chosen as the functional currency. Under the temporal method, the fixed assets are translated using the rate in effect at the time the assets were acquired.

If the Swiss Franc is chosen as the Switzerland subsidiary’s functional currency, H ltd will translate its inventory using the rate in effect at the end of the reporting period . The current rate method is used since the foreign currency is chosen to be the functional currency. All assets and liabilities are translated at the current (end-of-period) rate.

Assume that the euro is chosen as the Switzerland subsidiary’s functional currency. In that case, H Ltd. will translate its accounts receivable using the rate in effect at the end of the reporting period since monetary assets and liabilities such as accounts receivable are translated at current (end-of-period) rates regardless of whether the temporal or current rate method is used.

Question Assume that the euro appreciates against the Swiss Franc. If the Swiss Franc is chosen to be the Switzerland subsidiary’s functional currency, H Ltd. will most likely report a (an):      A. Subtraction from the cumulative translation adjustment.      B. Addition to the cumulative translation adjustment.      C. Translation gain/loss as a component of the net income. Solution The correct answer is A . The current rate method must be used when the foreign currency is chosen as the functional currency. All gains or losses from translation are reported as a cumulative translation adjustment to shareholder equity. When the foreign currency decreases in value (weakens), the current rate method results in a negative translation adjustment in stockholders’ equity. B is incorrect . An addition to the cumulative translation adjustment is most likely to result from the foreign currency appreciating (increasing in value). C is incorrect . A translation gain or loss arises under the temporal method when the foreign currency appreciates/depreciates relative to the parent company’s presentation currency.

Reading 13: Multinational Operations

LOS 13 (d) Compare the current rate method and the temporal method, evaluate the effects of each on the parent company’s balance sheet and income, and determine which method is appropriate in various scenarios.

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Currency Translation: Accounting Methods, Risks, and Examples

Daniel Liberto is a journalist with over 10 years of experience working with publications such as the Financial Times, The Independent, and Investors Chronicle.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

What Is Currency Translation?

Currency translation is the process of converting one currency in terms of another, often in the context of the financial results of a parent company's foreign subsidiaries into its functional currency —the currency of the primary economic environment in which an entity generates and expends cash flows.

For transparency purposes, companies with overseas ventures are, when applicable, required to report their accounting figures in one currency.

Key Takeaways

• Currency translation allows a company with foreign operations or subsidiaries to reconcile all of its financial statements in terms of its local, or functional currency.
• Currency translations use the exchange rate at the end of the reported period for assets and liabilities, the exchange rate on the date that income or an expense was recognized for the income statement, and a historical exchange rate at the date of entry to shareholder equity.
• There are two main methods of currency translation accounting: the current method, for when the subsidiary and parent use the same functional currency; and the temporal method for when they do not.
• Translation risk arises for a company when the exchange rates fluctuate before financial statements have been reconciled. This risk can be hedged with currency derivatives or forex positions.

How Currency Translation Works

Many companies, particularly big ones, are multinational, operating in various regions of the world that use different currencies . If a company sells into a foreign market and then sends payments back home, earnings must be reported in the currency of the place where the majority of cash is primarily earned and spent. Alternatively, in the rare case that a company has a foreign subsidiary , say in Brazil, that does not transfer funds back to the parent company, the functional currency for that subsidiary would be the Brazilian real.

Before a foreign entity's financial statements can translate into the reporting currency, the foreign unit's financial statements must be prepared in accordance with General Accepted Accounting Principles  (GAAP) rules. When that condition is satisfied, the financial statements expressed in the functional currency should use the following exchange rates for translation:

• Assets and Liabilities : The exchange rate between the functional currency and reporting currency at the end of the period.
• Income Statement : The exchange rate on the date that income or an expense was recognized; a weighted average rate during the period is acceptable.
• Shareholder Equity : The historical exchange rate at the date of entry to shareholder equity; the change in retained earnings uses historical exchange rates of each period's income statement.

Gains and losses resulting from currency conversions are recorded in financial statements. The change in foreign currency translation is a component of  accumulated other comprehensive income , presented in a company's consolidated statements of shareholders' equity and carried over to the consolidated balance sheet under shareholders' equity.

If a company has operations abroad that keep books in a foreign currency, it will disclose the above methodology in its  footnotes under "Note 1 - Summary of Significant Accounting Policies" or something substantially similar.

The Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 830, entitled "Foreign Currency Matters," offers a comprehensive guide on the measurement and translation of foreign currency transactions.

Currency Translation Accounting Methods

There are two main accounting standards for handling currency translation.

• The current rate method : A method of foreign currency translation where most items in the financial statements are translated at the current exchange rate. The current rate method is utilized in instances where the subsidiary isn't well integrated with the parent company, and the local currency where the subsidiary operates is the same as its functional currency.
• The temporal method : Also known as the historical method, this technique converts the currency of a foreign subsidiary into the currency of the parent company. The temporal method is used when the local currency of the subsidiary is not the same as the currency of the parent company. Differing exchange rates are used depending on the financial statement item being translated.

Translation Risk

Translation risk is the exchange rate risk associated with companies that deal in foreign currencies and list foreign assets on their balance sheets.

Companies that own  assets  in foreign countries, such as plants and equipment, must convert the value of those assets from the foreign currency to the home country's currency for accounting purposes. In the U.S., this accounting translation is typically done on a quarterly and annual basis. Translation risk results from how much the assets' value fluctuate based on exchange rate movements between the two counties involved.

Multinational corporations with international offices have the greatest exposure to translation risk. However, even companies that don't have offices overseas but sell products internationally are exposed to translation risk. If a company earns revenue in a foreign country, it must convert that revenue into its home or local currency when it reports its financials at the end of the quarter. 

Example of Currency Translation

International sales accounted for 64% of Apple Inc.’s revenue in the quarter ending Dec. 26, 2020. In recent years, a recurring theme for the iPhone maker and other big multinationals has been the adverse impact of a rising U.S. dollar. When the greenback strengthens against other currencies, it subsequently weighs on international financial figures once they are converted into U.S. dollars.

The likes of Apple seek to overcome adverse fluctuations in foreign exchange rates by hedging their exposure to currencies. Foreign exchange (forex) derivatives , such as futures contracts and options, are acquired to enable companies to lock in a currency rate and ensure that it remains the same over a specified period of time.

Constant Currencies

Constant currencies is another term that often crops up in financial statements. Companies with overseas operations often choose to publish reported numbers alongside figures that strip out the effects of exchange rate fluctuations. Investors generally pay a lot of attention to constant currency figures as they recognize that currency movements can mask the true financial performance of a company.

In its fiscal second-quarter ending Nov. 30, 2020, Nike Inc. reported a 9% increase in revenues, adding that sales rose 7% on a constant currency basis.

Financial Accounting Standards Board. " Statement of Financial Accounting, Standards No. 52, Foreign Currency Translation ," Page FAS52-4 and 5. Accessed March 31, 2021.

Financial Accounting Standards Board. " Statement of Financial Accounting, Standards No. 52, Foreign Currency Translation ," Page FAS52-5. Accessed March 31, 2021.

Deloitte. " A Roadmap to Foreign Currency Transactions and Translations ," Page 7. Accessed March 31, 2021.

Financial Accounting Standards Board. " Statement of Financial Accounting, Standards No. 52, Foreign Currency Translation ," Page FAS52-7. Accessed March 31, 2021.

Financial Accounting Standards Board. " Foreign Currency Matters (Topic 830) ." Accessed March 31, 2021.

Apple. " Apple Reports First Quarter Results ." Accessed March 31, 2021.

Nike. " Nike, Inc. Reports Fiscal 2021 Second Quarter Results ." Accessed March 31, 2021.

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• INTERNATIONAL / FINANCIAL REPORTING

Currency Translation Adjustments

• Accounting & Reporting
• International Financial Reporting Standards
• Management Accounting

EXECUTIVE SUMMARY

Susan M. Sorensen , CPA, Ph.D., has 30 years of public accounting experience and is an assistant professor of accounting, and Donald L. Kyle , CPA, Ph.D., is a professor of accounting, both at the University of Houston–Clear Lake. Their e-mail addresses are [email protected] and [email protected] , respectively.

When corporate earnings growth was in the double digits in 2006, favorable foreign currency translation was only a small part of the earnings story. But now, in a season of lower earnings coupled with volatility in currency exchange rates, currency translation gains represent a far greater portion of the total.

Using the concept that a picture is worth a thousand words—and a worksheet even more—this article uses Excel and real-world examples to explain why multinational companies are increasingly experiencing and managing what is often referred to as accounting risk caused by foreign currency exchange rate (FX) fluctuations. The article is designed to help the reader create the worksheet shown in Exhibit 3, and then use it to see firsthand how FX fluctuations affect both the balance sheet and income statement, and how currency translation adjustments (CTAs) may be hedged.

Accounting for translation risks can be very complex. This article addresses only the basics and provides some tools to help the reader understand the issues and find additional resources.

THE BALANCE SHEET PLUG Today “managing the balance sheet” goes far beyond watching the current asset–to–liability ratio. FX rate fluctuations may have a significant effect on assets, liabilities and equity beyond the effects that flow through the income statement. Globalization has changed the old accounting rule that debits equal credits (no plugging is permitted). Years ago, net income became just one part of comprehensive income (CI), and the equity part of the accounting equation became: Equity = Stock + Other Comprehensive Income + Retained Earnings. Other comprehensive income (OCI) contains items that do not flow through the income statement. The currency translation adjustment in other comprehensive income is taken into income when a disposition occurs.

The financial statements of many companies now contain this balance sheet plug. As shown in Exhibit 1, eBay’s currency translation adjustments (CTA) accounted for 34% of its comprehensive income booked to equity for 2006. General Electric’s CTA was a negative $4.3 billion in 2005 and a positive $3.6 billion in 2006. The CTA detail may appear as a separate line item in the equity section of the balance sheet, in the statement of shareholders’ equity or in the statement of comprehensive income.

Keeping accounting records in multiple currencies has made it more difficult to understand and interpret the financial statements. For example, an increase in property, plant and equipment (PP&E) may mean that the company invested in more PP&E or it may mean that the company has a foreign subsidiary whose functional currency strengthened against the reporting currency. This may not seem like a significant issue, but goodwill arising from the acquisition of a foreign subsidiary may be a multibillion-dollar asset that will be translated at the end-of-period FX rate.

TRANSACTION RISK VS. TRANSLATION RISK Because the terms for these two types of risk are similar, it is important to understand the difference and have a general idea of the effect that FX fluctuations have on these risks. In very simplified terms, these risks can be thought of as follows:

Currency transaction risk . Currency transaction risk occurs because the company has transactions denominated in a foreign currency and these transactions must be restated into U.S. dollar equivalents before they can be recorded. Gains or losses are recognized when a payment is made or at any intervening balance sheet date.

Currency translation risk . Currency translation risk occurs because the company has net assets, including equity investments, and liabilities “denominated” in a foreign currency.

Exhibit 2 provides a quick guide to the transaction and translation gain or loss effects of the U.S. dollar strengthening or weakening. GE explains its fluctuating pattern of currency translation adjustments in Note 23 of its 2006 financial statements by addressing the relative strength of the U.S. dollar against the euro, the pound sterling and the Japanese yen.

Translation risk is often referred to as “accounting risk.” This risk occurs because each “business unit” is required under FASB Statement no. 52, Foreign Currency Translation , to keep its accounting records in its functional currency and that currency may be different from the reporting currency. A business unit may be a subsidiary, but the definition does not require that a business unit be a separate legal entity. The definition includes branches and equity investments.

Functional currency is defined in Statement no. 52 as the currency of the primary economic environment in which the entity operates, which is normally the currency in which an entity primarily generates and expends cash. It is commonly the local currency of the country in which the foreign entity operates. It may, however, be the parent’s currency if the foreign operation is an integral component of the parent’s operations, or it may be another currency.

BASIC CONSOLIDATION WORKSHEET CPAs can use Excel to create a basic consolidation worksheet like the one in Exhibit 3 that demonstrates the source of currency translation adjustments and the effects of hedging (download these worksheets here ). As this worksheet is created, the equations will produce the amounts shown in Exhibit 4 . The worksheet includes lines used later, as shown in Exhibit 5 , to demonstrate how a parent company can hedge translation risk by taking out a loan denominated in the functional currency of the subsidiary. The cells are color coded. Titles and general information are in yellow. Hypothetical amounts for the two trial balances and the currency exchange rates are shown in green. Equations are shown in blue.

This worksheet is based on a simple situation where a U.S. parent company acquired a foreign subsidiary for book value at the beginning of the year and used the cost method to record its investment. Advanced and international accounting textbooks contain more detailed examples. The subsidiary’s trial balance is to the left of the parent to highlight the fact that the subsidiary’s trial balance must be translated before the companies can be consolidated. The number of accounts has been kept to a minimum. Additional accounts may be added, but any change to the lines or columns will require that the equations be altered accordingly. Although the worksheets use the current rate method, they can be adapted to another translation method.

There are two steps to getting a foreign subsidiary’s trial balance ready to consolidate.

Step 1 . Convert the accounting records from foreign GAAP to U.S. GAAP.

Step 2  Translate the trial balance into U.S. dollars.

Convergence with IFRS will reduce the need for Step 1. The worksheets assume Step 1 has already been completed. The current rate method can be summarized as follows:

LOCATING EXCHANGE RATES This worksheet is designed so that the reader can simulate “what if” scenarios with amounts and FX rates. FX quotes are available as both direct and indirect rates. The direct rate is the cost in U.S. dollars to buy one unit of the foreign currency. The indirect rate is the number of units of the foreign currency that can be purchased for one U.S. dollar. Current and historical FX rate information s available from Web sites such as OANDA at www.oanda.com , the Federal Reserve at www.federalreserve.gov/releases/H10/hist , or the Federal Reserve Bank of St. Louis at www.stls.frb.org/fred .

The worksheets use FX rates roughly based upon the Japanese yen-U.S. dollar relationship. The relationship between the current and historical exchange rates in Exhibits 3 and 4 indicates that the yen has strengthened against the dollar. Exhibit 4 shows a gain (credit) of $63,550 in the OCICTA account because net assets are being translated at a rate higher than the rates being used for the common stock, beginning retained earnings, and the net income from operations. The item “net income from operations” is used to draw the reader’s attention to the fact that the weighted average rate cannot be used in all situations.

If the exchange rates had not changed during the year, the net assets would have translated to only $550,000 instead of $618,750—an increase of $68,750. The net income of the foreign subsidiary would have been only $57,200 (6,500,000 * 0.0088). Reported translated net income was $5,200 higher than it would have been if FX rates had stayed at 0.0088 versus the weighted average of 0.0096. The change in the FX rates increased the subsidiary’s net income by 9%.

The CTA of $63,550 in this simplified example can be broken down into two pieces:

The specific effects of translation are often addressed in the Management section of the Annual Report or in the notes to the financial statements.

CURRENCY TRANSLATION HEDGING Accounting risks may be hedged. One way that companies may hedge their net investment in a subsidiary is to take out a loan denominated in the foreign currency. If companies choose to hedge this type of risk, the change in the value of the hedge is reported along with the CTA in OCI. Exhibit 5 demonstrates the situation where the parent company took out a foreign currency denominated loan at the date of acquisition in an amount equal to its original investment in the subsidiary. The loan amount is converted into U.S. dollars at the date of the transaction, and it is then adjusted under FASB Statement no. 133, Accounting for Derivative Instruments and Hedging Activities , on the parent’s books at the ending balance sheet rate.

Since the U.S. dollar has strengthened, the amount of U.S. dollars required to pay off the debt has decreased by $61,600. This decrease does not offset all of the CTA since there is an effect on CTA since net income is translated at the weighted average exchange rate.

Relevant GAAP

Comparison to IFRS

Currency translation adjustments also appear on financial statements prepared under IFRS. The treatment of currency translation is similar but not identical between IFRS and U.S. GAAP. Information on presentation in the financial statements may be obtained from sources such as Deloitte’s IAS Plus guide on IFRS model financial statements at www.iasplus.com/fs/2007modelfs.pdf .

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Example: Consolidation with Foreign Currencies

Last update: 10/2022 (video added to the end of the article)

In today’s world, most groups spread their activities abroad and logically different members of the group operate in different currencies.

Is the consolidation process of combining the financial statements of two (or more) companies different when they operate in different currencies?

Yes and no.

If you want to combine the financial statements prepared in different currencies, you will still follow the same consolidation procedures.

You still need to eliminate the share capital and pre-acquisition profits of a subsidiary with parent’s investment in a subsidiary (plus recognize any goodwill and/or non-controlling interest).

You still need to eliminate intragroup balances and transactions, including unrealized profits on intragroup sales and any dividends paid by a subsidiary to a parent.

So what’s the issue here?

You guessed it – you can’t combine apples and pears because it makes no sense.

Therefore, BEFORE you start performing the consolidation procedures, you need to translate the subsidiary’s financial statements to the parent’s presentation currency .

HOW?  

General rules: translating subsidiary’s financial statements

We need to follow the rules in IAS 21 The Effects of Changes in Foreign Exchange Rates for translating the financial statements to a presentation currency.

Just a small note: please, do not mess up a functional currency with a presentation currency.

Every company has just ONE functional currency , but it can present its financial statements in MANY presentation currencies .

While the functional currency depends on the economic environment of a company and its specific operations, the presentation currency is a matter of CHOICE .

What rates should we use to translate the financial statements in a presentation currency?

I’ve summarized in in the following table:

  Please note that the above table applies when neither functional nor presentation currency are that of a hyperinflationary economy.

Actual rates are the rates at the date of the individual transactions, but you can use the average rate for the year if the actual rates do not differ too much.

Why is there a CTD?

If you translate the financial statements using different foreign exchange rates, then the balance sheet would not balance (i.e. assets will not equal liabilities plus equity).

Therefore, CTD, or currency translation difference arises – it’s a balancing figure and shows the difference from translating the financial statements in the presentation currency.  

How to translate specific items to a presentation currency

If you translate the financial statements to a presentation currency for the purpose of consolidation, you need to be careful with certain items.  

How to translate equity items?

It’s true that the standard IAS 21 is silent on this matter. No rules.

Some time ago, the exposure draft proposed to translate the equity items at the closing rate, but it was not included in the standard.

It means that in most cases, companies decide whether they apply closing rate or historical rate. However, they need to be consistent.

In my own past practice, I’ve seen both cases – closing rates and historical rates, too.

What works the best?

Translating share capital

For the share capital, the most appropriate seems to apply the historical rate applicable at the date of acquisition of the subsidiary by the parent , rather than the historical rate applicable when the share capital was issued.

The reason is that it’s easier and logical to fix the rate at the date of the acquisition when the goodwill and/or non-controlling interest are calculated.

For example, let’s say that the German company was established on 10 September 2010 with the share capital of EUR 100 000.

Then, on 3 January 2015, the German company was acquired by the UK company.

The exchange rates were 0,8234 GBP/EUR on 10 September 2010, and 0,78 GBP/EUR on 3 January 2015.

When the UK parent translates German financial statements to GBP for the consolidation purposes, the share capital will be translated at the historical rate applicable on 3 January 2015.

Therefore, the share capital amounts to GBP 78 000, rather than GBP 82 340.  

Translating other equity balances

If the equity balances result from the transactions with shareholders (for example, share premium), then it’s appropriate to apply the historical rate consistently with the rate applied for the share capital.

If the equity balances result from income and expenses presented in OCI (e.g. revaluation surplus), then it’s more appropriate to translate them at the rate at the transaction date.  

How to translate intragroup balances?

Intragroup assets and liabilities.

Intragroup receivables and payables are translated at the closing rate , as any other assets or liabilities.

Many people assume that exchange differences on intragroup receivables or payables should NOT affect the consolidated profit or loss.

It’s not true.

In fact, they do affect profit or loss, because the group has some foreign exchange exposure, doesn’t it?

Let me illustrate again.

UK parent sold goods to the German subsidiary for GBP 10 000 on 30 November 2016 and as of 31 December 2016, the receivable is still open.

The relevant exchange rates:

• 30 November 2016: 0,8525 GBP/EUR
• 31 December 2016: 0,8562 GBP/EUR

At the date of transaction, German subsidiary recorded the payable at EUR 11 730 (10 000/0,8525).

On 31 December 2016, German subsidiary translates this monetary payable by the closing rate in its own financial statements. Be careful – this is the translation of a foreign currency payable to a functional currency, hence nothing to do with the consolidation.

Re-translated payable amounts to EUR 11 680 (10 000/0,8562) and the German subsidiary records the foreign exchange gain of EUR 50:

Debit Trade payables: EUR 50

Credit P/L – Foreign exchange gain: EUR 50

When the German company translates its financial statements to a presentation currency, then the intragroup trade payable of EUR 11 680 is translated to GBP using the closing rate of 0,8562 – so, it amounts to GBP 10 000 (11 680*0,85618).

You can eliminate it with the UK parent’s receivable of GBP 10 000.

However, there will still be exchange rate gain of EUR 50 reported in the subsidiary’s profit or loss. It stays there and it will become a part of a consolidated profit or loss, because it reflects the foreign exchange exposure resulting from foreign trade.

Here, let me warn you about the exception. When monetary items are a part of the net investment in the foreign operation, then you need to present exchange rate difference in other comprehensive income and not in P/L.

Let’s illustrate again.

Imagine the same situation as above. The only difference is that there was no intragroup sale of inventories.

Instead, the UK parent provided a loan to the German subsidiary of GBP 10 000. Let’s say that the settlement of the loan is not likely to occur in the foreseeable future and therefore, the loan is a part of the net investment in a foreign operation.

On the consolidation, the exchange rate gain of EUR 50 recorded in the German financial statements in profit or loss needs to be reclassified in OCI (together with the difference that arises on translation of the EUR 50 by the average rate).  

Intragroup sales and unrealized profit

With regard to profit or loss items, or intragroup sales – you should translate them at the date of a transaction if practical. If not, then apply the average rates for the period.

What about the provision for unrealized profit?

Here, IAS 21 is silent again, but in my opinion, the most appropriate seems to apply the rate ruling at the transaction date. This is consistent with the US GAAP, too.

So, let’s say the German subsidiary sold the goods to the UK parent on 30 November 2016 for EUR 5 000. They remain unsold in the UK warehouse at the year-end. The cost of goods sold for the German subsidiary was EUR 4 500.

The profit shown in German books is the unrealized profit for the group (as the goods are unsold from the group’s perspective).

It is translated at the transaction date rate, i.e. 0,8525 GBP/EUR (30 Nov 2016).

At the reporting date (31 Dec 2016), the consolidated financial statements show:

• The inventories at the historical rate (this is non-monetary asset translated to a functional currency at the historical rate): GBP 4 263 (5 000*0,8525)
• Less unrealized profit: – GBP 426 ((5 000- 4 500)*0,8525)
• Inventories at the year-end: GBP 3 837

Please note the little trick here. If the German subsidiary does NOT sell the inventories to the parent, but keeps them at its own warehouse – what would their amount for the consolidation purposes be?

You would need to translate them using the closing rate, isn’t it?

Therefore, their amount would be EUR 4 500 (German cost of sales) * 0,8562 (closing rate) = 3 853. This is different from the situation when they are in the UK’s books. Yes, that happens.  

Intragroup dividends

If a subsidiary pays a dividend to its parent, then the parent records the dividend revenue at the rate applicable when the dividend was DECLARED , not paid.

The reason is that the parent needs to recognize the dividend income when the shareholders’ right to receive it was established (and that’s the declaration date, not actual payment date).  

Example – translating the financial statements

The UK parent acquired a German subsidiary on 3 January 2015 when the subsidiary’s retained earnings amounted to EUR 4 000. On 30 November 2016, the UK parent purchased goods from the German subsidiary for EUR 5 000. All these goods were sold by the year-end and the payable was unpaid.

• 3 January 2015:0,78
• 30 November 2016: 0,8525
• 31 December 2016: 0,8562
• Average in 2016: 0,8188
• Average in 2015: 0,7261

The financial statements of the German subsidiary at 31 December 2016:  

Required: Translate the financial statements of the German subsidiary at 31 December 2016 in the presentation currency of GBP for the purposes of consolidation.

Before you start working on the translation, you should present the intragroup balances separately – please see the table below.

Also, I strongly recommend analyzing the retained earnings and equity items and present them separately as appropriate .

In this example, it’s appropriate to present the retained earnings by the individual years when they were generated, because you need to apply different rates to translate them.

Here, you should apply the acquisition date rate to the translation of pre-acquisition retained earnings, then the rate applicable in 2015 for 2015 profits, etc.

Please also note, that no rate was applied for the profit 2016 presented in the statement of financial position (under equity). The reason is that you simply transfer this profit from the statement of profit or loss.

The statement of financial position translated to GBP:

The statement of profit or loss translated to GBP:

• *Accumulated profit 2015 comes from the previous year’s financial statements. In this case, we can apply the average rate for 2015, as we assume everything was translated by the average rate. In reality, just take the previous year’s statements.
• **CTD is calculated in the end, after everything else is done. It is the balancing figure to make assets equal liabilities+equity.

Final warning

Now, you should be able to tackle the foreign currency consolidation yourself.

Once you have translated the foreign currency balance sheet and the profit or loss statement (or OCI), you can apply the usual consolidation procedures ( see the example here ).

Let me just warn you about the statement of cash flows .

It’s a huge mistake to make the statement of cash flows based on the consolidated balance sheets – i.e. make differences in balances, classify them, make non-cash adjustments, etc.

Your cash flow figures would contain a lot of non-cash foreign exchange differences and that’s not right. Also, this is NOT permitted by IAS 21.

Instead, please follow these steps:

• Make the individual statements of cash flows, separately for a parent and separately for a subsidiary.
• Translate subsidiary’s statement of cash flows to the presentation currency. You would usually use the transaction date rates for this purpose, but you can use the average rates as an approximation (exactly as for the income and expenses).
• Aggregate subsidiary’s and parent’s cash flows.
• Eliminate intragroup transactions. This requires a bit more work, but well, this is the correct approach.

Here’s the video showing the full process step by step:

Related reading:

• How to consolidate : Basic step by step example
• Consolidated statement of cash flows with foreign currencies : Step by step example
• How to consolidate special purpose entity (SPE)

Questions? Comments? Please, leave a comment below this article. Thank you!

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80 Comments

please would anyone help me with how to consolidate financial position and comprehensive income of exchange rates with other solved examples apart from this one??

For Balance Sheet i understand we apply Closing FX rate, however, i am confused about presentation under the PPE (Fixed assets) schedule so my opening balance is at USD using prior year closing rate and during current year shall i update my Closing value using CY rate where will i show the difference under the PPE schedule. I have noticed in some instances the Value for Eg. for Land & Building is same as opening so that means they are not converted using the Closing rate.

Hi Silvia, this is such a great article. To clarify, is it correct that regardless whether we translate the subsidiary’s Share Capital/Share Premium at historical rate or closing rate, the end result is the same, i.e. there will still be CTD arising? Either due to the sub’s BS not balancing if Share Capital and Premiums are translated at historical rate, or in the case of translating the Sub’s SC/SP at closing rate, the Parent’s investment in the Sub at historical rate will not equal to Sub’s SC/SP at closing rate?

Could you help me with a specific situation when consolidating some P&L items. Suppose we have a Parent and a Subsidiary. Parent receives from Subsidiary some interest on a loan given. Amount = 1000 USD. Parent functional currency is EUR, Subsidiary functional currency is USD. At the transaction date (USD/EUR rate = 0.815), Parent will record an income of 1000 x 0.815 = 815 EUR, and subsidiary will record an expense of 1000 USD. When translating the amounts to consolidation reporting currency EUR, we will use the Average rate USD/EUR = 0.81. Therefore Parent income = 815 EUR, and Subsidiary expense = 1000 x 0.81 = 810 EUR. This is an intercompany transaction so both sides should be eliminated. Since the amounts are not the same 815 ≠ 810, there will be a currency translation difference of 5 EUR. My question will be, what happens and how do we compute the difference due to ICO transaction when the transaction currency amount are different. Parent records in it’s books an income of 1020 USD and Subsidiary records 990 USD. On which side should we rely when computing the difference?

Thank you very much for your time

Hi Nicolae, this situation is quite normal. Many people think that the impact should be zero, since this is in intragroup transaction, but the truth is that the cash really passes here and yes, there is some foreign currency risk expressed in this difference. What I would advise is to take a consistent approach. For example, you can translate intragroup amounts with the rate valid at the date of transaction (not the average rate) and eliminate as it goes – in this case, the difference appears in CTD basically. However, your aim is to eliminate as far as it goes, consistently (similar transactions in the same consistent way) and yes, there will always be the impact on P/L, so you would almost never eliminate at zero. I hope this helps.

Hi Silvia. Follow up to this topic: where do I report this difference generated between using “average rate” on one side and “actual transaction rate” on parent side in an intragroup transaction? For consolidation purposes and IC elimination purposes I am left with this difference however I am not sure if this is CTA to be reported in the equity or FX gain/loss to be reported in P&L.

I sort of see it as a currency translation adjustment belonging to CTA and not a currency transaction adjustment as those coming from a re-valuation of monetary items in foreign currency.

Thanks for your topic. I need to advise from you/all of you for consolidated with associates (call “A”). We need to convert A’s FS to consolidation currency (GBP to USD). Therefore, we will have translation for share capital, RE and profit/loss during the year. For consolidation purpose, we only book converted profit/loss during the year or combine with translation difference as I mentioned above. Thank you in advance!

Dear Silvia Thanks for the clear and concise explanations.

What about non-controlling interest (NCI)? Are all transactions to be kept at historical rates, i.e. there will not be any adjustment of CTD to NCI?

Thanks in advance. Yoke

Hi Silvia i have an issue with PP&E we will face a difference in PP&E in the Depreciation Expense which i used the annual Average rate and the Accumulated Depreciation which translated by the Closing rate , if i used the same rate for the Depreciation and The Accumulated i will find a difference in the Depreciation Expense or in Net PP&E in Balance sheet

Hi Ahmed, did you solve this issue? I am also wondering about this. Although the CTD will show the overall difference, including from the PP&E, the Fixed Asset note will not balance unless the relevant portion is stated in the note.

Dear Silvia, One question: subsidiary of UK company is in Kazakhstan. Both have functional currency – USD. At which rate should Kazakh company translate its transactions into USD – at Kazakh national bank rate or Bank of England or any else? The rates of the same currencies vary greatly among national banks, which one should be taken? Of course, UK parent would like to use Bank of England’s rate for its subsidiary, but will it be ok for subsidiary’s standalone statements? Is there any info on that in standard?

Hi Silvia, your analysis has been thorough but at the same time simple to follow, thanks. In your opinion, could it be advisable for a company with the USD as the functional currency and the local currency as the presentation currency, to translate RE to closing rate every year when the presentation currency suffers from continuous devaluation? Otherwise, i.e. maintaining RE at every historical rate, shareholders could find very little to distribute in the future if they decide to keep RE in the company for some years (assuming only RE in local currency are distributable according to local regulations). This case is not an invention of mine, but a reality in my country. Thanks in advance!

Thank you, Silvia, for putting together everything in specific items to a presentation currency. I think you have covered all the major points in this article, I will share this with my network as well.

Hello SIr, Post translation into GBP, the balancing figure is shown in Currency translation difference a/c. ? Is this just a balancing figure without any corresponding affect ? I mean is it a single entry or double entry?

I am facing a unique issue. We make a quarterly consolidation and in 1 quarter there is Profit in P&L statement in functional currency but loss appearing in presentation currency due to fluctuation in currency. We translate P&L items on monthly average whereas Balance sheet items at Clsoing rate. Equity & Other Reserves on historical rates.

Please let me know how to deal in situations when profit in functional currency but loss in presentation currency.

Hi Silvia, Really great article and website! I’m having a bit of a brainteaser and think I know the answer but just wondering if I’m correct. A parent of a wholly-owned sub has presentation and functional currency in CAD. The child’s functional currency is USD but it also transacts in CAD. The sub revalues the item to its functional currency in its standalone P&L, but then should the parent translate that gain or loss to the consolidated P&L or to AOCI? It’s just weird because let’s say the sub has A/R of $10M CAD /$8M USD, but then it revalues to $7M USD and books a $1M loss, when you translate back to CAD you should get back to the $10M CAD. So does the FX loss get consolidated? Thank you!

Hi Gianni, thanks! I think I explained in the article that yes, these gains and losses can arise on translating back and forth because this is the cost of making the international transactions. Best, S.

Hi Silvia Thank you so much for the prompt reply. Yes I see it now, it was in the “intragroup balances” section but applies for any FX gain/loss in the subs books. The FX being translated and consolidated up to the parent’s P&L is what I was expecting. Thanks again!

Silvia, I have a question. I work for a US Company (USD Functional Currency) with a Legal Entity in Brazil (BRL Functional Currency). In order to hedge the cash flow exposure of my Brazil Legal Entity I was thinking on following the steps below:

Identify the Net USD Amount of Rev – COGS – Opex = Exposure and Hedge it. On this scenario, all BRL activities would be excluded, such as “Revenue from Sales and Salaries”.

From a Brazil entity perspective it makes sense. From a US perspective I have my doubts.

Comments / recommendations?

how to treat acquired goodwill in subsidiary books in parent books while doing consolidation

Dear Silvia. Regarding dividends receivable and payable recorded in different currencies which give rise to exchange differences. Would the exchange differences be captured in OCI upon consolidation if these monetary assets form part of net investment in foreign operations? What happens if the dividends have been paid (realized) subsequent to reporting date? Do the exchange differences be transferred from OCI to income statement?

Dear Silvia, first I would like to thank you for detailed explanation. I have a question regarding rates which is correct to be used for re translation of equity into presentation currency for consolidation purposes. Above you have mention that IAS 21 does not say about it. And we can use either historical date rate or closing date rate (as I understand reporting date). Please advice.

Thanks Silvia, Cost of Sales includes closing inventory i.e. Cost of Sales = Opening Inventory + Purchase + Other Incidental Expenses – Closing Inventory. If we translate all these items at Average Rate, then the value of closing inventory appearing in the balance sheet (statement of financial position) would differ from that appearing under Cost of Sales.

So is this difference correct or the closing inventory while calculating cost of sales should be translated at Closing Rate.

Please do reply if possible.

Of course there is a difference – the reason is that you are using the approximation (average rate) and there are also some closing rate differences within balance-sheet items. For the purpose of consolidation, you should simply calculate cost of sales in the functional currency and only then translate it by the average rate. S.

Hi Silvia, This is an excellent article and you have explained it so simply and clearly. I needed to know the calculation for translation gain which is quite clear now. Thanks and keep it up!

Hi Silvia, All good & clear. Now when consolidating, do you allocate the CTD to NCI as part of Equity in calculating the GW? Or how do you treat it please.

which rates apply for post acquisitions profits and impired good will …..

I have one question please on intragroups assets and liabilities. If a parent (EUR) receive a loan denominated in the functional currency of an affiliated (USD), Will we convert the loan in EUR (the presentation currency of the parent) and record the gain/loss at year-end related in the standalone accounts of the parent?

My question arises with this example: UK parent sold goods to the German subsidiary for GBP 10 000 on 30 November 2016 and as of 31 December 2016, the receivable is still open.

30 November 2016: 0,8525 GBP/EUR 31 December 2016: 0,8562 GBP/EUR

Parent co has invested CAD $10 million into a mutual fund on January 1 and is the only shareholder. The investment, which was made through a UK subsidiary, is in a US equity fund. The functional currency of the fund and the UK subsidiary are USD and GBP respectively. On January 1, the exchange rates are 1CAD = 1GBP = 1USD.

During the year the fund’s net value appreciates by USD $5 million due to dividends of USD $2 million and market appreciation USD $3 million. Both the gains and dividends occur evenly over the course of the year. As the Fund is still relatively new, The parent remains the only investor in the Fund at year end. As at period end the exchange have moved and are now 1CAD = 0.5 GBP, 1 CAD = 0.75 USD and 1 GBP = 1.5 USD, the changes in rates have occurred evenly throughout the year. The Fund retains all income and does not pay a distribution. The UK subsidiary does not consolidate the mutual fund subsidiary due to the scope exemption in IFRS 10.4, and as a results a gain on the investment is recorded in the UK Sub.

What are the CAD equivalent balances and results related to the investment in the mutual fund subsidiary which are included in the parents consolidated financial statements – please show balance sheet and comprehensive income?

Dear Ozar, well, this is really a long question to solve in the comments. These comments are better for quick and fast advices. We offer the online advisory service the IFRS Helpline where our top consultants can tackle similar questions – would you like me to send you more information?

Will a parent company that has currency translation differences in equity from preparing its financial statements in a presentation currency other than its functional currency be subject to the IFRS 1 exemptions and be able to reset them to nil?

For oversea subsidiary with paid-in capital, should this paid-in capital be translated at closing rate or historical rate?

Historical rate

There are no strict rules on this, but for more insight, s ee this article (search for Share capital in foreign currency).

Hi Silvia, Your analysis is quite informative. My question is, for property plant and equipment, what translation rate should I take for items of property plant and equipment that were there as an opening balance for continuing consolidations?

If you are translating the financial statements to presentation currently, you always use closing rate, also for PPE. But it is actually said in the article – revise the first table.

Hi Mam, I would like to know which exchange rate we have to use for translation of opening retained earnings of the component entity prepared in foreign currency to the presentation currency. Is it average rate of previous year or closing rate of previous year? Thanks in advance

Samboo, look to the table above in the article – it should be clear from it.

Hi Silvia, this article is amazing! Explanations and examples are very clear and useful. I’m going to buy the IFRS kit. Thanks!

Thank you, I’m glad you like it!

Hi Silvia, How to choose presentation current for consolidated financials, can it be different from local current of the parent company. Thanks.

Hi Bharath, yes, it can be totally different from any functional currency that a subsidiary or a parent might have. In fact, you can select more than one presentation currency, based on your goals. For example, you would need to present your financials to the stock exchange in USD, but you also have a loan from European bank and they require your financials in EUR. And let’s say that your functional currency is INR – in this case, you can present financial statements in 2 presentation currencies (USD and EUR), despite the fact that they are both different from your functional currency (INR).

thank you for explanation

Hi Silvia, thank you for the explanation. May I ask what happens when a subsidiary changed its functional currency to be the same as that of the parent’s? What happens to the currency translation reserves that has been recognised in the past to balance the balance sheet? Thank you

Hi Silvia, Thank you for the helpful explanation Do you have a video that explains these examples ?

Hello Silvia, on this topic I have one question, what about the differences of foreign exchanges resulted from translation of fair value reserve recognized at OCI in the consolidation of foreign subsidiary, should we record that difference with CTD or with fair value reserve at OCI.

Hi Silvia! Though most of the questions that came to my mind got answered when went through the extremely simple explanation, i have one question i.e., ” If a co., has a subsidiary (Non-integral foreign operation), what rate will the holding co., use to eliminate profit in the inventory lying at subsidiary, Historical or closing rate? Thanks in advance!

Hi Vikram,the most exact method is to do it with the historical rate. You can as well use the average rate method, but it’s approximation. Closing rate – no way 🙂 S.

I have read Current Rate Method which is used for translation. Whether it comes from paragraph 39 of IAS 21? Regarding the translation of equity items, if we use the closing rate, then we will be dividing whole Balance Sheet with the same rate eventually leading to differences only due to Retained earnings. Is this approach consistent with IAS 21?

Ashish, I did not use closing rate, but historic rate for translating equity. Also, please read above in the article – IAS 21 does not say anything about translating equity items to the presentation currency. If you use closing rate, then you can’t really reconcile CTD, but yes, you are right, all the differences would stay in the equity. S.

Dear Ms Silvia,

Please explain necessary steps and consolidation process if subsidiary accounting year is different with parents….

example Parent company accounting period 01/April to31 march. but subsidiary accounting period 01/January to December

Hi, I am confused about handling the following Consolidation items

1. should Retained earnings (RE) from 1 year ago be retranslated at the closing rate each period? E.g Financial y.end is 31/12/16 US RE for 2015 were $1000 @ 1.8

Closing rate 31/12/16 is 1.6 Should the $1000 earnings from 2015 be translated at $1.8 as they would have appeared in the 2015 consolidation?

Likewise, with Intercompany balances (2 years old not settled), should the historic balances be left @ $1.8. I ask this because my auditor seems to just translate the current year movement and post the value to FCTR. In a previous role, all balances were translated at the closing rate (i.e 1.6 rather than 1.8) so i translate all balances. I’m confused because fo how the audit firm seem to treat the entry.

And finally, I find when I translate the intercompany balances (historic and current year) to the closing rate there is always a difference to the Parent company balance. e.g creditor translated at closing rate is £100 but debtor balance is £90 in the Parent company. I assume this £10 should be posted to current year earnings. And, can I assume that the FCTR translation is calculated first and the £10 difference after. Thanks, Margaret

Hi Margaret, 1. No – please see above in the example. Retained earnings are reported at the historical rate. 2. Intercompany balances – as soon as they are not settled and still oustanding, you should translate all assets/liabilities with the current rate. As for the difference – yes, it can happen and please revise the article for the explanation (about intragroup assets and liabilities).

Thanks, Sylvia. Have you come across companies translating RE at the closing rate as I have described? So intercompany should be translated at the current rate rather than the closing rate and the gain/loss be taken to the P&l rather than FCTR. The intercompany in question is the parent funding a branch for over 2 years. When transfer pricing kick-ins the debt will start to reduce, but I think it could take 2 years to clear. Does the current rate hold in that instance?

I worked out the difference is because the parent incorrectly posted the original transaction in GBP so doesn’t have to re-translate each month. I was incorrectly putting the adjustment to the US entity. I believe it should go to the UK entity as the US entity is translated on a monthly basis and will have the correct valuation, i.e. closing or current.

Can you explain how to reconcile the movement of inventories provision when consolidating foreign subsidiaries between P&L and Balance Sheet?

Eg: Rates are given below:- Last year’s closing rate = 0.75 This year’s closing rate = 0.74 Current Average rate = 0.72

Balance Sheet:- Opening provisions @ last year’s closing rate = 1000 x 0.75 =750 Closing Provisions @ this year’s closing rate = 800 x 0.74 =592 ——————- Balance Sheet Movements = 200 =158

Income Statement (COGS): Current movement of provisions @ average rate = 200 x 0.72 = 144

==> Movement from Balance sheet is $158 but appears in P&L is $144. ==> Should I reconcile the different of $14 as impact from foreign exchange translation?

Appreciate your advise.

Hello silvia, iam a new subscriber, could you please assist me more practical examples of foreign currency tranlation and conversions, i will appreciate please.Thanks

I am reviewing US GAAP foreign currency accounting policy and I have some questions. Could you please help me?

Let´s suppouse the parent company (USA Inc) is a US company, located in the USA, and its reporting “or presentation” currency is the US dollar. USA Inc is the owner of Argentina SA, a subsidiary company located in South America.

As you may know, determining if remeasurement or translation is necessary under US GAAP depends, (among other matters), on how the subsidiary company prepares its financial statements. If they are prepared in US dollars, no remeasurement, nor translation needs to be done by the US company to consolidate its financial statements. If the subsidiary prepares its financial statements in a currency different from its functional currency, those statements need to be remeasured to its functinal currency. Once the subsidiary company statements were remeasured to functional currency, they need to be translated to the reporting currency (in this case USD).

But here come the questions… if this Latin American company decides to prepare its financial statements in both currencies (US and local entity currency), can the US Company use the USD statements of the subsidiary to consolidate? Is it generally accepted that a subsidiary prepares its financial statements in two different currencies? In this case it would be one for the parent company, intended to report to the management in USA using USD, and the other in local currency for local statutory presentation in the subsidiary country.

Can both financial statements be prepared, or should the local one be remeasured and/or translated to the US dollar for consolidating purposes of the parent company?

Thank you! Regards, Fernando

Excellent article. Just a quick question, are the foreign exchange differences in the parent company relating to intra group loans with those entities subsequently consolidated also recognised to OCI in both the unconsolidated and consolidated statements?

thanks a lot. The explanation and the practical case study is awesome. – i have a question in the case study, shouldn’t we calculate the intra-group transaction effect on COGS?. – could you please make further expatiation on temporal method of consolidation and the circumstances to use this method. maybe this needs a separate article.

Hi Silvia, I heard under equity method of investment parent investment should agree with subsidiary’s net equity. My question is equity in subsidiary is included with forex reserve or excluded with forex reserve. Kindly explain me.

Could you please explain how you get 12 451 GBP for profit 2016 though no rate are mentioned

as initial profit are in EUR for 15 000

Thanks in advance!

It is just the sum of operating profit and income tax expense as shown in the translated Profit and Loss statement below statement of financial position.

Hello Silvia,

Could you please help me with the following issue: The company A (functional currency – USD) has two foreign subsidiaries, B (EUR) and C (GBP). The presentation currency is USD. Companies B and C trade with each other, and have outstanding intragroup receivables and payables as at the year end amounting to 10,000 EUR. Say, the rates are as follows

1 EUR = 0,85 GBP 1 EUR = 1,10 USD 1 GBP = 1,25 USD

Company B recorded in it’s balance sheet a receivable amounting to 10,000 EUR, which is translated into 11,000 USD. Company C recorded in it’s balance sheet a payable amounting to 10,000*0,85=8,500 GBP, which is translated into 10,625 USD. When I try to eliminate them against each other I have to recognize a loss amounting to 11,000-10,625=375. It results from the difference between the “direct” exchange rate (1,1) and the exchange rate calculated with a reference to the third rate (0,85*1,25=1,0625). I understand that in a perfect world there should be no such differences, but the currencies in question are not actually USD, EUR and GBP and are not freely convertible, and a possibility for arbitrage exists. The question is – where does this difference (375) go in the consolidated FS? Is it a FOREX loss in PL or a translation difference in OCI? The amounts are material so I can’t just ignore the issue, but I can’t find an answer anywhere. I would be very grateful for your help.

Hi Silvia ,

Thanks for proving very much useful topic.

Requesting you to please provide me a excel template , if available, for the consolidation of foreign currency subsidiaries.

Regards Srinivas

Silvia, could you please give an example on IFRS 16: Leases which means how we can treat the prepayment for three years of building rent under lessee transaction and if you can please give detail examples of IFRS 16 as lessee and lessor. Thank you alot!

That’s off topic here. But, maybe in the future. S.

Hi Silvia, another fantastic article indeed! However, could you please clarify if the CTD should be directly parked in Equity or it needs to be taken through Other Comprehensive Income? The relevant section from the standard is quoted below;

Quote “Translation from the functional currency to the presentation currency The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy are translated into a different presentation currency using the following procedures: [IAS 21.39]

assets and liabilities for each balance sheet presented (including comparatives) are translated at the closing rate at the date of that balance sheet. This would include any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation are treated as part of the assets and liabilities of the foreign operation [IAS 21.47]; income and expenses for each income statement (including comparatives) are translated at exchange rates at the dates of the transactions; and all resulting exchange differences are recognised in “other comprehensive income.”” End Quote.

Current year exchange gains or losses on the translation of an overseas subsidiary and its goodwill are recorded in other comprehensive income

Thank you Silvia about your article. Very usefull. One question: for equity method in individual financial statements whe should use the same procedures as used for consolidation purposes, correct? Thank you again.

Hi Luis, exactly. The same rules for foreign currency translation apply for associates and joint ventures. S.

Thanks Silvia. In the example for Consolidation of Foreign subsidiary, intragroup sales of 5000 has been translated using exchange rate of the transaction date but related cost of sales 4500 has been kept at average rate due to which unrealized profit of 426 could not be eliminated. Please explain.

There is no element of unrealizable profits on it,they only gave inter coy sales which was deducted from revenue and cost of sales,it will have been diff if it was sold at cost plus, that is when we can realize profit

Sylvia, Weldome ma.

You said doing the differences in balance isn’t correct.But I don’t get how we will balance the cashflow based on the proposed method. Also how is the foreign currency translation treated on the cashflow since all we have is average rates from both the parent and the subsidiary. Please I don’t really get this. I think you need to give examples or practical illustrative to make it sink better.

Thanks great job

Dear Abdul, yes, I understood that the forex cash flows is something more difficult, so I promise, I’ll upload some article with the example the next time. S.

Silvia, could you please give an example how to eliminate the intragroup transactions out of the aggregate cash flows? By the way,the statement of cash flows here refers to which method, direct or indirect? Thanks alot!

Hi Fairuz, the cash flow statement here refers to either method. It applies for both, but it’s truth that it’s maybe a bit easier to make cash flows by direct method in this case. How to eliminate intragroup? In a very similar way as in the profit or loss statement. So for example, imagine a subsidiary paid 5 000 CU to a parent for the goods. Then, the adjustment to eliminate would be to deduct 5 000 CU from both cash received from customers and cash paid to suppliers (if done by direct method). In a case of indirect method, you need to think carefully in which items there are intragroup balances open in the operating part. E.g. if there were no intragroup balances in the opening and closing receivables and payables, then no adjustment is necessary as for the change in working capital. This is quite a complex question and deserves a separate article. I’ll do so in the future 🙂 S.

Thanks for a lot. I am looking forward to it.:)

I have a quesstion, I will be applying IFRS 16 on my rent for Jan 2020. Contract starts on 1 Jan 2020 and will end in 31 Dec 2045. Now in the contract amount for 2020-2025 is given but 2026-2045 is not given as it will depend on the market during that time. How will I record it then?

Hi Madelene, you would record it at the values valid at the contract inception. Then when they change, you will account for the lease remeasurement. S.

How can I answer this kind of question? “Foreign operations whose functional currency is that of the parent”

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Foreign currency translation: international accounting basics.

Foreign currency translation is the accounting method in which an international business translates the results of its foreign subsidiaries into domestic currency terms so that they can be recorded in the books of account.

The foreign entities owned by your business keep their accounting records in their own currencies. To apply the appropriate method of these investments, you must translate the financial statements from the foreign currency into domestic currency.

What this article covers:

What Is Foreign Currency Translation?

Foreign currency translation process, foreign currency translation methods, what is foreign currency translation adjustment.

If your business entity operates in other countries, you will be using different currencies in your business operations. However, when it comes to accounting, your financial statements have to be recorded in a single currency. This is why you need to perform foreign currency translation.

For example, if your company has its headquarters in the US but has operations in the UK, you must translate the British pound into US dollar.

A part of their financial record keeping, foreign currency translation is the process of estimating the amount of money in one currency in the denomination of another currency. The process of currency translation makes it easier to read and analyze financial statements which would be impossible if they were to feature more than one currency.

The three steps in the foreign currency translation process are as follows:

Determine the functional currency of the foreign entity

Businesses must determine a functional currency for reporting. The functional currency is the one which the company uses for the majority of its transactions. You can choose the currency of the country where your main headquarters are located or where your major operations are.

This can be difficult to determine when you conduct an equal amount of business in multiple countries. However, once you choose the functional currency, changes to it should be made only when there is a significant change in circumstances and economic facts.

Remeasure the financial statements of the foreign entity into the functional currency

You need to ensure that all your financial statements use the reporting currency.

The translation of financial statements into domestic currency begins with translating the income statement . According to the FASB ASC Topic 830, Foreign Currency Matters, all income transactions must be translated at the rate that existed when the transaction occurred.

The GAAP regulations require the items in the balance sheet be converted in accordance with the rate of exchange as on the date of balance sheet while the income statement items are converted according to the weighted average rate of exchange.

It is vital that you keep a close eye on the dates in which any of the above transactions occurred. Although most currency translation occurs at the financial year-end, the exchange rates are determined by the transaction date in some instances. Bank statements and income records help you to determine the right rates.

Record gains and losses on the translation of currencies.

The gains and losses arising from foreign currency transactions that are recorded and translated at one rate and then result in transactions at a later date and different rate are recorded in the equity section of the balance sheet.

Since exchange rates are constantly fluctuating, it can cause difficulty while accounting for foreign currency translations. Instead of simply using the current exchange rate, businesses may look at different rates either for a specific period or specific date.

Current rate Method

Using this method of translation, most items of the financial statements are translated at the current exchange rate. The assets and liabilities of the business are translated at the current exchange rate.

Since this can lead to volatility associated with changes in the exchange rate, gains and losses associated with this translation are reported on a reserve account instead of the consolidated net income account.

Temporal Rate Method

The temporal rate method, also known as the historical method, is applied to adjust income-generating assets on the balance sheet and related income statement items using historical exchange rates from transaction dates or from the date that the company last assessed the fair market value of the account.

Monetary-Nonmonetary Translation Method

The monetary-nonmonetary translation method is used when the foreign operations are highly integrated with the parent company.

The method translates monetary items such as cash and accounts receivable using the current exchange rate and translates nonmonetary assets and liabilities including inventories and property using the historical exchange rate.

The foreign currency translation adjustment or the cumulative translation adjustment (CTA) compiles all the fluctuations caused by varying exchange rate.

Businesses with international operations must translate their transactions like the acquisition of assets or the purchase of services into their functional currency. With foreign exchange fluctuations, the value of these assets and liabilities are also subject to variations.

The gains and losses arising from this are compiled as an entry in the comprehensive income statement of a translated balance sheet. According to the FASB Summary of Statement No. 52, a CTA entry is required to allow investors to differentiate between actual day-to-day operational gains and losses and those caused due to foreign currency translation.

There are different rules for translating items in financial statements including assets and liabilities, income statement items, cash flow statement items, etc. Considering its complexity, it may be best to consult an accountant regarding the rules of accounting for foreign currency translation.

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Functional Currency vs Presentation Currency

Written by Santiago Poli on Dec 21, 2023

Determining a company's functional currency is crucial, yet complex. Most would agree that navigating functional vs presentation currency can be confusing.

This article will clearly define functional and presentation currency, providing easy-to-understand examples and outlining straightforward translation procedures per IFRS guidelines .

You'll learn the key differences between functional and presentation currency, how to accurately determine a company's functional currency using primary indicators and secondary factors, and understand the impact currency choice has on financial statement analysis.

Introduction to Functional vs Presentation Currency

The functional currency refers to the primary currency used in a company's operations, while the presentation currency is the currency used to report the company's financial statements. There are some key differences between these two concepts:

Defining Functional Currency IFRS and Presentation Currency

Functional currency is the currency of the primary economic environment in which an entity operates. It reflects the underlying transactions, events, and conditions under which the entity conducts its business.

Presentation currency is the currency in which an entity presents its financial statements. Companies can choose to present their financials in a currency different from their functional currency.

For example, a French company doing most of its business in the Eurozone would likely have the Euro as its functional currency. However, it may present its financial statements in US dollars to make it easier for potential American investors to understand.

Exploring Functional Currency vs Presentation Currency Examples

Here are some examples to illustrate the difference:

A Canadian company that operates mainly in Canada and conducts transactions in Canadian dollars (CAD) would have CAD as its functional currency . If it presents financial statements in CAD, then CAD would also be its presentation currency .

An American company with operations across Europe and Asia that mostly transacts in British Pounds (GBP) would likely have GBP as its functional currency . However, it may present statements in US dollars (USD) for easier investor understanding, making USD its presentation currency .

A multinational company headquartered in Japan but transacting primarily in USD may use USD as its functional currency and JPY as its presentation currency for reporting purposes in its home country.

Significance of Functional Currency vs Local Currency

Choosing an appropriate functional currency is important for accurate financial reporting in international business. Using a non-functional local currency can distort financial statements during currency translation and not portray the true financial situation. On the other hand, the presentation currency can be tailored for investor convenience without impacting the underlying transactions.

What is the difference between functional currency and presentation currency?

The key difference between functional currency and presentation currency relates to which currency is used for measurement and reporting purposes in financial statements.

Functional Currency

The functional currency is the primary currency used by an entity to generate revenues, incur expenses, and operate day-to-day business activities. It is the currency of the primary economic environment in which an entity operates.

Some key indicators for determining an entity's functional currency include:

• The currency that mainly influences sales prices for goods and services
• The currency of the country whose competitive forces and regulations mainly determine the sales prices
• The currency that mainly influences labor, material, and other costs of providing goods or services

Presentation Currency

The presentation currency is the currency in which an entity presents its financial statements. Companies with foreign operations often translate functional currency financial statements into a presentation currency for consolidation purposes.

For example, a French company with a Euro functional currency may translate its financial statements into US Dollars for presentation if it has substantial operations in the United States or its investors are primarily US-based.

Key Differences

The main differences between functional and presentation currencies:

• Purpose - Functional currency reflects day-to-day business operations, while presentation currency is used for financial reporting.
• Determination - Functional currency depends on the primary economic environment, presentation currency is a choice based on user needs.
• Translation - Transactions in non-functional currencies require translation, presentation currencies involve translating entire financial statements.

In summary, the functional currency reflects the practical currency flows of regular business activities, while the presentation currency serves financial statement users and their preferred currency.

What is the difference between transactional currency and functional currency?

Functional currency is the primary currency used in a company's operations, while transactional currency is the currency used for individual transactions. Here are some key differences:

Functional currency reflects the main currency environment in which a company operates. It is usually the currency that mainly influences sales prices, labor, materials and other costs of providing goods or services. Some of the primary indicators for determining functional currency include:

• Currency that mainly influences sales prices
• Currency of the country whose competitive forces and regulations mainly determine sale prices
• Currency that mainly influences labor, materials and other costs
• Currency in which funds from financing activities are generated
• Currency in which receipts from operating activities are usually retained

Transactional currency is the currency used when buying or selling goods, services or assets. It is determined separately for each transaction based on the currency in which the transaction takes place. For example, if a French company purchases materials from a supplier in the U.S., the transactional currency would be USD.

Presentation currency is the currency used to present an entity's financial statements. Companies can choose any currency for financial reporting, regardless of functional currency. Presentation currency does not impact recognition or measurement in the financial statements.

For example, a Canadian company does most of its business in the U.S. Its functional currency is likely USD since that is the primary currency influencing its revenues, expenses, and cash flows. However, it can choose to present its financial statements in CAD as its presentation currency to better report performance to Canadian investors and stakeholders. The choice of presentation currency does not change the underlying recognition or measurement of transactions.

In summary, functional currency depends on a company's primary operating environment, transactional currency is determined separately for each transaction, and presentation currency is an independent choice for financial reporting. Properly distinguishing between these concepts is important from an accounting perspective.

What is an example of a functional currency?

For example, if a US-based multinational oil and gas company that uses the US dollar as its reporting currency maintains a distinct and separable operating subsidiary in Northern Africa that sells all of its oil production in transactions denominated in the US dollar, the US dollar would be the functional currency of that subsidiary.

Some key reasons why the US dollar is the functional currency in this example:

• The subsidiary's oil sales, which are likely the main source of revenue, are all denominated and settled in US dollars. This indicates the US dollar is the main currency influencing sales prices and cash flows.
• As a separable entity dealing almost exclusively in US dollars, the local currency of Northern Africa likely has little direct influence on the subsidiary's operations and transactions.
• The parent company's reporting currency is the US dollar, so maintaining the same functional currency simplifies consolidation and internal reporting.
• Oil is a global commodity typically traded in US dollars on international markets. The local currency likely has little impact on production costs or sales prices.

In summary, the key transactions, events, and conditions that impact this subsidiary's cash flows are primarily denominated in US dollars, making it the most appropriate functional currency based on IFRS guidance. The local currency in Northern Africa has little direct influence.

What is an example of presentation currency?

The subsidiaries use their local currency to prepare their financial statements, whereas the parent company uses USD to prepare its consolidated financial statements . USD, in this case, is called the presentation currency.

Here is an example to illustrate the difference between functional currency and presentation currency:

Consider a company XYZ Inc. that has a subsidiary in the UK. The UK subsidiary conducts all its business and transactions in British Pounds (GBP). So GBP is the functional currency for the UK subsidiary, as it reflects the economic reality of the subsidiary's operations.

However, XYZ Inc. prepares its consolidated financial statements in US dollars (USD). So when the parent company is consolidating the UK subsidiary's financial statements, it has to translate them from GBP to USD using the applicable foreign exchange rates. USD here is simply the presentation currency - it is the currency in which the consolidated financial statements are presented for the benefit of the parent company.

The key difference is:

Functional currency - reflects the underlying transactions, events, and conditions that are relevant to the entity.

Presentation currency - is simply the currency in which the financial statements are presented. It may be different from functional currencies of consolidated entities.

So in this example, GBP is the functional currency (based on UK subsidiary's operations) while USD is the presentation currency (for consolidation purposes at the parent company).

The choice of presentation currency is usually based on factors like investors' location, comparability with industry peers, headquarters location, etc. It does not change the underlying functional currencies used by individual entities for their operations.

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Determining a company's functional currency.

This section outlines the primary and secondary indicators that determine an entity's functional currency under IFRS guidelines.

Primary Indicators of Functional Currency

The currency which mainly influences sales prices and labor, material & other costs is given priority. Also considered is the currency in which funds from financing are generated and retained earnings held.

Some key factors when assessing an entity's functional currency include:

• The currency that mainly influences sales prices for goods and services. This is often the currency in which sales prices for its goods and services are denominated and settled.
• The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
• The currency that mainly influences labor, material and other costs of providing goods or services. This will depend on whether the entity's costs are primarily incurred and settled in a particular currency.

Funds from financing activities and the currency in which retained earnings are held and dividends are paid are also key considerations.

Assessing Secondary Factors

Other factors like the currency in which receipts from operating activities are usually retained and whether transactions with the reporting entity are in this currency.

Some secondary indicators to consider:

• The currency in which funds from financing activities are generated
• The currency in which receipts from operating activities are usually retained
• Whether transactions with the reporting entity are usually in a particular currency

These secondary factors can provide additional context in determining an entity's functional currency, especially when the primary indicators do not clearly identify a single currency.

Functional Currency vs Presentation Currency IFRS Compliance

Under IFRS guidelines, an entity's functional currency is the currency of the primary economic environment in which it operates. This is not necessarily the currency in which the entity presents its financial statements (presentation currency).

When an entity's functional currency differs from its presentation currency, it must translate its financial results into the presentation currency using the relevant foreign exchange rates. This translation process can impact revenues, expenses, assets and liabilities reported in the financial statements.

Compliance with IFRS requires entities to determine functional currency based on the primary economic environment, rather than choice. This ensures the financial statements reflect the underlying transactions, events and conditions relevant to the entity.

Careful determination of functional currency using the IFRS guidelines is important, as it has implications for the recognition, measurement and disclosure of transactions in the financial statements. Getting this right is key for comparability, consistency and transparency under IFRS standards .

Translating Foreign Currency Transactions

Spot rate application for initial recognition.

When a transaction denominated in a foreign currency first occurs, it must be translated into the functional currency by applying the spot exchange rate on the date of the transaction. The functional currency is the primary currency used in the company's operations.

For example, if a US company purchased inventory priced at 100,000 Mexican Pesos when the spot rate was 1 USD = 20 MXN, the initial recognition of the inventory in US dollars would be $5,000 (100,000 MXN / 20 MXN per USD). Using the spot rate at the date of initial transaction allows the foreign currency amount to be accurately translated into the functional currency.

End-of-Period Translation Procedures

At the end of each reporting period, foreign currency monetary items must be translated using the closing rate. The closing rate is the current exchange rate on the last day of the reporting period. This translation creates foreign exchange gains and losses that are recognized in profit or loss.

Non-monetary items measured at historical cost continue to use the same exchange rate as at the date of initial recognition. Only monetary items are retranslated at the end of each reporting period.

For example, using the previous example, if at the end of the reporting period the USD/MXN exchange rate changed to 1 USD = 18 MXN, the 100,000 MXN inventory would now translate to $5,555 USD (100,000 / 18). This difference of $555 is recognized as a foreign exchange gain.

Handling Exchange Rate Fluctuations

Foreign currency transactions can create exchange differences when exchange rates fluctuate over time. These exchange differences occur both on settlement of monetary items as well as at each financial reporting date for outstanding foreign currency monetary items.

For practical purposes, these gains and losses arising from foreign currency transactions are generally recognized as an expense item in profit or loss during the period of change. This helps account for the effect movements in exchange rates have on the financial reporting currency from period to period.

Translating Financial Statements into a Presentation Currency

If a company's presentation currency differs from its functional currency, additional translation is required using appropriate exchange rates in order to present uniform financial statements.

Presentation Currency Example: Assets and Liabilities

For financial reporting purposes, assets and liabilities are translated at the closing rate on the date of the financial statements between the functional and presentation currencies.

For example, if a company's functional currency is the Mexican Peso, but it presents financial statements in US Dollars, all assets and liabilities would be translated into US Dollars using the spot exchange rate on the last day of the reporting period. This allows assets and liabilities to be accurately stated in the presentation currency.

Income and Expense Translation Approach

Income and expenses should be translated using actual exchange rates at the dates of transactions, or an appropriate average rate over the reporting period.

Using the previous example, revenue and expenses originally denominated in Mexican Pesos would be translated into US Dollars by applying the exchange rates in effect on the date those transactions occurred. An average exchange rate for the period can also be used for simplification purposes. This method helps avoid distortion from exchange rate fluctuations.

Equity Items Translation Considerations

Components of equity are translated using the exchange rates at the date those components arose, rather than current closing rates at financial statement date.

For instance, common stock issued in Mexican Pesos would use the historical exchange rate at issuance date when translating the stock value into the US Dollar presentation currency. This prevents equity balances from showing artificial gains/losses due to exchange rate changes after stock issuance.

Impact of Functional vs Presentation Currency on Financial Analysis

Using appropriate functional and presentation currencies impacts key financial statement metrics and ratios used by analysts to assess performance.

Effects on Assets, Liabilities, and Equity

Line items reflecting economic events that occurred over past periods can be materially impacted when translated from functional to presentation currency. For example, if a company conducts most of its business in the Euro but reports in US dollars, fluctuations in the EUR/USD exchange rate can significantly impact the reported values of assets, liabilities, and equity over time.

This can distort period-over-period comparisons and trend analysis if the effects of foreign currency translation are not isolated. Analysts evaluating solvency measures like debt-to-equity ratios must understand how choice of presentation currency influences the values used in their models and ratios.

Trend Analysis and Exchange Rate Distortions

Fluctuations in exchange rates between functional and presentation currencies can distort trends in financial metrics over reporting periods. If revenues are earned in a foreign currency but converted to the presentation currency using current exchange rates each period, growth may appear volatile due purely to currency swings.

Similarly, margin analysis can be obscured when cost of goods sold is recorded in one currency but revenue converted at varying rates each period. Analysts must normalize data by using constant exchange rates before modeling trends.

Influence on Financial Ratios

Ratios involving margin analysis, solvency assessments and other metrics can vary significantly depending on currencies used. If a company conducts most business in its functional currency, converting financial statements to a different presentation currency using current exchange rates can introduce distortion.

For example, a company reporting improving profit margins year-over-year in its functional currency could show declining margins in the presentation currency due to exchange rate changes alone. Evaluating performance should focus on functional currency, with presentation conversion impacts isolated.

Conclusion and Key Takeaways

In summary, properly distinguishing between functional and presentation currencies is vital for accurate IFRS-compliant financial reporting and analysis.

Recap of Functional Currency vs Presentation Currency

The functional currency reflects the underlying economics of a company's operations, while the presentation currency allows for uniform financial statement presentation across a multinational company's subsidiaries. Key differences include:

• Functional currency is the currency of the primary economic environment in which an entity operates. It impacts how transactions are recorded and how assets and liabilities are translated.
• Presentation currency is the currency in which financial statements are presented. It allows standardized reporting across geographies.

Importance of Accurate Functional Currency Determination

Companies must carefully evaluate functional currency based on IFRS guidelines and key indicators such as cash flows, sales prices, financing, and expense settlement currencies. Inaccurate functional currency selection can lead to distorted financial reporting.

Implications for Financial Statement Analysis

Using appropriate functional and presentation currencies significantly impacts trends, ratios, and benchmarks used in financial statement analysis :

• Asset valuation - Translating asset costs into different currencies impacts valuations and depreciation.
• Equity - Foreign currency translation directly flows through to equity on the balance sheet.
• Revenue and margin trends - Top-line growth and profitability metrics are skewed by currency swings. Normalizing currency effects is critical for accurate analysis.

Proper determination and application of functional and presentation currencies as dictated by IFRS is vital for financial reporting quality and cross-border financial analysis .

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• Balance Sheet vs Income Statement
• Financial Statement Presentation: Structure and Requirements
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• Cash Flow Statement vs Funds Flow Statement

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FRS 102: Foreign currency translation under UK GAAP

Frs 102 section 30 sets out the requirements that apply to foreign currency transactions, foreign operations and translation of financial statements into a presentation currency., access the standard, icaew factsheets and guides, other resources.

The requirements relating to specific topics are set out as sections within FRS 102. However, individual sections of the standard should not be looked at in isolation as other parts may be relevant.

FRS 102 is regularly updated and amended by the Financial Reporting Council (FRC) . For the full text of FRS 102, guidance on which version of the standard to apply and notes on recent amendments, see our main FRS 102 page .

The Corporate Reporting Faculty's annual UK GAAP factsheets  provide a more detailed discussion of recent UK GAAP amendments.

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Presentation currency

The presentation currency is, unsurprisingly, the currency in which the financial statements are presented. There is a free choice of presentation currency, and there are no restrictions on changing it, so in theory a different currency could be chosen each year, though it would be hard to see how directors could justify this on the basis of providing more relevant information. It would also prove to be quite costly in presenting the financial statements in different currencies each year.

To translate a set of results from the functional currency into the chosen presentation currency, the following steps are followed (summarised from FRS 102:30.18 ):

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