What does IAS 21 cover and how does it work?

What IAS 21 covers

IAS 21 The Effects of Changes in Foreign Exchange Rates governs two distinct situations: (1) how an entity accounts for transactions denominated in a foreign currency in its own books, and (2) how an entity translates the financial statements of foreign operations into its presentation currency. The rules for each are fundamentally different.

Foreign currency transactions

When a single entity enters into a transaction priced in a currency other than its functional currency, IAS 21 requires initial recognition at the spot rate and remeasurement of monetary items at each subsequent reporting date.

• Foreign currency transactions → Spot rate at transaction date, retranslation of monetary items at closing rate, recognition of exchange differences in profit or loss — with journal entry examples.
• Monetary vs non-monetary items → Which balances get retranslated each period and which stay at the historical transaction-date rate.
• Functional currency determination → How to identify the primary economic environment and determine the correct functional currency, including for mixed-currency operations.

Foreign operations — translation

When consolidating or equity-accounting a foreign subsidiary, associate or branch with a different functional currency, a separate set of rules applies. Assets and liabilities are translated at the closing rate; income and expenses at transaction-date rates (or averages); resulting differences go to OCI as the cumulative translation adjustment (CTA).

• Translation of foreign operations → Step-by-step closing rate method: how assets, liabilities, income, expenses and equity are each translated, and how the CTA arises.
• Net investment in a foreign operation → When intercompany loans and parent borrowings qualify as part of the net investment, and why exchange differences on them go to OCI rather than P&L.
• Disposal of a foreign operation → Recycling the CTA from OCI to profit or loss on full disposal, and the rules for partial disposals.

Key paragraphs at a glance

• IAS 21.8 — Definition of functional currency.
• IAS 21.20–21 — Initial recognition of foreign currency transactions at spot rate.
• IAS 21.23 — Retranslation of monetary items at closing rate; non-monetary items stay at historical rate.
• IAS 21.24–25 — Exchange differences recognised in profit or loss (with exceptions).
• IAS 21.32–33 — Exchange differences on net investment in foreign operation recognised in OCI.
• IAS 21.39 — Closing rate method for translating foreign operations.
• IAS 21.48–49 — Recycling of CTA to profit or loss on disposal of foreign operation.