how to determine presentation currency

Functional Currency vs Presentation Currency

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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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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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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Accounting And Foreign Exchange – What To Look Out For

In the simplest of worlds, there would be one global currency.

In the simplest of companies you work on, most probably the file is organised, the company has no foreign currency exposure, and the client speaks your language.

Today’s article focuses on the main aspects to be on the lookout for when entities are exposed to foreign currencies.

The first distinction to make is that between three terms that tend to be confusing, that is – functional currency, presentation currency and foreign currency:

Functional Currency is the currency of the primary economic environment in which the entity operates.

Any currency in the world which is not the functional currency of an entity is a Foreign Currency

Presentation Currency is the currency in which the financial statements are presented.

Functional Currency

The determination of the functional currency is one of the crucial matters to determine before starting to work on any file. IAS 21 ‘The Effects Of Changes in Foreign Exchange Rates’ guides preparers in relation to how to determine the functional currency.

The primary indicators of the functional currency are the currencies that affect the sales price and costs of an organisation. Since the assessment of the primary indicators may not enable preparers to arrive at a conclusion in relation to which is the functional currency of an entity, the standards provides secondary factors. Such secondary factors include the currency of the entity’s financing activities and the currency in which receipts from operating activities are usually accumulated.

When determining the functional currency of a foreign operation, there are additional factors which are also listed in IAS 21, such as whether the foreign operation is autonomous from the reporting entity, or not.

In any case, the determined functional currency should be the currency in which the books of account are kept. Any other currencies in which the entity deals with are foreign currencies.

Presentation Currency

The presentation currency is the currency in which the financial statements of an entity are presented. This is an accounting policy choice under IAS 21. The entity is free to choose the currency in which to present to its shareholders. In general, the simplest solution would be to present financial statements in the same currency as the functional currency.

However, it’s imperative to stress that the Maltese Companies Act requires that the accounts are presented in the same currency as the share capital. As a result, there isn’t a choice for preparers.

Changes In Functional And Presentation Currency

In the rare eventuality of a change in functional currency, the change is made prospectively, and all figures are converted at the date of the change, including share capital.

Since the choice of the presentation currency is technically an accounting policy choice, it follows that a change in presentation currency is a change in accounting policy. As a result, the change needs to be reflected retrospectively, just like other changes in accounting policy.

Exchange Rate Selection

There are two main sets of rules when selecting exchange rates:

• Rules for booking transactions in foreign currency.
• Rules for other situations.

Transactions In Foreign Currency

Even though the entity has selected its functional currency, the entity may still enter into foreign currency transactions. For instance, a EUR company might purchase goods in USD. Such transactions are foreign currency transactions.

The exchange rate to use for transactions entered into is the rate at the date of the transaction. An average rate for the period is permitted insofar as this doesn’t distort the figures. The complication arises at the reporting date. The entity needs to distinguish between monetary and non-monetary items. Monetary items are those that will result in a settlement in a fixed or determinable number of units of currency (such as cash balances, debtors and creditors) whilst non-monetary items are all other items (such as property, inventory and shares). At the reporting date, all monetary items are translated at the exchange rate of that day, whilst non-monetary items are not retranslated from the historical exchange rate (that is, from the rate at the date of initial recognition).

Differences on transactions are recognised in profit or loss – retranslations result in unrealised exchange movements whilst gains or losses upon settlement result in realised exchange movements.

Other Situations

There are other situations requiring different treatment, whereby assets and liabilities are converted at the closing rates, irrespective of whether they’re monetary or not. Income statement items are converted at actual (or average) rates, just like with transactions in foreign currency. In this case, differences are recognised in the exchange fluctuation reserve.

Such situations include:

• The process of converting from the functional currency of an entity to its presentation currency.
• The process of converting a foreign operation into the presentation currency of the reporting entity.

Should you wish to discuss further our IFRS team would be happy to assist you.

Contact us on  [email protected]

Disclaimer  –  Please note that this article is intended for information purposes only and whilst utmost care has been taken to ensure a correct application and interpretation of IFRS rules, Zampa Debattista shall bear no responsibility legal or otherwise, for misuse.

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The Effects of Changes in Foreign Exchange Rates

Determining an entity’s functional currency, determining the functional currency of a foreign operation, and dealing with a change in such a currency.

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IAS 21 The Effects of Changes in Foreign Exchange Rates provides guidance to determine the functional currency of an entity under International Financial Reporting Standards (IFRS). The standard also prescribes how to include foreign currency transactions and foreign operations in the financial statements of an entity and how to translate financial statements from the entity’s functional currency into its presentation currency. This factsheet will delve into determining an entity’s functional currency, determining the functional currency of a foreign operation, and dealing with a change in the said functional currency.

Definition and determination of functional currency

The functional currency is the currency in which an entity records and measures its transactions, in other words, the currency in which it maintains its accounting records. It is determined by reference to the currency of the primary economic environment in which that entity operates. To determine the functional currency an entity needs to consider various factors, which IAS 21 splits into 2 categories, that is the primary and the secondary factors.

The primary factors that an entity needs to consider are the following:

• the currency that mainly influences the sales prices for the goods and services, which will often be 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 price of its goods and services; and
• the currency that mainly influences labour, material and other costs of providing goods or services, which normally is the currency in which such costs are denominated and settled.

Very often, the application of points (a) and (b) above to gaming entities, does not give a straightforward interpretation of what that gaming entity’s functional currency is. This is because a company with a gaming licence in a specific country, would have the facility to operate in several different jurisdictions , which could result in having revenues denominated in various currencies .

With respect to point (c), the management of the gaming entity would need to look at the location where its labour force is operating, the currency used to settle their respective salaries and any other costs it would be incurring. 

The following secondary factors should also be considered to provide additional evidence of an entity’s functional currency:

• the currency in which funds from financing activities are generated; and
• the currency in which receipts from operating activities are usually retained.

In view of the fact that an analysis of the primary factors may not be definitive in determining the functional currency for a gaming entity, management is required to carry out an assessment taking also into consideration the above-mentioned secondary factors. Management is required to assess the funding obtained by the gaming entity and how the receipts from its operating activities are retained. 

Therefore, to determine the functional currency of an entity management is required to carry out an assessment, taking into consideration the above mentioned primary and secondary indicators, which most faithfully represent the economic effects of the underlying transactions, events and conditions pertaining to the entity. When the above indicators are mixed and therefore do not give a clear indication of the entity’s functional currency, management must exercise its judgement and, especially where gaming entities are concerned, give more weight to the secondary indicators.

Functional currency of a foreign operation

The term ‘foreign operation’ includes subsidiaries, associates, joint ventures or branches of a reporting entity, and which activities are based or conducted in a country or currency other than those of the reporting entity. IAS 21 requires an assessment to determine whether the foreign operation ‘inherits’ the reporting entity’s functional currency, or whether it has a functional currency in its own right. The following additional factors are considered when determining the functional currency, and whether its functional currency is the same as that of the reporting entity:

• Autonomy - Whether the operation is essentially an extension of the reporting entity. 
• Proportion of transactions – Whether the foreign operation’s transactions with the reporting entity constitute a high or low proportion of the operation’s activities.
• Proportion of cash flows – Whether cash flows from the activities of the foreign operation directly affect the cash flows of the reporting entity and are readily available for remittance to it. 
• Debt service – Whether a foreign operation’s cashflow can service its debt obligations without funds being made available by the reporting entity. 

As described above, an entity’s functional currency reflects the underlying transactions, events and conditions that are relevant to it. Hence, once determined, the functional currency does not change unless there is a change in the underlying nature of the transactions and relevant conditions and events. For example, a change in the currency that mainly influences the sales prices of the goods and services following a relocation of a significant component of the entity’s business may led to a change in an entity’s functional currency.

The effect of a change in the functional currency is accounted for prospectively. Therefore, an entity translates all items into the new functional currency using the exchange rate at the date of change. The resulting translated amounts for non-monetary items are treated as their historical cost. Exchange differences arising from the translation of a foreign operation previously recognised in other comprehensive income are not reclassified from equity to profit and loss until the disposal of the operation.

The responsibility to determine the functional currency lies with the entity’s management, yet it is also the responsibility of the auditors to review critically and exercise professional judgement and scepticism, to ensure that the assessment made by management is appropriate and in accordance with IAS 21 principles.

IAS 21 – Determining the functional currency under IFRS.

Accounting challenges can arise as a result of developments in underlying accounting requirements.

Accounting challenges can arise as a result of developments in accounting requirements.

Jonathan Dingli

Partner, Corporate Accounting Advisory Services

KPMG in Malta

Email [email protected]

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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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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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Audit Procedures for Foreign Currency Translation: Risks, Procedures, Assertions

Foreign currency translation is a process used to convert financial statements from one currency to another. It is a critical component of financial reporting for multinational companies that operate in multiple countries and require a consolidated view of their financial results.

Accounting Treatment

The accounting treatment of foreign currency translation requires a consistent application of the exchange rate in order to accurately reflect the financial performance of a company.

Audit Risks

Foreign currency translation poses several audit risks that must be considered by auditors in order to ensure the accuracy of financial statements. The following are ten key audit risks associated with foreign currency translation:

Audit Assertions

Walkthrough testing.

To perform walkthrough testing, the auditor should review the foreign entity’s accounting policies, procedures, and processes, and ask questions of the entity’s accounting personnel to gain an understanding of how the entity prepares its financial statements.

Test of Control

To perform test of control, the auditor should review the foreign entity’s internal controls, including its policies and procedures, to assess their design and operating effectiveness.

Substantive Audit Procedures

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