Many entities do business with overseas suppliers or customers, or have overseas operations. This gives rise to two main accounting issues:
- Some transactions (for example, those with overseas suppliers or customers) might be denominated in foreign currencies. These transactions are expressed in the entity’s own currency (‘functional currency’) for financial reporting purposes.
- A parent entity might have foreign operations, such as overseas subsidiaries, branches or associates. The functional currency of these foreign operations might be different from the parent entity’s functional currency, and therefore the accounting records might be maintained in different currencies. Because it is not possible to combine transactions measured in different currencies, the foreign operation’s results and financial position are translated into a single currency, namely that in which the group’s consolidated financial statements are reported (‘presentation currency’).
The methods required for each of the above circumstances are summarised below.
Expressing foreign currency transactions in the entity’s functional currency
A foreign currency transaction is expressed in an entity’s functional currency, using the exchange rate at the transaction date. Foreign currency balances representing cash or amounts to be received or paid in cash (‘monetary items’) are retranslated at the end of the reporting period, using the exchange rate on that date. Exchange differences on such monetary items are recognised as income or expense for the period. Nonmonetary balances that are not remeasured at fair value and are denominated in a foreign currency are expressed in the functional currency, using the exchange rate at the transaction date. Where a non-monetary item is remeasured at fair value in the financial statements, the exchange rate at the date when fair value was determined is used.
Translating functional currency financial statements into a presentation currency
Assets and liabilities are translated from the functional currency to the presentation currency at the closing rate at the end of the reporting period. The income statement is translated at exchange rates at the dates of the transactions, or at the average rate if that approximates the actual rates. All resulting exchange differences are recognised in other comprehensive income. The financial statements of a foreign operation that has the currency of a hyper-inflationary economy as its functional currency are first restated in accordance with IAS 29, ‘Financial reporting in hyper-inflationary economies’. All components are then translated to the presentation currency at the closing rate at the end of the reporting period.