Ind AS 21 – Effects of changes in Foreign Exchange rates – Treatment of exchange differences

Let us examine the treatment of exchange differences in the books of accounts with a practical example.

Let us analyse the treatment of foreign exchange differences arising on account of translating the foreign currency balances to the presentation currency in respect of monetary items.

The exchange differences arise either on settlement or on remeasurement at the reporting date.

In both these cases, the exchange differences are recognised in the profit and loss account.

Let us briefly understand the difference between the FX revaluation entry and the FX translation entry.

The FX revaluation is converting every transaction in foreign currency into functional currency at the exchange rate on the date of transaction.

This means that there will be an entry in functional currency for each and every transaction in foreign currency.

FX translation on the other hand is performed at the account level.

There will be one journal entry for each account at the valuation date or at the settlement date based on the exchange rate on the date of valuation or settlement, as the case may be.

Let us take an example of accounting for the exchange differences arising on account of purchase of equity shares designated in foreign currency.

Let us assume that the functional currency is INR.

Bought 100 shares at $59 per shareEntry in foreign currency

Date Particulars Debit (Rs.) Credit (Rs.)
5-Jan-X1 Investment (Equity Shares – FVTPL) A/c

5900

  To Payable to Broker A/c 5900
(Being 100 shares of Zenith Inc purchased at $59)

 Revaluation of transaction above FX rate Rs. 63/- – FX Revaluation entry

Date Particulars Debit (Rs.) Credit (Rs.)
5-Jan-X1 Investment (Equity Shares – FVTPL) A/c

3,71,700

  To Payable to Broker A/c

3,71,700

(The entry for purchase of equity shares @ 63.00 being the exchange rate on traded date)

 Settlement of liabilitySettlement entry in foreign currency

Date Particulars Debit (Rs.) Credit (Rs.)
8-Jan-X1 Payable to broker  A/c

5900

  To Bank A/c

5900

(Being the settlement of liability towards purchase of equity shares on settlement date)

 Revaluation of above transaction to broker FX rate Rs. 63.22 – FX Revaluation entry

Date Particulars Debit (Rs.) Credit (Rs.)
8-Jan-X1 Payable to broker  A/c

3,73,057

  To Bank A/c

3,73,057

(Being revaluation of the amount paid to the broker at the exchange rate of 62.83, which is the exchange rate on the date of settlement)

Recognition of gain/loss on settlementFX translation entry

Date Particulars Debit (Rs.) Credit (Rs.)
8-Jan-X1 Realised currency loss A/c

1,357

  To payable to broker A/c

1,357

(Being the realised currency loss adjusted with the broker account representing the fluctuation in the exchange rate between the trade date and the settlement date as shown in the following table)

 

Currency gains/loss on settlement date: 08-Jan-X1 INR
a) Purchase price as of 05-Jan-X1

3,71,700

b) Settlement amount in INR terms on 8-Jan-X1

3,73,057

Ind AS 21 – Effects of changes in Foreign Exchange rates – Translation to presentation currency

Let us see how the financial statements are translated to presentation currency

Financial statements should be translated to presentation currency if the currency is different from the functional currency.

The assets and liabilities are translated based on the closing rate at which the balance sheet is prepared.

Income and expenses are translated at the exchange rate at the respective transaction dates.

Sometimes, this could also be based on the average rate for a period where the exchange rates do not fluctuate significantly.

The exchange differences arising on account of translation of the financial statements to the presentation currency are recognised in other comprehensive income.

Note that the exchange differences on monetary as well as non-monetary items are all recognised in other comprehensive income.

The exchange difference should not be recognised in profit and loss account.

Ind AS 21 – Effects of changes in Foreign Exchange rates – Recognition and measurement

Let us see the recognition and measurement of foreign currency transactions in the books of accounts.

First we need to understand what is meant by a foreign currency transaction.

Foreign currency transaction is a transaction in a currency other than the functional currency of the entity.

A foreign currency transaction is the one that is denominated in foreign currency that requires settlement in such foreign currency.

Let us look at the requirements for recognising a foreign currency transaction initially.

First, the foreign currency transaction is entered in separate books of accounts.

Then, the same is revalued by applying the spot rate to get the value in the functional currency of the entity.

In certain situations, average exchange rate may also be allowed, provided certain conditions are fulfilled.

Let us look at the requirements for subsequent measurement of such foreign currency transactions.  Foreign currency transaction should be translated into functional currency.

For translating into functional currency, the rate at which the account balances should be converted into foreign currency is determined based on whether the item is a monetary item or a non-monetary item.

Monetary items are translated to the functional currency using the closing rate as on the reporting date.

For non-monetary items, the exchange rate to be used will depend upon the basis of measurement of such item.

If the basis is historical cost, then the account balance should be translated at the rate as on the date of transaction. However, if the basis of measurement is fair value, then the account balance should be translated into the functional currency at the rate as on the date on which the fair value is determined.

Ind AS 21 – Effects of changes in Foreign Exchange rates – Presentation currency

Let us understand what is a presentation currency and how it is different from the functional currency.

Presentation currency is the currency in which the financial statements are prepared.

This can be in a currency chosen by the entity as the entity is free to choose its own currency.

This is mainly for the purpose of presenting the financial statements to the stake holders who are located in another geographical area having a different local currency.

The main difference between a functional currency and the presentation currency should be understood very clearly.

Functional currency is determined by applying the factors that are specified in the standard which are known as primary factors.

If there is a conflict in the primary factors, then the entity should look for secondary indicators.

Selecting the correct functional currency is extremely important as this will have a severe impact on the profit and loss account if not selected properly.

The functional currency is determined individually for different entities even within the same group and there is no such concept called group functional currency.

However, presentation currency is selected by the entity as a matter of choice.

Selecting any currency will have no impact on the profit and loss account.  There could also be a group presentation currency if the group so decides.

Ind AS 21 – Effects of changes in Foreign Exchange rates – Monetary and non-monetary items

Let us understand what is meant a monetary item and a non-monetary item.

Monetary item

Monetary item represents a right to receive or an obligation to deliver a fixed or determinable number of units of a currency.

Some of the examples of a monetary item are investment in debt security in foreign currency classified as amortised cost.  This is recorded as a monetary item, because the entity would hold this item till maturity and on maturity would receive the stated maturity amount from the issuer in a pre-determined number of units of the foreign currency.

  • Pension benefits payable in cash
  • Provisions to be settled in cash
  • Dividends payable by an entity recognised as liability

Non-monetary item

In a non-monetary item, there is no existence of a right to receive or an obligation to pay a fixed or determinable number of units of a currency.

For example, investment in equity shares denominated in foreign currency.  This is recorded as a non-monetary item because the entity will be able to get the investment back only by selling the same either in a stock exchange or privately.  In other words, the entity has no right to receive a fixed or determinable number of units of such foreign currency from the issuer.

  • Pre-paid expenses
  • Investment in intangible assets
  • Investment in DPE

Now for all these examples, the entity will not be able to receive a fixed or determinable number of units of a specified currency.

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