foreign exchange translation

It is commonly the local currency of the country in
which the foreign entity operates. It may, however, be the parent’s
currency if the foreign operation is an integral component of the
parent’s operations, or it may be another currency. The values of current assets and liabilities are converted at the exchange rate that prevails on the date of the balance sheet. On the other hand, non-current assets and liabilities are converted at a historical rate. For example, assume that a company paid €10,000 in salaries for part-time contractors located in Europe at an exchange rate of $1.15 to 1 euro, the transaction is recorded in the income statement as $11,500 at the end of the accounting period. Companies that conduct business abroad are continually affected by changes in the foreign currency exchange rate.

foreign exchange translation

The Interpretations Committee noted that predominant practice is to apply the principle in paragraph 26 of IAS 21, which gives guidance on which exchange rate to use when reporting foreign currency transactions in the functional currency when several exchange rates are available. Hence, despite the issue’s widespread applicability, the Interpretations Committee decided not to take the first issue onto its agenda. Gains and losses resulting from currency conversions are recorded in financial statements.

Foreign Currency Translation

The Committee discussed whether, in those circumstances, an entity is required to use an official exchange rate(s) in applying IAS 21. The lack of exchangeability with other currencies has resulted in the foreign operation being unable to access foreign currencies using the exchange mechanism described in (a) above. For additional exchange rates not listed below, refer to the governmental and external resources listed on the  Foreign Currency and Currency Exchange Rates page or any other posted exchange rate (that is used consistently).

Monetary account items, such as cash and accounts receivable, are translated at the current exchange rate, whereas non-monetary accounts are translated at a historic rate. Without accounting for these exchange rate gains and losses, the amount of operating net income reported or tax payable foreign currency translation in a given period could increase. The Committee observed that all requirements in IAS 21 that specify the recognition (or presentation) of exchange differences require an entity to recognise (or present) exchange differences in profit or loss or other comprehensive income (OCI).

Removing the Impact of Foreign Exchange Translation from Financial Analysis

Paragraph 12 states that when the ‘indicators are mixed and the functional currency is not obvious, management uses its judgement to determine the functional currency that most faithfully represents the economic effects of the underlying transactions, events and conditions’. In addition, paragraph 17 of IAS 21 requires an entity to determine its functional currency in accordance with paragraphs 9⁠–⁠14 of the standard. Therefore, paragraph 9 should not be considered in isolation when determining the functional currency of an entity. The key difference is that a foreign currency transaction is when the company transacts with an unaffiliated 3rd party.

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