Researched by Hafsa Research and Analysis Company
Introduction
Under IAS 21 The Effects of Changes in Foreign Exchange Rates, entities account for transactions in foreign currencies by distinguishing between:
- Functional currency – the primary economic environment in which the entity operates
- Presentation currency – the currency in which financial statements are presented
The determination of functional currency is based on:
- Primary factors: currency influencing sales prices, labour, and material costs
- Secondary factors: financing activities and cash retention
Foreign currency transactions are initially recognised using the spot exchange rate at the date of the transaction.
At the reporting date:
- Monetary items → translated at closing rate
- Non-monetary items (historical cost) → transaction-date rate
- Non-monetary items (fair value) → valuation-date rate
Exchange differences are generally recognised in profit or loss, except for those relating to net investment in foreign operations, which are recognised in other comprehensive income (OCI) until disposal.
Lack of Exchangeability – New Amendments
In August 2023, the International Accounting Standards Board introduced amendments to IAS 21 addressing situations where a currency cannot be exchanged into another currency.
These amendments apply when:
- A currency is not exchangeable at the measurement date
- There is no observable exchange rate available
Definition of Exchangeability
A currency is considered exchangeable when:
- It can be converted within a normal administrative timeframe, and
- The transaction occurs through a market or mechanism that creates enforceable rights and obligations
If these conditions are not met, the currency is deemed non-exchangeable.
Accounting Treatment When Currency Is Not Exchangeable
When exchangeability is lacking:
- Estimate the Spot Exchange Rate
Entities must estimate a rate that reflects an orderly transaction between market participants under current economic conditions. - Judgement-Based Approach
The standard does not prescribe a single method, allowing the use of:- Observable indirect rates
- Parallel or unofficial markets
- Economic indicators
- Enhanced Disclosures
Entities must disclose:- Nature of the restriction
- Estimation techniques used
- Risks and financial impact
Big Four Perspective
Leading firms such as PwC highlight that the amendments significantly increase the need for:
- Professional judgement
- Transparency in assumptions
- Robust disclosure frameworks
They emphasize that exchangeability assessment requires consideration of:
- Purpose of exchange
- Availability of markets
- Volume restrictions
- Timing delays
Objective of the Amendments
The amendments aim to improve financial reporting by:
- Clearly defining exchangeability
- Providing guidance where exchange rates are unavailable
- Enhancing comparability and transparency through disclosures
Closing Thoughts
The amendments to IAS 21 represent a significant step toward addressing real-world economic challenges, particularly in countries facing currency controls or foreign exchange shortages.
While the flexibility in estimating exchange rates allows entities to reflect economic reality, it also introduces subjectivity and potential inconsistency. Therefore, the emphasis on disclosures and transparency is critical.
For finance professionals, especially those pursuing ACCA, mastering these amendments is essential—not only for exams but also for practical application in global financial reporting.
Researched by Hafsa Research and Analysis Company
