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The Effect of Changes in Foreign Exchange Rates

How to translate the financial statements of a foreign subsidiary under IAS 21

Business entities might be engaged in foreign exchange related transactions in many ways. To include the foreign currency transactions and foreign operations into their financial statements, the transactions should be expressed and reported in the reporting currency of the enterprise. In this regard, the Ind AS 21 prescribes how to include the foreign currency transactions and foreign operations into the financial statements of an entity and how to translate financial statements into a presentation currency. The major challenges being which exchange rate(s) to be used and how to report the effect of changes in exchange rates in the financial statements of the entity. 

The standard applies to following:

  • Accounting of foreign transaction and balances in foreign currency ;
  • Translating foreign results and financial position of foreign operations; and
  • Translating entity’s financial results and financial position into presentation currency.

Not Applicable
The standard does not apply to following:

  • Foreign currency derivatives transactions (covered by Ind AS 109);
  • Accounting for hedging for foreign currency items (including hedge of net investment in foreign operation)(covered by Ind AS 109);
  • Presentation in statement of cash flows(covered by Ind AS 7):
    • cash flows arising from foreign transactions
    • translation of cash flows from foreign operations; and
  • Long term foreign currency monetary items for which the business entity has opted exemption under Ind AS 101 (Para D13AA).

Foreign Currency and factors can be considered in determining functional currency
Functional Currency is the currency of primary economic environment in which the entity operates i.e., the one in which it expends cash in normal course of business. 

Primary Factors

  • Currency in which sales prices are denominated and settled and currency of the country whose competitive forces and regulations mainly determines sales price;
  • Currency in which costs like labor, material and other costs are denominated and settled.

Secondary Factors

  • Currency in which funds from financing activities are generated;
  • Currency in which proceeds from operating activities are normally retained.

Additional factors

  • Activities of foreign operation are carried out as an extension of reporting entity;
  • Transactions with reporting entity are high proportion of foreign operation activities;
  • Foreign operation’s cash flows directly affects reporting entity’s cash flows and readily available for remittance to reporting entity;
  • Foreign operation’s cash flows are not sufficient to service expected debt obligations without funds being made available by reporting entity.

For example a foreign operation only sells goods imported from reporting entity and remits the proceeds to it. In this case, foreign operation is an extension of reporting entity.

Functional currency cannot be changed unless there is a change in those underlying transactions, events and conditions. When there is a change in functional currency, entity should apply the translation procedures prospectively from the date of the change. 

Translation of foreign currency transactions:
Initial recognition: Apply spot exchange at the date of the transaction to the foreign currency amount.

At end of each reporting period:

  • Foreign currency monetary items are translated using closing rate;
  • Foreign currency non-monetary items that are measured in terms of historical cost are translated using the rate at the date of the transaction;
  • Foreign currency non-monetary items that are measured at fair value are translated using the rate when the fair value was measured.

Exchange difference on monetary items shall be recognized in profit or loss in the period in which they arise.

Presentation currency is the currency in which the financial statements are presented and the standard permits presentation currency of entity to be any currency.


  • An entity is required to disclose the exchange difference in statement of Profit and Loss, Equity and reconciliation of such exchange difference at beginning and end of the period;
  • An entity should disclose the fact that presentation currency and functional currency are two different currencies, if these are different, and the functional currency of the entity and reason thereof;
  • An entity shall further describe the financial statements as complying with Ind ASs only if translation procedures are completely complied with otherwise three additional disclosures are also required; and
  • An entity is required to disclose the fact that functional currency, either of reporting entity or of significant foreign operation, has changed during the period and the date of change in functional currency and reason thereof.

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