This is the short summary of IAS 21 The Effects of Changes in Foreign Exchange Rates.
In today's world, the entities carry out their foreign activities in 2 ways: 1. They have some transactions in foreign currencies, or
2. They Have a foreign operation.
An entity can also decide to present its financial statements in some foreign currency other than their own.
The objective of IAS 21 is to prescribe
• How to include foreign currency transactions and foreign operations in the financial statements of an entity; and
• How to translate financial statements into a presentation currency.
Functional currency is the currency of the primary economic environment in which the entity operates. It is the own entity's currency and all other currencies are "foreign currencies".
The primary economic environment is normally the one in which the entity primarily generates and expends the cash, but more factors needed to be considered, such as the currency in which the sales prices are denominated, etc.
Presentation currency is the currency in which the financial statements are presented.
How to report transactions in FUNCTIONAL CURRENCY
Initially, all foreign currency transactions shall be translated to functional currency by applying the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.
Subsequently, at the end of each reporting period, you should translate:
• All monetary items in foreign currency using the closing rate;
• All non-monetary items measured in terms of historical cost using the exchange rate at the date of transaction (historical rate);
• All non-monetary items measured at fair value using the exchange rate at the date when the fair value was measured.
All exchange rate differences shall be recognized in profit or loss with some exceptions.
How to translate financial statements into a PRESENTATION CURRENCY
When an entity's functional currency is NOT the currency of a hyperinflationary economy, then an entity should translate:
• All assets and liabilities for each statement of financial position presented (including comparatives) using the closing rate at the date of that statement of financial position.
• All income and expenses and other comprehensive income items (including comparatives) using the exchange rates at the date of transactions.
All resulting exchange differences shall be recognized in other comprehensive income as a separate component of equity.
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