## Learning Outcomes

After reading this article, you will be able to explain how foreign currency transactions are initially measured, identify when and how to translate monetary and non-monetary items at the reporting date, recognise exchange differences in profit or loss, and account for exchange differences on settlement and disposal under IAS 21 for the ACCA Financial Reporting exam.

## ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand how to account for foreign currency transactions, with emphasis on:

- Explaining the difference between functional and presentation currency
- Knowing the initial measurement and subsequent translation of foreign currency transactions
- Accounting for unsettled monetary and non-monetary items at the reporting date
- Recognising exchange differences in the statement of profit or loss on settlement and at reporting date
- Applying IAS 21 rules when a foreign currency transaction or monetary balance is settled or disposed

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. According to IAS 21, which rate should be used to record a foreign currency purchase on the transaction date?
   a) Year-end closing rate
   b) Spot rate at transaction date
   c) Average rate for the year
   d) Spot rate at reporting date

2. Would a trade payable in a foreign currency outstanding at year-end be retranslated? If so, to which rate?

3. When a foreign currency receivable is settled, what happens to any previous exchange differences that have arisen?

4. How are exchange differences on monetary items recognised in the statement of profit or loss?

## Introduction

IAS 21 The Effects of Changes in Foreign Exchange Rates sets out the approach to account for transactions in currencies other than an entity’s functional currency. At the ACCA FR level, you must be able to translate foreign currency transactions, deal with monetary and non-monetary items at the reporting date, and recognise exchange differences in profit or loss. You must also handle the accounting implications when monetary items are settled or disposed.

> **Key Term: functional currency**
> The currency of the primary economic environment in which an entity operates, usually reflecting the currency that mainly influences sales prices and costs.
>
> **Test Tip:**
> When revising Exchange differences: recognition and disposal, connect each definition, method, or rule to the kind of question the assessment is likely to ask.

### Foreign Currency Transactions: Initial and Subsequent Measurement

When an entity enters into a transaction denominated in a foreign currency, it must be translated into the functional currency for financial reporting purposes.

![Foreign currency monetary transaction accounting from initial recognition to settlement, including spot-rate translation, closing-rate retranslation, and exchange differences in profit or loss.](https://static.pastpaperhero.com/images/acca-fr-foreign-currency-transactions-ias-21-exchange-differences-recognition-and-disposal_00.png)

_Monetary foreign currency balances are translated using spot, closing, and settlement rates, with prior exchange differences retained in profit or loss._

### Initial Recognition

At the date of the transaction, a foreign currency amount is translated using the spot rate—that is, the exchange rate at that specific date.

> **Key Term: spot rate**
> The exchange rate for immediate delivery between two currencies at the date of transaction.

### Subsequent Measurement of Unsettled Transactions

Foreign currency transactions often remain unsettled at the reporting date, meaning the related asset or liability appears on the statement of financial position.

#### Monetary vs Non-Monetary Items

- **Monetary items**: Units of currency held, or assets/liabilities to be received/paid in a fixed or determinable number of currency units (e.g., cash, receivables, payables, loans).
- **Non-monetary items**: Items not giving right to receive or obligation to deliver a fixed or determinable amount of currency (e.g., inventory, tangible fixed assets).

> **Key Term: monetary items**
> Assets or liabilities to be received or paid in a fixed or determinable amount of currency (e.g., receivables, payables, loans).
> **Key Term: non-monetary items**
> Items that do not meet the definition of monetary items. Examples include inventory, property, plant and equipment measured at cost, and intangible assets.

#### Translation at the Reporting Date

- **Monetary items:** Retranslated at the closing rate (exchange rate at the reporting date). Any resulting exchange difference is recognised in profit or loss.
- **Non-monetary items measured at historical cost:** Remain at the transaction date rate, not retranslated.
- **Non-monetary items measured at fair value:** Translated at the rate on the date when fair value was determined.

### Exchange Differences: Recognition

- **Settlement during the year:** A difference may arise between the recorded amount (using initial or previous reporting date rates) and the amount paid/received using the rate at settlement. The resulting exchange difference is recognised in profit or loss.
- **Reporting date retranslation:** For monetary items not yet settled, retranslation at the closing rate produces exchange differences, which are again taken to profit or loss.

> **Key Term: exchange difference**
> The difference resulting from translating a given number of units of one currency into another at different exchange rates.

### Worked Example 1.1

> **Question:**
> On 1 November 20X6, Light Co purchases inventory from an overseas supplier for €10,000. The transaction is recorded at the spot rate of €1.25 = \$1. At year-end, 31 December 20X6, the closing rate is €1.20 = \$1. Light Co settles the payable on 15 January 20X7, when the rate is €1.18 = \$1. How are the exchange differences recognised in the accounts for the year ended 31 December 20X6 and on settlement?
>
> **Answer:**
>
> - **Initial recognition (1 Nov):** €10,000 / 1.25 = \$8,000 (recorded as inventory and payable).
> - **Year-end (31 Dec):** Payable is retranslated at €10,000 / 1.20 = \$8,333. There is an exchange loss of \$333 (\$8,333 – \$8,000), recognised in profit or loss.
> - **Settlement (15 Jan):** Paid in USD = €10,000 / 1.18 = \$8,475. The difference between the year-end carrying amount and the settlement is a further exchange loss of \$142 (\$8,475 – \$8,333), recognised in profit or loss.
>
> **Exam Warning:**
> It is a common mistake to incorrectly leave monetary items at their initial translation rate, rather than retranslate them at the closing rate. In the exam, always check for foreign currency monetary balances at the reporting date and be sure to retranslate them.

### Exchange Difference Recognition: Profit or Loss and Disposal

IAS 21 requires that all exchange differences on monetary items are recognised as income or expense in the profit or loss in the period in which they arise. This includes:

- Differences arising on settlement
- Differences arising from translation at each reporting date

When a transaction is finally settled (e.g., the liability paid or the receivable collected), any exchange differences previously recognised in profit or loss are not reversed; settlement merely generates the final exchange difference for recognition at that date.

### Disposal of a Foreign Currency Monetary Item

Disposal or settlement refers to when the monetary item is removed from the books (e.g., liability paid off, receivable collected). The final gain or loss on foreign exchange is calculated as the difference between the original spot rate and the settlement rate, taking into account any previous retranslation adjustments.

### Worked Example 1.2

Kite Co has a year-end of 31 March 20X9. On 1 March, Kite Co sells goods to a customer in South Korea, invoicing KRW 10,000,000. The spot rate on 1 March is KRW 1,000 = \$1. At 31 March, the closing rate is KRW 950 = \$1. The customer pays on 15 April, when the rate is KRW 970 = \$1. Show the accounting entries and exchange differences recognised for the year ended 31 March 20X9 and on settlement.

> **Answer:**
>
> - **Initial recognition (1 March):** KRW 10,000,000 / 1,000 = \$10,000 (trade receivable and revenue).
> - **Year-end retranslation (31 March):** KRW 10,000,000 / 950 = \$10,526. Exchange gain of \$526 (\$10,526 – \$10,000), credited to profit or loss.
> - **Settlement (15 April):** KRW 10,000,000 / 970 = \$10,309. Settlement is less than retranslated amount, so an exchange loss of \$217 (\$10,309 – \$10,526), debited to profit or loss in the following period.

### Reporting Exchange Differences

Exchange differences on trading balances (e.g., payables, receivables) are reported as part of operating income or expense. Differences relating to financing activities (e.g., loans) may be included as finance costs or income.

Exchange differences on non-monetary items carried at fair value (e.g., revalued property) are recognised in other comprehensive income if the related gain/loss is taken there.

## Summary

Foreign currency transactions should be recorded at the spot rate on the transaction date, with monetary balances retranslated at the year-end closing rate. Exchange differences arising from these revaluations or from settlement must be recognised in profit or loss. Disposal (settlement) of monetary items finalises the cumulative exchange difference, but does not remove previously recognised amounts from profit or loss.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Explain the difference between functional and presentation currency under IAS 21
- Record the initial measurement of foreign currency transactions
- Distinguish between monetary and non-monetary items for translation at period end
- Retranslate monetary items at closing rate and recognise exchange differences in profit or loss
- Account for exchange differences on settlement and on disposal of foreign currency balances

## Key Terms and Concepts

- functional currency
- spot rate
- monetary items
- non-monetary items
- exchange difference


Foreign currency transactions (IAS 21) - Exchange differences: recognition and disposal