Foreign Exchange transactions at an individual company level under IAS 21

When a company enters into transactions in a currency that’s different to its functional currency (i.e. a foreign exchange transaction), the results of these transactions should be translated and recorded in the company’s accounting records in its functional currency.

The company can use either:

  • the spot exchange rate on the date the transaction occurred, or
  • Using an average rate over a period of time providing the exchange rate has not fluctuated significantly.

At the end of the accounting period (i.e the balance sheet dates), the following process must be applied:

  • Foreign currency monetary items (e.g. debtors, creditors, cash, loans) must be translated using the closing rate. The closing rate is the exchange rate at the balance sheet date.
  • Foreign currency non-monetary items (fixed assets, investments, stock) are not re-translated. They are left at the exchange rate that was used at the date of the transaction (called the historic rate).

For example, if a company purchased inventory during the year in a differnet currency, and still had to pay its supplier. The only amount that would be retranslated at the year end is the amount owing to the supplier (i.e. the monetary item). The inventory stays on the financial statements at its cost on the day of purchase.

What happens to the foreign exchange gain/loss?

Any exchange differences on settlement of monetary items or on retranslating monetary items are recognised in the income statement.