1. HKAS 21 Effects of Changes in Foreign Exchange Rates
Date: November 1, 2008

2. Content Objective and scope of HKAS 21 Functional currency
Translation foreign currency transactions
Disclosure
Examples
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3. 1. Objective of HKAS 21 The objective of HKAS 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
The principal issues are
- which exchange rates to use and
- how to report the effects of changes in exchange rates in the financial statements.
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4. 1. Scope of HKAS 21 HKAS 21 shall be applied:
a) in accounting for transactions and balances in foreign currencies, except for those derivatives transactions and balances that are within the scope of HKAS 39
b) in translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation, proportionate consolidation or the equity method; and
c) in translating an entity’s results and financial position into a presentation currency.
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5. 1. Basic Terms
Functional currency – the currency of the primary economic environment in which the entity operates.
Presentation currency – the currency in which the financial statements are presented.
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6. 2. Functional currency
Functional currency = The currency of the primary economic environment in which the entity operates
Determine the functional currency:
Primary indicator: Currency influence sales price or cost.
Other indicators: Currency of financing funds, receipt from operating activities, portion of foreign operation activities, cash flows, currency which the receipts are retained, etc
If indicators are mixed or not obvious: Management judgement on which currency represented most faithfully.
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7. 2. Functional currency
once determined, the functional currency is not changed unless there is a change in those underlying transactions events and conditions
hyperinflationary economy
restate financial statement in accordance with HKAS 29
Examples:
HK Co, sales denominated in USD, expenses paid in HKD =>USD
HK Head office, branch in UK, most sales in GBP => GBP
e.g. Standard Chartered Bank =>are presented in US dollars, which is the Group’s functional and presentation currency
e.g. HSBC =>Functional currency are measured using the currency which the entity operates, presented in US dollars,
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8. 2. Functional Currency -Recognition
Initial Recognition
by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction
Subsequent B/S date
Monetary item ⇒ translated at closing rate
Non-monetary item ⇒ historical cost (rate at date of transaction)
Non-monetary item measured at fair value ⇒ rate at date when fair value was determined
Non-monetary item measured at other amount ⇒ rate at date when other amount was determined (e.g. NRV, Impairment)
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9. 2. Functional Currency -Recognition
Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.
– Pensions and other employee benefits to be paid in cash
– Provisions that are to be settled in cash
– Cash dividends that are recognised as a liability
Non-monetary items includes:
– Amounts prepaid for goods and services
– Prepaid rent
– Goodwill and intangible assets
– Inventories
– Property, plant and equipment
– Provisions that are to be settled by a non-monetary asset
Closing rate
Historical rate
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10. 2. Functional Currency -Recognition
Exchange rates:
Closing rate -> rate at b/s date
Historical rate -> rate at transaction
Average rate -> average rate within a period
Spot rate -> rate for immediate delivery (i.e. at transaction)
Web site for searching exchange rates:
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11. 2.Functional currency - Exchange difference
Monetary Items: (e.g. Accounts receivable)
Exchange differences arising
– on the settlement of monetary items or
– on translating monetary items at rates different from those at which they were translated on initial recognition ⇒ recognised in profit or loss, except for those form part of net investment in a foreign operation
Non-monetary items: (e.g. PPE)
When a gain or loss on a non-monetary item is recognised directly in equity ⇒ any exchange component of that gain or loss shall be recognised directly in equity
When a gain or loss on a nonmonetary item is recognised in profit or loss ⇒ any exchange component of that gain or loss shall be recognised in profit or loss
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12. 2.Functional currency - Exchange difference
Exchange differences on a monetary item that is part of a net investment in a foreign operation
(e.g. long term loan that is not plan to be settled in the foreseeable future):
Separate financial statements
– are recognised in the income statement of the separate financial statements.
Consolidated financial statements
– In consolidated financial statements these exchange differences are recognised in the foreign exchange reserve in shareholders’ equity.
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13. 3.Presentation currency
Presentation currency is the currency in which the financial statements are presented.
Functional currency different from the presentation currency are translated into the presentation currency as follows:
i) assets and liabilities ⇒ translated at the closing rate at B/S date
ii) income and expenses (P/L) ⇒ translated at average exchange rates (unless this average is not a reasonable approximation); and
iii) all resulting exchange differences are recognized as a separate component of equity.
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14. 3.Translation of foreign operation
Goodwill arising on acquisition
• Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation
– shall be treated as assets and liabilities of the foreign operation.
– shall be expressed in the functional currency of the foreign operation and
– shall be translated at the closing rate
On disposal of foreign operation:
- the translation reserve is recognise to P/L
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15. 4. Disclosure SIGNIFICANT ACCOUNTING POLICIES Foreign currencies
(a) Functional and presentation currency
Items included in the accounts of the Company are measured using the currency of the primary economic environment in which the Company operates (“the functional currency”). The financial statements are presented in Hong Kong dollars (“HKD”), which is the functional currency and the presentation currency of the Company.
(b) Transactions and balances
Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement.
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16. SIGNIFICANT ACCOUNTING POLICIES
(c) Group companies (For consolidated account only)
The results and financial position of all the group entities (none of which has the currency of a hyperinflationary economy) that have a functional currency different from the presentation currency are translated into the presentation currency as follows:
(i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet;
(ii) income and expenses for each income statement are translated at average exchange rates (unless the average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and
(iii) all resulting exchange differences are recognised as a separate component of equity.
On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to equity. When a foreign operation is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale.
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17. 4. Disclosure Disclose: - exchange difference recognised in P/L
- exchange difference in equity
- the functional currency, and reason for using different presentation currency (if any)
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18. 5. Example Recognition of exchange difference in equity
Property purchased at GBP300k when exchange rate is GBP1 = HK$12
Dr. PPE HK$3,600k
Cr. Bank HK$3,600k
One year later, the property revaluated to GBP 330k, exchange rate is GBP1 = HK$13
Dr. PPE HK$360k
Cr. Revaluation reserve HK$360k
Dr. PPE (330k *(13-12)) HK$330k
Cr. Revaluation reserve HK$330k
(exchange difference booked in equity, if the item is recognized directly in equity)
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19. 5. Example Part of net investment
UK Holding co lent GBP100 to a HK subsidiary at rate HK$1 = GBP12
(i.e. HK subsidiary’s AP is HK$1,200)
At year end, the rate is HK$1 = GBP13
⇒ At company level, HK subsidiary need to revaluate its AP
Dr. P/L – exchange loss HK$100
Cr. AP HK$100
At consolidation , the exchange difference will reclassify to exchange reserve:
Dr. Exchange reserve [$100/13] GBP7.69
Cr. P/L – echange loss GBP7.69
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20. 5. Translating foreign subsidiaries
Sales – third parties Avg rate
Sales – interco Historical rate
COS Avg rate
Interco expense Historical rate
Other expense Avg rate
Dividend – inter co Historical rate
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21. 5. Translating foreign subsidiaries
Non Monetary Assets
PPE, Stock Closing rate
Monetary Assets / Liabilities
AR, Cash, AP, Loan Closing rate
Shareholders fund
Share capital Pre-acq rate (Historical)
Pre-acq reserve Pre-acq rate (Historical)
Current year profit (per calculation: avg & historical)
Translation reserve (Balancing figure)
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22. THE END
This presentation only covers the basic items in HKAS 21. You are recommended to attend the training courses organised by the HKICPA.
(c) Morison Heng 2008