HKAS 21 The Effects of Changes in Foreign Exchange Rates
This Standard shall be applied:
in accounting for transactions and balances in foreign currencies, except for those derivative transactions and balances that are within the scope of HKAS 39 Financial Instruments: Recognition and Measurement;
in translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation or the equity method; and
in translating an entity’s results and financial position into a presentation currency. (HKAS 21.3)
This Standard does not apply to hedge accounting for foreign currency items, including the hedging of a net investment in a foreign operation. HKAS 39 applies to hedge accounting. (HKAS 21.5)
This Standard does not apply to the presentation in a statement of cash flows of the cash flows arising from transactions in a foreign currency, or to the translation of cash flows of a foreign operation (see HKAS 7 Statement of Cash Flows). (HKAS 21.7)
The following terms are used in this Standard with the meanings specified:
Foreign operation is an entity that is a subsidiary, associate, joint arrangement or branch of a reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity.
Functional currency is the currency of the primary economic environment in which the entity operates.
Presentation currency is the currency in which the financial statements are presented.
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.
Net investment in a foreign operation is the amount of the reporting entity’s interest in the net assets of that operation. (HKAS 21.8)
Elaboration on the definitions
The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash. An entity considers the following factors in determining its functional currency:
that mainly influences sales prices for goods and services (this will often be the currency in which sales prices for its goods and services are denominated and settled); and
of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
the currency that mainly influences labour, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled). (HKAS 21.9)
The following factors may also provide evidence of an entity’s functional currency:
the currency in which funds from financing activities (ie issuing debt and equity instruments) are generated.
the currency in which receipts from operating activities are usually retained. (HKAS 21.10)
The following additional factors are considered in determining the functional currency of a foreign operation, and whether its functional currency is the same as that of the reporting entity (the reporting entity, in this context, being the entity that has the foreign operation as its subsidiary, branch, associate or joint arrangement):
whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy. An example of the former is when the foreign operation only sells goods imported from the reporting entity and remits the proceeds to it. An example of the latter is when the operation accumulates cash and other monetary items, incurs expenses, generates income and arranges borrowings, all substantially in its local currency.
whether transactions with the reporting entity are a high or a low proportion of the foreign operation’s activities.
whether cash flows from the activities of the foreign operation directly affect the cash flows of the reporting entity and are readily available for remittance to it.
whether cash flows from the activities of the foreign operation are sufficient to service existing and normally expected debt obligations without funds being made available by the reporting entity. (HKAS 21.11)
The Board also discussed whether a foreign operation that is integral to the reporting entity (as described in the previous version of IAS 21) could have a functional currency that is different from that of its ‘parent’. The Board decided that the functional currencies will always be the same, because it would be contradictory for an integral foreign operation that ‘carries on business as if it were an extension of the reporting enterprise’s operations’ to operate in a primary economic environment different from its parent. (HKAS 21.BC6)
When the above indicators are mixed and the functional currency is not obvious, management uses its judgement to determine the functional currency that most faithfully represents the economic effects of the underlying transactions, events and conditions. As part of this approach, management gives priority to the primary indicators in paragraph 9 before considering the indicators in paragraphs 10 and 11, which are designed to provide additional supporting evidence to determine an entity’s functional currency. (HKAS 21.12)
An entity’s functional currency reflects the underlying transactions, events and conditions that are relevant to it. Accordingly, once determined, the functional currency is not changed unless there is a change in those underlying transactions, events and conditions. (HKAS 21.13)
Net investment in a foreign operation
An entity may have a monetary item that is receivable from or payable to a foreign operation. An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, a part of the entity’s net investment in that foreign operation, and is accounted for in accordance with paragraphs 32 and 33. Such monetary items may include long-term receivables or loans. They do not include trade receivables or trade payables. (HKAS 21.15)
The entity that has a monetary item receivable from or payable to a foreign operation described in paragraph 15 may be any subsidiary of the group. For example, an entity has two subsidiaries, A and B. Subsidiary B is a foreign operation. Subsidiary A grants a loan to Subsidiary B. Subsidiary A’s loan receivable from Subsidiary B would be part of the entity’s net investment in Subsidiary B if settlement of the loan is neither planned nor likely to occur in the foreseeable future. This would also be true if Subsidiary A were itself a foreign operation. (HKAS 21.15A)
Summary of the approach required by this Standard
In preparing financial statements, each entity—whether a stand-alone entity, an entity with foreign operations (such as a parent) or a foreign operation (such as a subsidiary or branch)—determines its functional currency in accordance with paragraphs 9-14. The entity translates foreign currency items into its functional currency and reports the effects of such translation in accordance with paragraphs 20-37 and 50. (HKAS 21.17)
Reporting foreign currency transactions in the functional currency
A foreign currency transaction shall be recorded, on initial recognition in the functional currency, 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. (HKAS 21.21)
The date of a transaction is the date on which the transaction first qualifies for recognition in accordance with HKFRSs. For practical reasons, a rate that approximates the actual rate at the date of the transaction is often used, for example, an average rate for a week or a month might be used for all transactions in each foreign currency occurring during that period. However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate. (HKAS 21.22)
Reporting at the ends of subsequent reporting periods
At the end of each reporting period:
foreign currency monetary items shall be translated using the closing rate;
non-monetary items that are measured in terms of historical cost in a foreign currency shall be translated using the exchange rate at the date of the transaction; and
non-monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the date when the fair value was measured. (HKAS 21.23)