Chapter 22: Foreign Currency

Perspective and Issues

In recent years globalization seems to have become the watchword. Corporations worldwide are reaching beyond national boundaries and engaging in international trade. Global economic restructuring is rampant: signings of trade pacts such as GATT, NAFTA, and the World Trade Organization (WTO) have lent further impetus to the process of internationalization. International activity by most domestic corporations has increased significantly, which means that transactions are consummated not only with independent foreign entities but also with foreign subsidiaries.

Foreign subsidiaries, associates, and branches typically handle their accounts and prepare financial statements in the respective currencies of the countries in which they are located. Thus, it is more than likely that a multinational company (MNC) ends up receiving, at year-end, financial statements from various foreign subsidiaries expressed in a number of foreign currencies, such as francs, pounds, lira, dinars, dirhams, riyals, and yen. However, for users of these financial statements to analyze the MNC's foreign involvement properly, these foreign currency denominated financial statements must first be expressed in terms that the users can understand. This means that the foreign currency financial statements of the various subsidiaries will have to be translated into the currency of the country where the MNC is registered.

The international accounting standards governing the translation of foreign currency financial statements and foreign currency transactions are found primarily in IAS 21, The Effects of Changes in Foreign Exchange Rates. IAS 21 applies to

1. Accounting for foreign currency transactions (e.g., exports, imports, and loans) which are denominated in other than an enterprise's functional currency

2. Translation of foreign currency financial statements of branches, divisions, subsidiaries, and other investees that are incorporated in the financial statements of an enterprise by consolidation, proportionate consolidation, or by the equity method

IAS 21 did not address hedge accounting for foreign currency items, other than the classification of exchange differences arising from a foreign currency liability accounted for as a hedge of a net investment in a foreign entity. IAS 39 has established the accounting for hedges of a net investment in a foreign entity, which closely parallels that prescribed for cash flow hedging as set forth under this standard.

The IASB's Improvements Project has proposed several changes to IAS 21. These are discussed in this chapter.

Sources of IAS

IAS 21, 39

SIC 7, 11, 19, 30