Recognition and measurement – Ind AS 21
Executive summary of recognition and measurement
Let us see the recognition and measurement of foreign currency transactions in the books of accounts.
First we need to understand what is meant by a foreign currency transaction.
Foreign currency transaction is a transaction in a currency other than the functional currency of the entity.
A foreign currency transaction is the one that is denominated in foreign currency that requires settlement in such foreign currency.
Let us look at the requirements for recognising a foreign currency transaction initially.
First, the foreign currency transaction is entered in separate books of accounts.
Then, the same is revalued by applying the spot rate to get the value in the functional currency of the entity.
In certain situations, average exchange rate may also be allowed, provided certain conditions are fulfilled.
Let us look at the requirements for subsequent measurement of such foreign currency transactions. Foreign currency transaction should be translated into functional currency.
For translating into functional currency, the rate at which the account balances should be converted into foreign currency is determined based on whether the item is a monetary item or a non-monetary item.
Monetary items are translated to the functional currency using the closing rate as on the reporting date.
For non-monetary items, the exchange rate to be used will depend upon the basis of measurement of such item.
If the basis is historical cost, then the account balance should be translated at the rate as on the date of transaction. However, if the basis of measurement is fair value, then the account balance should be translated into the functional currency at the rate as on the date on which the fair value is determined.
Foreign currency transactions
- Foreign currency transaction is one that is denominated in foreign currency or that requires settlement in foreign currency
- Goods and services paid or sold in foreign currency
- Acquisition or disposal of assets in foreign currency
- Liabilities settled or incurred in foreign currency
Nature of foreign currency transactions
- Foreign currency transactions may be entered into by an entity on a day to day basis
- Such transactions involve increase or decrease and the net assets of the entity
- As and when transactions are entered into, an entity must record those transactions in such foreign currency initially
- Foreign currency transactions are entered into in separate books of accounts denominated in such foreign currency
- The transactions recorded in foreign currency are then revalued by applying the spot exchange rate between the functional currency and the foreign currency at the date of transaction
- Sometimes it may not be practical to apply the actual rate at the date of transaction in order to convert such transactions into functional currency
- The standard allows, for practical reasons, to apply a rate that approximates the actual rate at the date of transaction e.g., an average rate for a week or for a month for all the transactions that occur during the specified period
- If the exchange rates fluctuate significantly, then the standard prohibits use of the average rate for such period, as it may not be appropriate
- The foreign currency transactions which are converted into the functional currency should be treated differently depending upon whether it is a monetary or non-monetary item and depending upon whether such item is carried out at hysterical cost or at fair value.
Measurement at subsequent periods
- Monetary items should be translated into functional currency using a closing rate as on the reporting date
- If it is non-monetary item having a measurement basis as historical cost, then the same should be translated into functional currency using the exchange rate on the date of the transaction. In other words, non-monetary items having historical cost as measurement basis do not undergo FX impacts on account of translation
- For non-monetary items having measurement basis of fair value, the exchange rate that should be used to translate would be the rate at the date on which the fair value was determined
Determination of the carrying amount
- The carrying amount is determined based on certain requirements mentioned in the accounting standards that are relevant for such item
- For example, Ind AS 16 permits the property, plant and machinery to be measured either at fair value basis or historical cost basis
- Irrespective of the basis of such determination of the carrying amount, if the amount is denominated in foreign currency, then the same should be translated into functional currency as per the requirements of Ind AS 21 only
Comparison of two items
- Carrying amount of certain items may be determined based on a comparison of two or more amounts
- For example, the carrying amount of inventory is determined as per the requirements of Ind AS 2. As per Ind AS 2, the carrying amount is lower of cost and net realisable value
- Similarly, the carrying amount of asset showing an indication of impairment is determined to be lower of its varying amount before considering possible impairment losses and its recoverable amount as per Ind AS 36
Carrying amounts and non-monetary items
- When an asset is non-monetary and is measured in a foreign currency, the carrying amount is determined by comparing
- the cost or carrying amount, as appropriate, translated at the exchange rate at the date when that amount was determined (i.e., the rate at the date of the transaction for an item measured in terms of historical cost); and
- the net realisable value or recoverable amount, as appropriate, translated at the exchange rate at the date when that value was determined (e.g. the closing rate at the end of the reporting period)
Effect of comparison
- The effect of comparison of the two rates as computed above may result in an impairment loss which occurs in the foreign currency not being recognised in the functional currency
- This is best illustrated with an example as shown in the next slide
- A foreign currency asset amounting to Euro 200,000 is recorded at the date of purchase when the exchange rate was Rs.52 at Rs.104 lacs
- The recoverable amount of the asset on the reporting date is calculated as Euro 175,000. The exchange rate on the date of valuation was Rs.60 to a Euro
- The carrying value of the foreign currency asset will be determined based on the recoverable amount of the asset converted into functional currency at the exchange rate on valuation date which is Rs.105 lacs
- The impairment loss of Euro 25,000 in foreign currency is not recognised.
Existence of several exchange rates
- When several exchange rates are available, the rate used for conversion purposes would be the rate at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measure date
- Whether the exchangeability between currencies does not exist temporarily, then the rate used is the first subsequent rate at which the exchanges could be made
Example: Foreign currency monetary item
An entity (functional currency INR) has an outstanding trade payable for A$2,500 which arose from a transaction when the spot exchange rate was 1A$ = Rs.45 and hence was initially recorded at INR 112,500. The closing rate is 1A$ = Rs.48.75. At what amount should the payable be recorded at the end of the reporting period?
Answer: Rs. 121,875. At the end of each reporting period, foreign currency monetary items are translated using the closing rate. The payable is therefore is A$ 2500 x Rs.48.75 = Rs.121,875 at the end of the reporting period
Non-Monetary item – historical cost
An entity (functional currency INR) purchased a machine for A$15,000 when the spot exchange rate was 1$ = Rs.58. The closing rate is 1$ = 64.25. At what amount should the machine be recorded at the end of the reporting period?
Answer: Rs. 870000. At the end of each reporting period, non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. The machine is shown as Rs.8,70,000 (Rs.58 x 15,000) at the end of the reporting period.
Non-Monetary item – Fair value
An entity (functional currency INR) owns a building. The entity carries buildings at their revalued amounts. The valuation of the building was done at the end of the reporting period and the fair value was Euro 150,000. The building was purchased for Euro 100,000 when the spot rate was 1 Rs = 53 . The closing rate is 1 Rs. = 68.
At what amount should the building be recorded at the end of the reporting period?
Answer: Rs. 102,00,000. At the end of each reporting period, non-monetary items that are measured at fair value in a foreign currency are translated using the exchange rates at the date when the value was determined. The building is shown as Rs.102,00,000 (=Euro 150,000 x Rs.68) at the end of the reporting period.