IAS 21 refers to International Accounting Standard 21 –

 The Effects of Changes in Foreign Exchange Rates. This standard prescribes how to:  Include foreign currency transactions and operations in the financial statements of an entity.  Translate financial statements into a presentation currency.

🔑 Key Objectives of IAS 21

IAS 21 deals with:

  1. Functional Currency:

    • The currency of the primary economic environment in which the entity operates.

    • All transactions are initially recorded in the functional currency.

  2. Foreign Currency Transactions:
    These are transactions denominated in a currency other than the entity’s functional currency, such as:

    • Sales/purchases of goods or services

    • Loans or borrowings in foreign currencies

    • Foreign investments

  3. Translation at Initial Recognition:

    • A foreign currency transaction is recorded at the spot exchange rate on the transaction date.

  4. Subsequent Measurement:

    • Monetary items (e.g., cash, receivables, payables) ➜ Re-translated at the closing rate.

    • Non-monetary items (e.g., fixed assets, inventory) ➜ Use the historical rate or rate at transaction, depending on whether they are measured at cost or fair value.

  5. Exchange Differences:

    • Recognized in profit or loss, unless arising on a net investment in a foreign operation (then reported in Other Comprehensive Income).

  6. Translation of Financial Statements (for foreign operations):

    • Assets and liabilities ➜ Closing rate

    • Income and expenses ➜ Exchange rates at the transaction dates (or an average rate if it approximates actual)

    • Exchange differences ➜ Recorded in Other Comprehensive Income (OCI) as a component of equity.



🧾 Example

Let’s say a company based in the UAE (AED as functional currency) purchases equipment from the US for USD 10,000 on June 1, 2025:

  • On June 1: 1 USD = 3.67 AED ➜ Record equipment at AED 36,700.

  • If unpaid at year-end, and exchange rate changes to 1 USD = 3.75 AED:

    • Liability increases to AED 37,500.

    • AED 800 (37,500 – 36,700) ➜ Exchange loss recorded in the income statement.

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