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IAS21

Comprehensive Guide to IAS 21 – Effects of Changes in Forex Rates

In this blog, we discuss IAS 21 which deals with the effects of changes in foreign exchange rates, and it specifically focuses on its implications in the context of UAE.

 

There are so many companies in UAE that are engaging in transactions with foreign companies across various sectors like international trade, investment, partnership etc. For example, UAE companies import raw materials and goods from foreign suppliers and export consumable products to international markets. In such cases, the companies generate revenue in foreign currency regarding export. Here the relevance of IAS 21 comes!

 

Applicability of IAS 21

In generally the companies present their financial statements in the functional currency, which is the currency of the primary economic environment in which the country operates. In some cases, the companies present the financials other than the functional currency because the standard permits the entity to present the financials in any currency and they can select the presentation currency.

 

In the case of businesses in the UAE, which operate in a multi-currency environment, the understanding of appropriate exchange rates to use for reporting the financial statements is crucial, and they should translate such transactions into their functional currency/presentation currency to present the financial statements.

 

What is the importance of IAS 21?

IAS 21 stands for how to include foreign currency transactions and foreign currency operations in the financial statements of a company. To be clear, it outlines how entities should translate these transactions/operations to their functional currency. It ensures that the financial statements are accurate without any currency fluctuations.

 

What are the steps involved in foreign currency translation?

While translating the foreign currencies into functional currency, the following key aspects should be considered:

 

  • Determination of Functional currency: In UAE, there are so many entities which deal with multiple currencies depending on their international activities. The initial step of the reporting entity should be the determination of its functional currency, it is the currency of the primary economic environment in which the entity operates. The entity cannot change the functional currency unless there is a change in those underlying transactions, events and conditions.

 

  • Initial Translation: On initial recognition, a foreign currency transaction should be recorded in the functional currency. This amount is determined by converting the amount in foreign currency using the spot exchange rate in force at the date of each transaction.

 

  • Subsequent Translation: At the end of each reporting period, we shall translate all these foreign transactions according to their nature.
    1. Foreign currency monetary items must be translated using the closing rate. For example, items like cash or bank, receivables or payables in foreign currency etc.
    2. Non-monetary items that are measured in terms of historical cost continue to be translated using the spot exchange rate at the date of the transaction. For example, inventories, tangible assets etc.
    3. Non-monetary items carried at fair value should be reported at the rate that existed when the fair values were determined.

 

 

  • Recognition of differences:
    1. The exchange differences arising on the settlement of monetary items should be recognized as income or expenses in the period in which they arise.
    2. The unrealized exchange differences arising from the re-translation of monetary items at the end of the reporting period should be recognized as income or expenses.
    3. Exchange differences arising on monetary items that form part of the reporting entity’s net investment in a foreign operation are recognized, in the consolidated financial statements that include the foreign operation, in other comprehensive income; they will be recognized in profit or loss on disposal of the net-investment.

 

Translation of functional currency into presentation currency

The standard refers to foreign operations, via a subsidiary company, associated company, joint venture or branch, whose financial statements are consolidated with those of the parent company.

 

The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy are translated into a different presentation currency using the following procedures:

  • Assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet. This would include 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 are treated as part of the assets and liabilities of the foreign operation.
  • Income and expenses for each income statement are translated at exchange rates at the dates of the transactions.
  • All resulting exchange differences are recognized in other comprehensive income.

 

Example

Imagine, there is a UAE entity, and this entity operates in Dubai, so majority of its expenses are in AED (Arab Emirates Dirham), so its functional currency is AED. Let’s say there is UAE company sells goods to German customer, and as a result it has receivable in EURO which is currency in Germany. Then the UAE company needs to translate the amount of its receivables to its functional currency or AED.

 

Now, let’s say that is UAE entity is a subsidiary of American Parent company, and there for UAE company needs to provide financial reports to its parent. So, the company needs to translate all financial statements in AED to presentation currency which is US Dollar in this case. Of course, UAE company can present its financial statements in a different presentation currency too, when needed.

 

You can understand this through the following flow chart:

IAS21

 

Disclosure

The financial statements must disclose the following:

  • The exchange rates applied should be disclosed in the financials.
  • When there is a change in functional currency, the entity should apply the translation procedures prospectively from the date of the change.
  • An entity is required to disclose the fact that functional currency, either of reporting entity or of significant foreign operation, has changed during the period and the date of change in functional currency and reason thereof.
  • The amount of realized and unrealized exchange differences included in profit or loss for the reporting period.

 

Conclusion

Understanding and implementing IAS 21 ensures that UAE based companies uphold transparency and integrity in their financial reporting. By adhering to these international standards, businesses in the UAE can mitigate risks associated with currency fluctuations, maintain accurate financial reporting, and facilitate better decision-making for stakeholders.

 

Why Spectrum Auditing?

Why Spectrum Auditing?

Spectrum Auditing is a duly registered auditor authorized by the Ministry of Economy in the UAE. Furthermore, Spectrum holds accredited auditor status within multiple free zones and enjoys recognition as an approved auditor by prominent UAE banks. This solidifies Spectrum Auditing’s reputable standing in the industry.

 

Spectrum Auditing guides you with the laws and regulations of UAE, covering most compliances applicable as well as enable you deal with any queries pertaining to Risk Advisory, Economic Substance Regulations (ESR),  Corporate Tax (CT), Transfer Pricing (TP), Ultimate Beneficiary Owner (UBO), Anti Money Laundering (AML), etc., after reviewing your business. We specialize in conducting audits adhering to International Standards on Auditing (ISA), International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS).

 

Call us today for any kind of assistance at +971 4 2699329  or email [email protected] to get all your queries addressed. Spectrum is your partner in your success.

 



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