Remeasurement and translation are often discussed as if they were the same. Under IAS 21, however, there are two economically and accounting-distinct stages: accounting for foreign-currency transactions in the functional currency, then translating financial statements from the functional currency into another presentation currency.
Start with functional currency
Functional currency is the currency of the primary economic environment in which the entity operates. It is not a cosmetic choice and is not determined solely by legal domicile or group reporting currency. It must be determined first, and transactions are accounted for within it.
Stage one: foreign-currency transactions and balances
A company with SAR as functional currency holds USD cash or borrows in USD. USD is foreign currency to that entity. The item is initially recorded at the transaction-date rate, followed by the subsequent measurement requirements.
- Monetary items such as cash, receivables, payables, and loans: closing rate.
- Non-monetary items at historical cost: transaction-date rate.
- Non-monetary items at fair value: rate when fair value was measured.
Exchange differences on monetary items are generally recognized in profit or loss, subject to specific exceptions such as certain items forming part of a net investment in a foreign operation and hedge-accounting requirements.
Stage two: translation to presentation currency
Assume a UK subsidiary has GBP functional currency and correctly prepared GBP financial statements, while the group presents in USD. We do not remeasure each account as though it were a foreign transaction; we translate the financial statements into the presentation currency.
- Assets and liabilities: closing rate.
- Income and expenses: transaction-date rates; an average may be used when it is an appropriate approximation and rates have not fluctuated significantly.
- Resulting translation differences: other comprehensive income, accumulated in a separate equity component until the relevant disposal accounting applies.
Why is monetary versus non-monetary not the translation test?
Because the financial statements have already been measured in the functional currency. The objective is no longer to remeasure an item in the entity’s records, but to present a complete statement of financial position in another currency. Therefore, assets and liabilities are translated at closing rate in the normal non-hyperinflationary case.
An example showing both effects
If the UK entity has a USD loan, the USD/GBP movement first creates a foreign-exchange effect in its GBP functional-currency statements, generally in profit or loss. The complete GBP statements are then translated into USD for group presentation, producing a translation difference in OCI. Both effects can arise in the same period.