IAS 21 foreign currency accounting explained

What IAS 21 is

IAS 21 The Effects of Changes in Foreign Exchange Rates is the IFRS standard that sets how an entity records transactions in other currencies and how it translates the financial statements of foreign operations into the currency it reports in. It matters because it decides which exchange differences hit profit, which go to equity, and which balances are never retranslated at all.

IAS 21 answers three questions in order. What is the entity's functional currency? How are transactions in other currencies recorded in that currency, both when they happen and at each reporting date? And how are results and financial position translated into a different presentation currency, for example when a group consolidates a subsidiary abroad? Two amendments are recent: Lack of Exchangeability, effective from 1 January 2025, and Translation to a Hyperinflationary Presentation Currency, issued in November 2025 and effective from 1 January 2027.

Functional currency: a fact, not a choice

The functional currency is the currency of the primary economic environment in which the entity operates, normally the one in which it mainly generates and spends cash. It is determined by looking at the facts, and management cannot simply choose it. IAS 21 lists indicators in order of weight:

• Primary: the currency that mainly influences sales prices, often the currency in which prices are set and settled.
• Primary: the currency of the country whose competitive forces and regulations mainly determine the sales prices.
• Primary: the currency that mainly influences labour, material and other costs.
• Secondary: the currency in which financing is raised, and the currency in which receipts from operations are usually retained.
• For a foreign operation, also: whether it acts with significant autonomy or as an extension of the parent, how much of its activity is with the parent, whether its cash flows directly affect the parent's, and whether it can service its own debts.
• Gulf pegs: the Saudi riyal is pegged at SAR 3.75 and the UAE dirham at AED 3.6725 to the US dollar. The peg keeps exchange differences on dollar balances negligible while it holds, but it does not make the dollar the functional currency; the indicators still decide.

Functional currency versus presentation currency

The presentation currency is the currency in which financial statements are presented, and IFRS lets an entity choose it freely. A Dutch subsidiary of a Canadian group keeps its books in euros because the euro is its functional currency, while the group presents its consolidated statements in Canadian dollars. A company may also present in a second currency for investors, for example a UAE company presenting in US dollars.

The distinction matters because the two use different mechanics. Converting transactions into the functional currency uses the rules for foreign currency transactions, with most differences in profit or loss. Converting functional-currency statements into a presentation currency is translation, with the differences in other comprehensive income. Mixing the two is one of the most common IAS 21 errors, for example putting translation differences of a subsidiary through profit or loss, or retranslating a parent's non-monetary assets at the closing rate.

Recording transactions in a foreign currency

A foreign currency transaction is initially recorded in the functional currency at the spot exchange rate on the transaction date, the date the transaction first qualifies for recognition. For practical reasons a rate that approximates the actual rate, such as an average for a week or a month, may be used for all transactions in that period, provided rates do not fluctuate significantly. A written policy naming the rate source, for example a central bank reference rate, and the time of day keeps this consistent and auditable.

Advance payments have their own rule. IFRIC 22 says the date of the transaction, for the purpose of the exchange rate, is the date the entity first recognises the non-monetary asset or liability arising from the advance. If a customer pays a deposit in euros, the contract liability is recorded at that day's rate and is never retranslated; when the goods are delivered, the revenue is recognised at the rate of the advance date for the part already paid, not the delivery-date rate.

Monetary and non-monetary items

At each reporting date, monetary items in a foreign currency are retranslated at the closing rate. Non-monetary items measured at historical cost stay at the rate on the transaction date, and non-monetary items measured at fair value use the rate at the date fair value was measured. The essential feature of a monetary item is a right to receive, or an obligation to deliver, a fixed or determinable number of units of currency.

• Monetary: cash and bank balances, trade receivables and payables, loans given and received, lease liabilities, accrued expenses, and provisions and employee benefits settled in cash.
• Non-monetary: inventory, property, plant and equipment, right-of-use assets, intangible assets and goodwill, prepaid expenses, and advances paid to suppliers for goods or services.
• Also non-monetary: contract liabilities and customer deposits that will be settled by delivering goods or services, and investments in equity instruments.
• Tests for borderline items: a deposit that will be refunded in cash is monetary; a deposit that will be applied to future deliveries is non-monetary.

Worked example: transactions through a year end

Lakeshore Instruments Inc. of Toronto has the Canadian dollar as its functional currency and a 31 December year end. Rates are quoted as the Canadian dollar price of one unit of foreign currency, sales tax is left out, and every entry below is in Canadian dollars.

• 20 November: buys inventory for USD 50,000 on credit at 1.38. Dr Inventory 69,000 / Cr Trade payables 69,000.
• 1 December: a German customer pays a EUR 10,000 advance for goods to be delivered in January, at 1.59. Dr Bank 15,900 / Cr Contract liability 15,900.
• 5 December: sells goods for EUR 40,000 on credit at 1.60. Dr Trade receivables 64,000 / Cr Revenue 64,000.
• 31 December, the payable is retranslated at the closing rate of 1.40 to 70,000: Dr Foreign exchange loss 1,000 / Cr Trade payables 1,000.
• 31 December, the receivable is retranslated at 1.62 to 64,800: Dr Trade receivables 800 / Cr Foreign exchange gain 800.
• 25 January: pays the USD 50,000 at 1.37, costing 68,500. Dr Trade payables 70,000 / Cr Bank 68,500 / Cr Foreign exchange gain 1,500.
• January delivery against the advance: Dr Contract liability 15,900 / Cr Revenue 15,900, at the advance-date rate under IFRIC 22.
• Result: a net loss of 200 in 2026 profit or loss (1,000 loss on the payable, 800 gain on the receivable). No entry is made for the inventory (69,000) or the advance (15,900), because both are non-monetary. Over its life the purchase cost 68,500 in cash against 69,000 booked to inventory, a net gain of 500 split across two years.

Realised and unrealised differences, and where they go

IAS 21 does not distinguish realised from unrealised differences: both go to profit or loss in the period they arise. The distinction is still useful in management reporting and often in tax, where some jurisdictions tax only realised gains. An unrealised difference arises from retranslating an open balance at a reporting date; a realised difference arises on settlement and is measured against the balance's last carrying amount, not its original amount, which is why Lakeshore's January gain is 1,500 and not 500.

From 2027 IFRS 18 decides where the differences sit in the income statement: in the same category as the income and expenses from the items that gave rise to them. Differences on trade receivables and payables therefore fall in the operating category, and differences on a bank loan in the financing category. A single foreign exchange account in the chart of accounts can no longer serve both, as our guide on IFRS 18 presentation and disclosure explains. Month-end discipline for foreign currency usually covers:

• A rate table loaded from the policy source for each month end.
• Retranslation of every open foreign-currency receivable, payable, loan and bank balance, with the calculation kept as evidence.
• Reconciliation of each foreign-currency bank account in its own currency before translation, as in our guide on bank reconciliation.
• A check that no non-monetary balance was retranslated by mistake.

Translating a foreign operation

When a subsidiary, branch, associate or joint arrangement has a functional currency different from the group's presentation currency, its statements are translated. Assets and liabilities, including goodwill and fair value adjustments from the acquisition, are translated at the closing rate. Income and expenses are translated at the rates on the transaction dates, for which an average rate for the period is usually an acceptable approximation. Equity items are kept at historical rates. All resulting differences go to other comprehensive income and accumulate in a separate component of equity, often called the translation reserve.

A monetary item receivable from or payable to a foreign operation, whose settlement is neither planned nor likely in the foreseeable future, forms part of the net investment in that operation. Its exchange differences go to profit or loss in the separate statements of the lender or borrower, but to other comprehensive income in the consolidated statements. On disposal of the foreign operation, the cumulative translation reserve relating to it is reclassified from equity to profit or loss as part of the gain or loss on disposal.

Worked example: translating an Irish subsidiary

Lakeshore sets up a subsidiary in Ireland on 1 January 2026 with share capital of EUR 100,000, when EUR 1 = CAD 1.50. The subsidiary's functional currency is the euro. In 2026 it earns revenue of EUR 200,000 and incurs expenses of EUR 180,000, a profit of 20,000, and pays no dividend. The average rate for the year is 1.55 and the closing rate 1.60. At 31 December its net assets are EUR 120,000: property, plant and equipment 80,000, receivables 50,000 and cash 30,000, less payables 40,000.

• Income statement at the average rate: revenue 200,000 x 1.55 = CAD 310,000, expenses 180,000 x 1.55 = 279,000, profit 31,000.
• Balance sheet at the closing rate: 128,000 + 80,000 + 48,000 - 64,000 = CAD 192,000 of net assets.
• Equity at historical rates: share capital 100,000 x 1.50 = 150,000, plus retained earnings 31,000 = 181,000.
• Translation difference: 192,000 - 181,000 = CAD 11,000 credit to other comprehensive income.
• Proof: opening net assets 100,000 x (1.60 - 1.50) = 10,000, plus profit 20,000 x (1.60 - 1.55) = 1,000, total 11,000.
• If the subsidiary is sold later, the accumulated 11,000 (plus later movements) is reclassified to profit or loss as part of the disposal gain or loss.

Hyperinflation and currencies that cannot be exchanged

If a functional currency is hyperinflationary, IAS 29 requires the entity's statements to be restated in terms of the measuring unit current at the reporting date before translation, and all amounts are then translated at the closing rate, with special rules for comparatives when the presentation currency is not hyperinflationary. Hyperinflation is judged on indicators, such as cumulative inflation over three years approaching or exceeding 100 percent. The amendments issued in November 2025, effective from 1 January 2027, add requirements for translating from a non-hyperinflationary functional currency into a hyperinflationary presentation currency.

The Lack of Exchangeability amendments, effective since 1 January 2025, deal with currencies that cannot be exchanged, for example because of capital controls. A currency is exchangeable when the entity can obtain more than an insignificant amount of the other currency within a normal administrative delay through a market or mechanism that creates enforceable rights. When it cannot, the entity estimates the spot rate that an orderly transaction between market participants would use, and discloses how it estimated the rate and the risks to which it is exposed.

Doing this in Skyline Nexus ERP

Skyline Nexus ERP records foreign-currency sales and purchases on a single base-currency ledger. With Enable Multi-Currency switched on in the Exchange Rates Center under Business Settings, a sale can carry an Invoice Currency and an exchange rate, and a purchase can be made in another currency with its Currency Exchange Rate. Documents are stored and posted in the base currency at the rate entered, which gives the transaction-date recording IAS 21 requires, and the invoice shows the foreign-currency equivalents. Rates are entered manually, and Fiscal Authority > Exchange Rates keeps the rate table with a Variance Report. Treasury bank accounts can carry their own currency. Our guide on foreign-currency invoicing in Skyline Nexus ERP walks through these screens step by step.

Month-end retranslation and settlement differences are recorded as journals. At each month end, retranslate open foreign-currency receivables, payables and bank balances in a working paper and post the differences through Fiscal Authority > Journal Entries > New Journal Entry, using separate exchange difference accounts for trade balances and borrowings; record the realised difference on each settlement the same way. For groups, Fiscal Authority > Consolidation snapshots each member business's trial balance translated to the group's base currency, so a foreign operation with its own functional currency is set up as its own business on the platform and brought in through consolidation.

Related guides

Currency touches revenue, receivables, presentation and tax. These guides continue from here.

• What is IFRS: the framework, who must use it and a map of the standards.
• IFRS 9 expected credit losses: measuring the allowance on foreign-currency receivables.
• IFRS 15 revenue recognition: advances, contract liabilities and when revenue is recognised.
• IFRS 18 presentation and disclosure: which category each exchange difference belongs in.
• Bank reconciliation step by step: reconciling each currency account before translation.
• Consolidation accounting and intercompany accounting: eliminating group balances around the translation step.
• Month-end close checklist: where retranslation fits in the close routine.