ACCT6010 · Financial Reporting For Business Groups
Foreign-Currency Translation
AASB 121 governs two distinct problems. First, foreign-currency transactions: a single entity that buys, sells or borrows in a currency other than its functional currency (the currency of its primary economic environment) records the transaction at the spot rate on the date, then at each reporting date retranslates monetary items (receivables, payables, loans) at the closing rate — with the exchange differences going to profit or loss — while non-monetary items stay at their historical rate. Second, translating a foreign operation into the group's presentation currency: under the current-rate method assets and liabilities are translated at the closing rate, income and expenses at average rates, and the resulting foreign currency translation reserve (FCTR) is taken to other comprehensive income, not profit. The exam tests the functional-currency hierarchy, an FX receivable across initial recognition, reporting date and settlement, and the FCTR movement on consolidating a foreign subsidiary.
What this chapter covers
- 01The three currencies (AASB 121.8) and why they differ
- 02Determining functional currency — the hierarchy
- 03Foreign-currency transactions: initial, reporting date, settlement
- 04Monetary vs non-monetary items and where exchange differences go
- 05Worked example — an EUR receivable across three dates
- 06Translating a foreign operation — current-rate method and the FCTR
Worked example: an FX receivable across reporting date and settlement
- +1Initial recognition at spot: €100,000 ÷ 0.60 = AUD 166,667; Dr Receivable 166,667, Cr Sales 166,667.
- +1Reporting date — retranslate the monetary item at the closing rate: €100,000 ÷ 0.625 = AUD 160,000.
- +1Exchange difference to profit or loss: 160,000 − 166,667 = a loss of AUD 6,667 (the receivable is now worth fewer AUD); Dr FX loss 6,667, Cr Receivable 6,667.
- +1Settlement after year end: €100,000 ÷ 0.50 = AUD 200,000 received; gain since reporting date = 200,000 − 160,000 = AUD 40,000.
- +1Where it goes: because a receivable is a monetary item, every exchange difference (the 6,667 loss, then the 40,000 gain) is recognised in profit or loss, not reserves.
Key terms
- Functional currency
- The currency of the primary economic environment in which an entity operates — the one that mainly determines its sales prices and costs. It is determined by a hierarchy of indicators, not chosen freely, and drives how every transaction is measured.
- Presentation currency
- The currency in which the financial statements are presented (here, AUD for an Australian group). It may differ from a foreign operation's functional currency, which is why that operation must be translated on consolidation.
- Monetary vs non-monetary items
- Monetary items (cash, receivables, payables, loans) are retranslated at the closing rate each reporting date, with exchange differences in profit or loss. Non-monetary items measured at historical cost stay at their historical rate and are not retranslated.
- Current-rate method
- The method for translating a foreign operation into the presentation currency: assets and liabilities at the closing rate, income and expenses at average rates, equity at historical rates, with the balancing difference in the FCTR.
- Foreign currency translation reserve (FCTR)
- The equity reserve that captures exchange differences on translating a foreign operation under the current-rate method. It is recognised in other comprehensive income, not profit, and recycled to profit only on disposal of the operation.
Foreign-Currency Translation FAQ
What is functional currency and why does it matter?
Functional currency is the currency of the primary economic environment in which an entity operates — broadly, the currency that mainly drives its selling prices and costs. It matters because it determines how every transaction is measured: items in any other currency are foreign-currency transactions that must be translated, and a foreign operation whose functional currency differs from the group's presentation currency must be translated on consolidation.
Which items are retranslated at the reporting date?
Only monetary items — cash, receivables, payables and loans — are retranslated at the closing rate at each reporting date, with the exchange difference recognised in profit or loss. Non-monetary items carried at historical cost (inventory, property, plant and equipment) stay at the rate on their original transaction date and are not retranslated.
Where do exchange differences go — profit or reserves?
It depends on the item. Exchange differences on a single entity's foreign-currency monetary items go to profit or loss. The exchange differences that arise from translating a whole foreign operation under the current-rate method go to other comprehensive income and accumulate in the foreign currency translation reserve, only reaching profit when the operation is disposed of.
How does the current-rate method translate a foreign subsidiary?
Assets and liabilities are translated at the closing rate, income and expenses at average rates for the period, and equity at historical rates. Because these rates differ, the translated statements don't balance exactly — the balancing figure is the foreign currency translation reserve, taken to other comprehensive income, which preserves the net investment's exposure to currency movements outside profit or loss.
Exam move
Split the topic in two and keep them separate. For transactions: fix the functional currency from the hierarchy, record at spot, then at each reporting date retranslate only the monetary items at the closing rate with the difference to profit or loss; rehearse an FX receivable across initial recognition, reporting date and settlement, watching the quote direction. For translating a foreign operation: memorise the current-rate recipe — assets and liabilities at closing, income and expenses at average, equity at historical — and remember the balancing FCTR goes to other comprehensive income, not profit. The single most common slip is sending a translation difference to profit instead of the FCTR (or vice versa).
