Ind AS 21

What is Ind AS 21? Understanding the Effects of Changes in Foreign Exchange Rates

Ind AS 21, formally known as “The Effects of Changes in Foreign Exchange Rates,” is an Indian Accounting Standard that prescribes how entities should account for foreign currency transactions and operations in their financial statements. It is a converged standard, meaning it is largely aligned with International Accounting Standard (IAS) 21 issued by the International Accounting Standards Board (IASB). The primary objective of Ind AS 21 is to ensure that an entity’s financial statements reflect the financial position and performance as if all transactions and foreign operations were denominated in the entity’s functional currency, while also providing users with information about the impact of changes in exchange rates.

The Journey to Ind AS 21: A Global Standard in Indian Context

The adoption of Ind AS 21 is part of India’s broader initiative to converge with International Financial Reporting Standards (IFRS), aiming to enhance the comparability and transparency of financial reporting across the globe. The Ministry of Corporate Affairs (MCA) in India notified the Ind AS framework, making it mandatory for certain classes of companies in a phased manner starting from April 1, 2016. Before this, Indian companies followed Accounting Standard (AS) 11, “The Effects of Changes in Foreign Exchange Rates,” which had some significant differences from IFRS/Ind AS 21. The transition to Ind AS 21 brought Indian companies closer to international best practices, ensuring that their financial statements are more understandable and comparable to those prepared under IFRS in other jurisdictions.

Navigating Foreign Exchange: A Deep Dive into Ind AS 21 Principles

Ind AS 21 provides comprehensive guidance on:

• How to incorporate foreign currency transactions into the financial statements.
• How to translate the financial statements of foreign operations into the entity’s presentation currency.

Key Definitions Central to Ind AS 21

• Functional Currency: This is the currency of the primary economic environment in which an entity operates. It’s the currency that primarily influences sales prices, and costs of goods sold, and in which funds are generated and expended. Determining the functional currency is a critical first step as it dictates how foreign currency items are treated.
• Presentation Currency: This is the currency in which an entity’s financial statements are presented. It might or might not be the same as the functional currency.
• Foreign Currency: Any currency other than the functional currency of an entity.
• Exchange Difference: The difference resulting from translating a given number of units of one currency into another currency at different exchange rates.

Initial Recognition of Foreign Currency Transactions

A foreign currency transaction (e.g., purchasing or selling goods or services whose price is denominated in a foreign currency, borrowing or lending in foreign currency) should be recorded, on initial recognition, in the functional currency by applying the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.

Subsequent Measurement at Reporting Date

At each reporting date, Ind AS 21 requires specific treatment for foreign currency monetary and non-monetary items:

• Monetary Items: These are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency (e.g., trade receivables, trade payables, bank balances, loans). Monetary items denominated in a foreign currency must be translated using the closing rate (spot rate at the reporting date).
• Non-Monetary Items Measured at Historical Cost: These items (e.g., property, plant, and equipment, inventories) that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction (historical rate). They are not retranslated at the closing rate.
• Non-Monetary Items Measured at Fair Value: Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined.

Recognition of Exchange Differences

• Monetary Items: Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were initially recognized are generally recognized in profit or loss in the period in which they arise.
• Non-Monetary Items: If a gain or loss on a non-monetary item is recognized directly in Other Comprehensive Income (OCI) (e.g., revaluation surplus on property, plant, and equipment or fair value gains/losses on equity instruments designated at FVTOCI), any exchange component of that gain or loss is also recognized in OCI. Conversely, if the gain or loss is recognized in profit or loss, the exchange component is also recognized in profit or loss.

Translation of Financial Statements of Foreign Operations

Ind AS 21 distinguishes between two types of foreign operations:

• Integral Foreign Operation: This is not a distinct business unit but rather an extension of the reporting entity’s operations. Its transactions are treated as if they were the reporting entity’s own, and individual foreign currency items are translated as per the principles for foreign currency transactions.
• Non-Integral Foreign Operation (often referred to simply as a ‘foreign operation’ in Ind AS 21): This is a distinct business with its own financial and operating autonomy. When translating its financial statements for consolidation or equity accounting purposes, the following rules apply:
  • Assets and liabilities (including goodwill and fair value adjustments arising on acquisition) are translated at the closing rate.
  • Income and expenses are translated at exchange rates at the dates of the transactions (often, for practical reasons, an average rate for the period is used, provided exchange rates do not fluctuate significantly).
  • All resulting exchange differences are recognized in OCI and accumulated in a separate component of equity (Foreign Currency Translation Reserve – FCTR). These differences are recycled (reclassified) to profit or loss only on the disposal or partial disposal of the foreign operation.

Key Disclosures

Entities must disclose the amount of exchange differences recognized in profit or loss and in OCI, a reconciliation of the foreign currency translation reserve, the functional currency, and the reasons for any change in the functional currency.

The Critical Role of Ind AS 21 in Financial Reporting and Decision-Making

Ind AS 21 is crucial for businesses operating internationally because it ensures that their financial performance and position are accurately represented, irrespective of currency fluctuations. Failure to apply Ind AS 21 correctly can lead to misstated financial statements, impacting profitability, asset valuations, and ultimately, investor confidence. For stakeholders, understanding Ind AS 21 helps in interpreting financial results, especially for companies with significant global footprints, by providing clarity on how foreign exchange movements have impacted reported figures. It’s vital for assessing a company’s true economic performance and risk exposure.

Real-World Scenarios: Where Ind AS 21 Comes into Play

• Import/Export Businesses: Companies buying or selling goods internationally, where invoices are denominated in a foreign currency, need to apply Ind AS 21 to recognize payables/receivables and subsequent exchange differences.
• Multinational Corporations (MNCs): Parent companies with foreign subsidiaries must translate the financial statements of these subsidiaries into their own presentation currency for consolidation, applying the specific rules for foreign operations.
• Borrowing/Lending in Foreign Currencies: Entities that take foreign currency loans or provide foreign currency advances must account for the principal and interest repayments as per Ind AS 21.
• Foreign Currency Bank Accounts: Holding funds in foreign currency bank accounts necessitates retranslation at each reporting date.
• Foreign Direct Investments (FDI): When an Indian company invests in a foreign entity or a foreign company invests in India, Ind AS 21 rules are paramount for the investor’s financial reporting.

Connected Concepts: Understanding the Broader Financial Reporting Landscape

Ind AS 21 does not operate in isolation; it interacts with several other accounting standards:

• Ind AS 1 (Presentation of Financial Statements): Governs the overall structure and content of financial statements, including the presentation of OCI where foreign currency translation differences are initially recognized.
• Ind AS 109 (Financial Instruments): Deals with the recognition, measurement, and derecognition of financial assets and liabilities. This is particularly relevant when entities use hedging instruments to manage foreign currency risk, as Ind AS 109 dictates the accounting for such hedges.
• Ind AS 10 (Events After the Reporting Period): Relevant if significant foreign exchange rate changes occur between the reporting date and the date the financial statements are authorized for issue.
• IFRS / US GAAP: While Ind AS 21 is converged with IAS 21, understanding the nuances and differences with other major frameworks like US Generally Accepted Accounting Principles (US GAAP) is crucial for companies that report under multiple frameworks.

Staying Current: Recent Developments and Interpretations

While the core principles of Ind AS 21 have remained stable, accounting standards bodies continuously monitor their application. Interpretations by the IFRS Interpretations Committee (IFRIC) or the Ind AS Transition Facilitation Group (ITFG) in India can clarify complex situations, such as accounting in highly inflationary economies or specific application issues related to functional currency determination. Staying updated on these interpretations is essential for accurate application.

Who Needs to Know? Impact Across Business Functions

• Finance & Accounting Department: This is the primary custodian of Ind AS 21, responsible for its accurate application in financial reporting, consolidation, and disclosures.
• Treasury Department: Directly involved in managing foreign currency exposures, hedging strategies, and understanding the accounting impact of these activities as per Ind AS 21 and Ind AS 109.
• Tax Department: Foreign exchange gains and losses can have significant tax implications, requiring close coordination with accounting to ensure compliance and optimize tax positions.
• Strategic Planning & Mergers & Acquisitions (M&A): When evaluating foreign acquisitions or divestitures, understanding how Ind AS 21 will impact the valuation and post-acquisition financial reporting is critical.
• Senior Management & Investors: Key decision-makers need to understand the impact of foreign exchange volatility on reported financial performance to make informed strategic and investment decisions.

Looking Ahead: The Evolution of Foreign Currency Accounting

While Ind AS 21 is a well-established standard, the global economic landscape is ever-changing. Future trends might include increased scrutiny on functional currency determination in complex global structures, especially with the rise of digital and decentralized currencies. There might also be a continued emphasis on clearer disclosures regarding foreign exchange risk management. As technology advances, new tools and automation could streamline the application of Ind AS 21, making compliance more efficient for businesses with extensive international operations.