This helpsheet has been issued by ICAEW’s Technical Advisory Service to help members understand foreign currency translation under FRS 102.

Members may also wish to refer to the following related helpsheets:

• Can accounts be prepared and filed at Companies House in a foreign currency?
• Hedge accounting under FRS 102

Functional currency

The glossary to FRS 102 defines the functional currency as ‘the currency of the primary economic environment in which the entity operates’ and is normally the one in which it primarily generates and expends cash. Further consideration of identifying the functional currency is provided within paragraphs 30.3 to 30.4 of FRS 102.

The functional currency of an entity is a matter of fact, rather than a matter of choice, and it is important to consider the facts and circumstances of a particular entity or operation when determining the functional currency. The functional currency of an entity will only change when there is a change in the primary economic environment in which it operates. If the functional currency changes, such a change is accounted for prospectively from the date of the change in accordance with paragraph 30.14.

In assessing the functional currency of a foreign operation (i.e. a foreign subsidiary, associate, joint venture or branch), FRS 102 paragraph 30.5 requires consideration of whether the activities of that foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy. For example, a foreign subsidiary that only sells goods imported from the parent and remits the proceeds back to the parent is likely to be acting as an extension of the parent and its functional currency may therefore be considered to be the same as the parent.

Presentation currency

Presentation currency is defined in the glossary to FRS 102 as ‘the currency in which the financial statements are presented’. The presentation currency does not need to be the same as the functional currency and is a free choice of the entity. Members may wish to refer to the helpsheet Can accounts be prepared and filed at Companies House in a foreign currency?.

If the presentation currency differs from the functional currency, it is necessary to translate its financial statements into the presentation currency.

The presentation currency of an entity or group is an accounting policy choice. Any change in presentation currency is, therefore, a change in accounting policy and is adjusted retrospectively in accordance with Section 10 of FRS 102.

FRS 102 30.7 requires all foreign currency transactions to be translated at the spot exchange rate between the foreign currency and the functional currency at the date of the transaction.

For practical reasons, the standard does allow a rate that approximates the actual rate at the date of the transaction to be used, for example an average rate for a week or a month might be used for all transactions in each foreign currency occurring during that period. However, if exchange rates fluctuate significantly in a given period, or if a particularly material transaction takes place at a particular point in time, the use of the average rate may not be considered appropriate.

The requirements for translating foreign currency balances into the functional currency are dependent on whether such balances are monetary items or not. The glossary of FRS 102 defines monetary items as ‘units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency’.

Monetary items would include usually include cash, bank balances, loan balances, accrued expenses, trade payables, tax payables, trade receivables, accrued income and deferred tax balances.

Examples of non-monetary items would include property, plant and equipment, intangible assets, goodwill, equity balances, prepayments, inventories and deferred income.

Foreign currency denominated monetary balances

FRS 102 paragraph 30.9(a) requires all foreign currency denominated monetary items in the balance sheet to be translated at the closing rate at the year-end. FRS 102 paragraph 30.10 requires any such foreign exchange differences to be recognised in profit or loss in the period in which they arise.

Non-monetary items measured in terms of historical cost

FRS 102 paragraph 30.9(b) requires non-monetary items that are measured at historic cost in a foreign currency to be translated at the exchange rate at the date of the transaction and are not subsequently retranslated. For example, fixed assets and inventories are non-monetary items and once translated and included in the balance sheet, cannot be subsequently retranslated (unless designated as hedged items in a fair value hedging relationship under Section 12 of FRS 102 – see Hedge accounting options under FRS 102).

Non-monetary items that are measured at fair value

FRS 102 paragraph 30.9(c) requires non-monetary items that are measured at fair value in a foreign currency to be translated at the exchange rate ruling at the date when fair value was determined. Any gain or loss is treated in the same way as the movement in fair value. For example, foreign exchange differences arising on a foreign investment property accounted for at fair value through profit or loss would also be recorded in profit or loss.

FRS 102 paragraphs 30.17 to 30.23 set out the requirements for translation from the functional currency into the presentation currency. Broadly, an entity translates the results and financial position into the presentation currency using the procedures set out in paragraph 30.18 as follows (the same procedure applies whether an entity is translating its own results and financial position into a different presentation currency or where an overseas subsidiary with a different functional currency for example is being translated for the consolidated accounts):

• Assets and liabilities for each statement of financial position presented (i.e. including comparatives) shall be translated at the closing rate at the date of that statement of financial position.
• Income and expenses for each statement of comprehensive income (i.e. including comparatives) shall be translated at exchange rates at the dates of the transactions.
• All resulting exchange differences shall be recognised in other comprehensive income.

Again, for practical reasons, where the income and expenses are translated at the date of the transactions, a rate that approximates the actual rate at the date of the transaction is often used unless exchange rates fluctuate significantly (FRS 102 paragraph 30.19).

The exchange differences recognised in other comprehensive income are not required to be separated into a separate reserve, however many entities choose to present a translation reserve or a foreign exchange reserve.

Foreign currency loan and a forward exchange contract

Use of a forward contract rate to translate a foreign currency loan (often referred to as ‘synthetic hedging’) was permitted by SSAP 20 under old UK GAAP. However, this is not permitted under FRS 102. Instead, the foreign currency loan must be translated at the year-end at the closing foreign exchange rate, and any forward exchange contracts must be recognised on the balance sheet and accounted for at fair value through profit or loss.

A full numerical example can be found in the FRC’s Staff Education Note 11 – Foreign exchange contracts.

Section 12 of FRS 102 contains specific requirements for the use of hedge accounting and, depending on the facts and circumstances, it may be possible to treat a forward foreign exchange contract as a fair value or cash flow hedge of a foreign currency loan (see Hedge accounting under FRS 102 for more information).

Net investment in foreign operation

Where an entity has made a long-term foreign currency denominated loan to a subsidiary, this may be presented in the accounts as a fixed asset investment. It is, however, still a foreign currency denominated monetary item and should therefore be translated into the functional currency using the closing rate.

FRS 102 does, however, include the concept of ‘monetary items that form part of the net investment in a foreign operation’ (FRS 102 paragraphs 30.12 and 30.13), for which settlement is neither planned nor likely to occur in the foreseeable future. This is likely to include long-term loans (but not trade debtors for example) where the intention of the investor is not to require repayment in the near future and where the loan is considered to be, in substance, part of the investment in the foreign operation.

For such items, the accounting depends on whether individual or consolidated accounts are being prepared. In individual accounts, the accounting is the same as described above, i.e. the balance is retranslated at the closing rate and any foreign exchange differences are recognised in profit or loss. In the consolidated accounts prepared by the investor, foreign exchange differences are instead included in other comprehensive income and accumulated in equity. They are never recycled to the profit and loss account.

ICAEW members, affiliates, ICAEW students and staff in eligible firms with member firm access can discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or via webchat.