Last reviewed: August 2026.
IAS 21 The Effects of Changes in Foreign Exchange Rates explains how to record foreign-currency transactions in an entity’s functional currency and how to translate financial statements into a different presentation currency. The central questions are which exchange rate to use and where the resulting exchange difference belongs.
This practical guide focuses on individual purchases, sales, receivables and payables. It explains functional currency, monetary and non-monetary items, reporting-date retranslation, settlement gains and losses, journal entries, advance consideration, foreign-operation translation and the latest exchangeability amendments.
IAS 21 at a glance
| Stage | Rate and accounting |
|---|---|
| Initial recognition | Translate the foreign-currency amount using the spot rate at the transaction date. |
| Monetary item at reporting date | Retranslate using the closing rate; normally recognise the exchange difference in profit or loss. |
| Historical-cost non-monetary item | Keep the transaction-date rate; do not retranslate merely because the exchange rate changed. |
| Fair-value non-monetary item | Use the rate at the date when fair value was measured; recognise the exchange component where the underlying gain or loss is recognised. |
| Settlement | Compare the functional-currency cash paid or received with the carrying amount of the receivable or payable. |
The IFRS Foundation IAS 21 overview identifies functional currency, exchange rates and reporting of currency effects as the Standard’s core issues.
Functional currency, foreign currency and presentation currency
Functional currency is the currency of the primary economic environment in which the entity operates. A foreign currency is any currency other than that functional currency. Presentation currency is the currency in which financial statements are presented and may differ from functional currency.
Management gives greatest weight to the currencies that mainly influence sales prices and the labour, material and other costs of providing goods or services. Financing currency and the currency in which operating receipts are retained provide supporting evidence. Functional currency is not selected for convenience and changes only when the underlying transactions, events and conditions change.
What is a foreign-currency transaction?
A foreign-currency transaction is denominated in, or requires settlement in, a currency other than the entity’s functional currency. Common examples include importing inventory, exporting goods, borrowing funds, purchasing equipment, paying rent or professional fees, and receiving customer advances in another currency.
The transaction is initially recorded in functional currency using the spot exchange rate on the date it first qualifies for recognition. A weekly or monthly average may be a practical approximation when rates are stable, but an average is inappropriate when rates fluctuate significantly.
Monetary versus non-monetary items
| Item type | Examples | Reporting-date treatment |
|---|---|---|
| Monetary | Cash, trade receivables, trade payables, loans, cash-settled provisions and lease liabilities | Retranslate at the closing rate. |
| Non-monetary at historical cost | Inventory at cost, prepaid expenses, property and equipment at cost, right-of-use assets, goodwill and many intangible assets | Keep the transaction-date rate. |
| Non-monetary at fair value | Revalued property and assets measured at fair value | Use the rate on the fair-value measurement date. |
The distinction depends on whether there is a right to receive, or an obligation to deliver, a fixed or determinable number of currency units. For example, a lease liability is monetary, while the related right-of-use asset is non-monetary. The site’s IFRS 16 lease accounting guide explains the underlying lease balances.
Reporting-date retranslation
At each reporting date, foreign-currency monetary items are translated using the closing rate. Historical-cost non-monetary items remain at the transaction-date rate. Non-monetary items measured at fair value use the rate at the date when fair value was measured.
A non-monetary asset may still require a comparison under another Standard. For example, foreign-currency inventory may be tested against net realisable value using the rate when that value is determined, and an asset may be tested for impairment using a recoverable amount translated at the rate when it is measured. See the IAS 36 impairment guide for the recoverable-amount mechanics.
Worked example: foreign-currency purchase and payable
An entity whose functional currency is CU buys inventory for USD10,000. Assume the quoted rates show the CU cost of one US dollar.
- Transaction-date rate: CU0.90 per USD
- Reporting-date closing rate: CU0.95 per USD
- Settlement-date rate: CU0.92 per USD
| Date | Payable in CU | Exchange effect |
|---|---|---|
| Purchase: USD10,000 × CU0.90 | 9,000 | — |
| Year end: USD10,000 × CU0.95 | 9,500 | CU500 loss |
| Settlement: USD10,000 × CU0.92 | 9,200 | CU300 gain after year end |
Entry on the purchase date
Dr Inventory CU9,000
Cr Trade payable CU9,000
Entry at the reporting date
Dr Foreign-exchange loss CU500
Cr Trade payable CU500
The inventory remains at its historical translated cost of CU9,000 unless another Standard requires a write-down or different measurement. The payable is monetary and therefore increases to CU9,500.
Entry on settlement
Dr Trade payable CU9,500
Cr Cash CU9,200
Cr Foreign-exchange gain CU300
Across the full life of the payable, the entity records a net CU200 exchange loss: the CU500 reporting-date loss less the later CU300 gain. That equals the difference between the original CU9,000 liability and CU9,200 cash paid.
Worked example: foreign-currency sale and receivable
An entity sells goods for EUR20,000 when one euro equals CU1.10. Revenue and the receivable are initially CU22,000. The customer pays when one euro equals CU1.06, so cash received is CU21,200.
Sale and settlement entries
At sale: Dr Trade receivable CU22,000; Cr Revenue CU22,000
At settlement: Dr Cash CU21,200; Dr Foreign-exchange loss CU800; Cr Trade receivable CU22,000
The fall in the translated value of the receivable creates a loss. If the customer had paid more functional-currency units than the receivable’s carrying amount, the difference would be a gain.
Where are exchange differences recognised?
Exchange differences on settling or re-translating ordinary monetary items are generally recognised in profit or loss when they arise. Important exceptions include qualifying hedge-accounting effects under IFRS 9 and monetary items that form part of a net investment in a foreign operation.
For a non-monetary item, the exchange component follows the underlying gain or loss. If a revaluation gain is recognised in other comprehensive income (OCI), the related exchange component is also recognised in OCI. If the underlying fair-value movement is in profit or loss, its exchange component is also in profit or loss.
Advance consideration and IFRIC 22
A foreign-currency prepayment asset or deferred-income liability is non-monetary. IFRIC 22 Foreign Currency Transactions and Advance Consideration clarifies the transaction date used to determine the exchange rate when consideration is paid or received in advance.
In practical terms, the rate is fixed when the non-monetary prepayment asset or deferred-income liability is initially recognised for that portion of the transaction. If there are several advance payments or receipts, a transaction date is determined for each portion. A common error is to retranslate the prepayment as though it were a monetary receivable.
Translating a foreign operation
When a non-hyperinflationary foreign operation’s functional currency differs from the group’s presentation currency, assets and liabilities are translated at the closing rate. Income and expenses use transaction-date rates; appropriate averages may be used when they approximate actual rates. The resulting translation differences are recognised in OCI and accumulated in a separate equity component until the relevant disposal rules apply.
This translation process is different from recognising exchange gains and losses on the operation’s own foreign-currency receivables and payables. It should also remain separate from the site’s frozen consolidation-accounting clusters.
Change in functional currency
A functional-currency change is applied prospectively from the date the underlying economic conditions change. All items are translated into the new functional currency using the exchange rate on that date, and the resulting amounts for non-monetary items become their new historical costs.
Management should document why the currency influencing prices, costs and cash flows changed. A desire to reduce volatility, use a familiar currency or match the parent’s reporting currency is not by itself a basis for changing functional currency.
Lack of exchangeability
The August 2023 amendments apply for annual periods beginning on or after 1 January 2025. An entity assesses exchangeability at the measurement date for the specified purpose. When a currency is not exchangeable into another currency, the entity estimates a spot rate that reflects the rate at which an orderly exchange transaction would occur between market participants under prevailing economic conditions.
Disclosures explain the nature and financial effects of the lack of exchangeability, the rate used, the estimation process and the resulting risks. The assessment should use observable exchange transactions or another estimation technique as appropriate and must be supported by a clear audit trail.
2027 hyperinflationary-presentation-currency amendment
In November 2025, the IASB issued narrow amendments clarifying translation from a non-hyperinflationary functional currency into a hyperinflationary presentation currency. The amendments are effective for annual periods beginning on or after 1 January 2027, with earlier application permitted. The IASB announcement on the 2027 IAS 21 amendments explains their purpose and effective date.
This specialised presentation issue should not be confused with ordinary foreign-currency transaction accounting. Entities affected by hyperinflation also need to apply the relevant IAS 29 requirements and the final amendment text.
Disclosure and close controls
- Document the functional-currency assessment and significant judgements.
- Maintain approved exchange-rate sources and evidence for transaction and closing rates.
- Reconcile foreign-currency subledgers to the general ledger before retranslation.
- Separate monetary from non-monetary items and identify fair-value measurement dates.
- Reconcile exchange gains and losses by currency, account and business unit.
- Disclose exchange differences recognised in profit or loss and the movement in translation differences accumulated in equity when required.
- State when presentation currency differs from functional currency and explain the reason.
- Review tax effects under IAS 12 and presentation under the applicable financial-statement Standard.
The IFRS 18 presentation guide explains the broader financial-statement presentation framework.
Common IAS 21 mistakes
- Using presentation currency instead of functional currency as the accounting base.
- Using a period average when rates fluctuate significantly.
- Retranslating historical-cost inventory, equipment or prepayments at the closing rate.
- Failing to retranslate foreign-currency receivables, payables and lease liabilities.
- Capitalising ordinary exchange losses into inventory or equipment without a requirement in another Standard.
- Recording all exchange differences in OCI rather than distinguishing transaction gains and losses from foreign-operation translation.
- Double-counting an exchange difference at settlement after a reporting-date retranslation.
- Changing functional currency for convenience rather than changed economic conditions.
- Using an unsupported rate when currencies are not exchangeable.
IAS 21 review checklist
- Confirm each entity’s functional currency.
- Identify transactions and balances denominated in other currencies.
- Record each transaction using the appropriate transaction-date rate.
- Classify balances as monetary or non-monetary.
- Retranslate reporting-date monetary items at the closing rate.
- Use measurement-date rates for fair-value non-monetary items.
- Recognise exchange differences in the correct location.
- Process settlement entries without double-counting earlier gains or losses.
- Complete translation, disclosure, tax and control reconciliations.
Key takeaway
IAS 21 starts with functional currency. Record a foreign-currency transaction at the transaction-date spot rate, retranslate monetary items at the closing rate, keep historical-cost non-monetary items at their historical rate and recognise exchange differences in the correct location. Clear rate evidence and reconciled subledgers turn the rule into reliable accounting.
Free IFRS quick reference
Use the IFRS Concepts & Policies Quick Reference to review core recognition, measurement and presentation principles.