Foreign currency transactions (IAS 21) - Monetary vs non-mon...

Learning Outcomes

After reading this article, you will be able to distinguish between monetary and non-monetary items per IAS 21, accurately translate foreign currency transactions at the appropriate exchange rate, explain initial and subsequent reporting of these items, and identify common areas of ACCA exam confusion around foreign currency measurement and reporting.

ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand the correct accounting treatment for foreign currency transactions under IAS 21, with particular focus on the distinction between monetary and non-monetary items. Specifically, you should know how these items are initially measured, how they are treated at the reporting date, and the effects of exchange differences. This article addresses:

• Identify and explain the difference between monetary and non-monetary foreign currency items (IAS 21)
• Translate foreign currency transactions at initial recognition
• Account for the retranslation of monetary and non-monetary items at the reporting date
• Recognise where exchange differences should be recorded in the financial statements

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the correct exchange rate to use when initially recognising a non-monetary asset acquired in a foreign currency?
2. Which of the following is a monetary item?
   a) Trade receivable
   b) Inventory
   c) Prepaid rent
   d) Tangible fixed asset
3. At the reporting date, which items must be retranslated using the closing rate?
4. How are exchange differences arising on monetary items recognised in the financial statements?

Introduction

Foreign currency transactions are common in many businesses, including purchases, sales, and loans. IAS 21 The Effects of Changes in Foreign Exchange Rates establishes how to account for transactions in currencies other than the entity’s functional currency, particularly how to measure them at the correct exchange rate, and whether subsequent exchange differences arise. A critical distinction in this process is between monetary and non-monetary items, as this determines the translation rate to apply at the reporting date and the treatment of resulting gains or losses.

Key Term: functional currency
The currency of the primary economic environment in which the entity operates. IAS 21 requires all transactions in other currencies to be translated into the functional currency.

Foreign Currency Transactions: Initial Recognition

All foreign currency transactions must be translated into the functional currency at the spot rate (the exchange rate at the date the transaction occurs) when first recognised.

• Purchases and sales are recorded at the exchange rate prevailing on the transaction date.
• If an average rate is used for practical reasons (where variances are not significant), this is acceptable for multiple similar transactions.

Key Term: spot rate
The exchange rate at the date a foreign currency transaction takes place, used for initial recognition under IAS 21.

Monetary vs Non-Monetary Items

IAS 21 classifies all assets and liabilities as either monetary or non-monetary, and this determines how they are measured at the reporting date.

Key Term: monetary item
A unit of currency held, or an asset or liability to be received or paid in a fixed or determinable number of currency units (e.g., cash, receivables, payables, loans).

Key Term: non-monetary item
An asset or liability that does not give rise to a right to receive (or obligation to deliver) a fixed or determinable number of currency units (e.g., inventory, property, plant and equipment, intangible assets, prepayments).

Monetary Items: Subsequent Measurement

At each reporting date, monetary items denominated in a foreign currency are retranslated at the closing rate (the exchange rate at the reporting date).

• Any exchange gains or losses arising on retranslation are recognised in profit or loss for the period.

Typical examples of monetary items:

• Trade receivables and payables
• Loans receivable/payable
• Accrued income and expenses
• Cash at bank

Non-Monetary Items: Subsequent Measurement

Non-monetary items are not retranslated at the reporting date.

• They remain at the amount translated at the spot rate when initially recognised, unless carried at fair value or revaluation.

Non-monetary items measured at historical cost:

• Translate at the spot rate at the date of transaction; no adjustment at period end.

Non-monetary items measured at fair value (e.g., revalued property, plant and equipment; fair value investments):

• Translate at the exchange rate at the date the fair value was determined.
• Do not retranslate at the reporting date unless a new valuation/fair value has been obtained.

Example Items

• Monetary: Trade receivables, payables, cash, loans.
• Non-monetary: Inventory, property, plant and equipment, intangible assets, prepayments.

Worked Example 1.1

Fern Ltd has the following foreign currency balances at 31 December:

• Cash at bank of €20,000 (monetary)
• Inventory purchased for €9,000 on 4 September, not yet sold (non-monetary)

Exchange rates are:

• 4 September: €1 = $1.10
• 31 December: €1 = $1.30

Required: How are these balances reported at 31 December?

Answer:

• The cash at bank (€20,000) is a monetary item. It is translated at the closing rate (€1 = $1.30): $26,000.
• The inventory is a non-monetary asset measured at historical cost, so remains at the rate when purchased: €9,000 × $1.10 = $9,900.
• No retranslation is made for the inventory balance at year end.

Worked Example 1.2

A UK company buys machinery from a US supplier for $100,000 on 15 November. The equipment was worth £78,000 at that day's spot rate. At the year-end, the balance remains unpaid. The exchange rate at the reporting date is £1 = $1.25.

Required: How is the machinery and payable recorded at year-end?

Answer:

• Machinery: Non-monetary. Stays at the amount recognised at the transaction date (£78,000). No retranslation at the reporting date.
• Payable: Monetary. Retranslate remaining liability at closing rate. $100,000 / $1.25 = £80,000. Exchange loss of £2,000 (80,000 - 78,000) through profit or loss.

Exam Warning

A common error is to retranslate non-monetary items (e.g., inventory, PPE) at the reporting date. Only monetary items are retranslated at the closing rate. Non-monetary items measured at cost remain at the initial translation rate.

Summary Table: Measurement of Foreign Currency Items

Key Point Checklist

This article has covered the following key knowledge points:

• Translate all foreign currency transactions at the spot rate on the date of transaction
• At the reporting date, retranslate only monetary items at the closing rate
• Non-monetary items measured at cost remain at the historic rate; no year-end translation
• Non-monetary items carried at fair value are translated using the rate at the date fair value was determined
• Exchange gains and losses on monetary items are recognised in profit or loss

Key Terms and Concepts

• functional currency
• spot rate
• monetary item
• non-monetary item