Key takeaways
- Every entity first determines its functional currency — the currency of the primary economic environment in which it operates.
- Foreign currency transactions are recorded at the spot rate on the transaction date.
- At each reporting date, monetary items (cash, receivables, payables, loans) are retranslated at the closing rate; non-monetary items at historical cost are not.
- Exchange differences on monetary items go to profit or loss; translation of foreign operations into a presentation currency goes to other comprehensive income.
For Bangladeshi exporters and importers, foreign currency is part of daily business: export sales invoiced in US dollars, back-to-back L/Cs for fabric and accessories, foreign currency loans, and overseas trading or liaison entities. IAS 21 The Effects of Changes in Foreign Exchange Rates sets out how to record these transactions and how to translate the financial statements of foreign operations. When exchange rates move sharply, the effect on reported profit can be large, so it is essential to apply the standard consistently.
1. Functional currency
The functional currency is the currency of the primary economic environment in which the entity operates — normally the one in which it primarily generates and spends cash. Primary indicators are the currency that mainly influences sales prices and the currency of the country whose competitive forces and regulations mainly determine prices, together with the currency that mainly influences labour, material and other costs. Secondary indicators include the currency of financing and the currency in which operating receipts are retained.
Most manufacturers in Bangladesh have the Bangladesh taka (BDT) as their functional currency, even when export sales are invoiced in USD, because wages, utilities, local purchases and taxes are in BDT and the regulatory environment is Bangladeshi. An offshore trading entity that buys and sells almost entirely in USD may instead have USD as its functional currency. The decision requires judgement and must be documented; it changes only if the underlying circumstances change.
2. Initial recognition
A foreign currency transaction is initially recorded in the functional currency at the spot exchange rate on the date of the transaction — the date it first qualifies for recognition under IFRS. For practical reasons, an average rate for a week or month may be used if rates do not fluctuate significantly.
Where consideration is received or paid in advance, IFRIC 22 sets the transaction date as the date the entity recognises the non-monetary advance (the prepayment asset or deferred income liability). Revenue or cost related to that advance is not later retranslated.
3. Monetary vs non-monetary items
| Monetary items (retranslate at closing rate) | Non-monetary items (keep historical rate if at cost) |
|---|---|
| Cash and bank balances in foreign currency | Property, plant and equipment, intangible assets |
| Trade receivables and payables | Inventories |
| Loans, borrowings and L/C liabilities | Prepayments and advances for goods or services |
| Provisions to be settled in cash | Equity instruments and goodwill |
| Lease liabilities | Contract liabilities (customer advances) |
The essential feature of a monetary item is a right to receive, or an obligation to deliver, a fixed or determinable number of units of currency. Non-monetary items measured at fair value in a foreign currency are translated at the rate when fair value was measured.
4. Worked example: an export receivable
A BDT-functional-currency garment exporter ships goods and invoices a buyer USD 100,000 on 20 December, when the rate is BDT 120.00 per USD. At the 31 December year-end the closing rate is BDT 121.50. The buyer pays on 15 February, when the rate is BDT 119.80.
| Date | Event | Rate | Entry (BDT) |
|---|---|---|---|
| 20 Dec | Recognise revenue and receivable | 120.00 | Dr Receivable 12,000,000 / Cr Revenue 12,000,000 |
| 31 Dec | Retranslate receivable (monetary item) | 121.50 | Dr Receivable 150,000 / Cr Exchange gain 150,000 |
| 15 Feb | Receive cash and settle receivable | 119.80 | Dr Bank 11,980,000; Dr Exchange loss 170,000 / Cr Receivable 12,150,000 |
Swipe sideways to see the full chart →
USD 100,000 export receivable in BDT: from invoice to cash (illustrative rates)
View the data behind this chart
| Step | Amount | Effect |
|---|---|---|
| Revenue at transaction rate | 12.00m | Starting point |
| Year-end retranslation | +0.15m | Favourable |
| Settlement difference | −0.17m | Adverse |
| Cash received | 11.98m | Result |
Exchange rates in this example are illustrative and do not represent actual historical BDT/USD rates.
Note that revenue stays at BDT 12.0 million; only the receivable moves. The two exchange differences — a gain this year and a loss next year — are presented in profit or loss. Many companies present them within operating or finance items depending on the nature of the underlying balance; IFRS 18 introduces specific classification rules from 2027 (see my article on IFRS 18).
5. Translating a foreign operation
When a group has a subsidiary with a different functional currency — say a Hong Kong trading company with USD functional currency owned by a Bangladesh parent presenting in BDT — its financial statements are translated for consolidation:
- Assets and liabilities at the closing rate at the reporting date;
- Income and expenses at the rates at the transaction dates (an average rate is often used as an approximation);
- All resulting exchange differences in other comprehensive income, accumulated in a foreign currency translation reserve, and reclassified to profit or loss on disposal of the foreign operation.
Goodwill and fair value adjustments arising on acquiring a foreign operation are treated as assets and liabilities of the foreign operation and translated at the closing rate. Intercompany balances that form part of the net investment in a foreign operation create further translation complexities — one more reason to follow a disciplined intercompany reconciliation process with a single rate table.
6. Practical controls
- Document the functional currency assessment for every entity and review it when the business model changes.
- Use a single, approved rate source (for example, the central bank or a specified commercial bank) for transaction, closing and average rates.
- Run month-end revaluation of all open foreign currency monetary items in the ERP, and reconcile unrealised exchange differences.
- Separate realised and unrealised exchange differences in the ledger for analysis and tax purposes.
- Report foreign currency exposure (net monetary position by currency) to management with the cash forecast.
7. Related topics
IAS 21 was amended to address lack of exchangeability (effective for periods beginning on or after 1 January 2025): when a currency cannot be exchanged into another currency, the entity estimates a spot rate reflecting the rate an orderly transaction would have taken place at, and discloses information about the effects. Entities in hyperinflationary economies apply IAS 29 in addition to IAS 21. Hedge accounting for foreign exchange risk is covered by IFRS 9.
Standards referenced in this article
IAS and IFRS are one body of standards — IFRS Accounting Standards, issued by the IASB. Standards issued before 2001 keep their IAS numbers and remain fully in force unless replaced. See the full IFRS & IAS standards list for every number and replacement.
| Standard | Title | Status | IFRS # & IAS # link |
|---|---|---|---|
| IFRS 9 | Financial Instruments | In force (2018) | Replaced most of IAS 39 |
| IFRS 18 | Presentation and Disclosure in Financial Statements | Effective 1 Jan 2027 | Replaces IAS 1 |
| IAS 21 | The Effects of Changes in Foreign Exchange Rates | In force | No IFRS number — IAS 21 is the IFRS standard |
| IAS 29 | Financial Reporting in Hyperinflationary Economies | In force | No IFRS number |
| IFRIC 22 | Foreign Currency Transactions and Advance Consideration | In force (Interpretation of IAS 21) | — |
Frequently asked questions
What is a functional currency under IAS 21?
The currency of the primary economic environment in which the entity operates — normally the currency in which it primarily generates and expends cash, considering which currency mainly influences sales prices and costs.
Are inventories retranslated at the closing rate?
No. Inventories are non-monetary items. If they are measured at historical cost, they remain at the exchange rate on the date of the transaction. Only monetary items such as receivables, payables, cash and loans are retranslated at the closing rate.
Where are exchange differences recognised?
Exchange differences on settling or retranslating monetary items are recognised in profit or loss. Differences arising on translating a foreign operation into the group's presentation currency are recognised in other comprehensive income.
Conclusion
IAS 21 rests on a few clear rules: determine the functional currency, record transactions at the spot rate, retranslate monetary items at each closing rate through profit or loss, and translate foreign operations through other comprehensive income. For export-oriented businesses, getting these mechanics right — with one rate source and a monthly revaluation routine — makes reported margins and exchange results understandable for management and lenders.
Written by Liakat Hossain
Finance and accounts professional with experience in FP&A, SAP FICO, Power BI, internal control, reporting, audit, tax, VAT and export-oriented business operations.
This article is original educational content based on professional finance practice. Real-project examples are anonymized, and scenario figures are identified as model outputs rather than guaranteed results.