A Nigerian importer agrees to pay a German supplier in euros in 60 days. On the day of the deal, the euro costs one price. When the importer pays, it costs another. Which price goes in the books, and where does the difference go? That is the whole subject.
The answer is always the same two steps: record at the rate on the day, then retranslate money items at each year end and settlement.
This topic covers functional and presentation currency, foreign currency transactions at initial recognition, retranslation at the year end, settlement, and the difference between monetary and non-monetary items, all under International Accounting Standard (IAS) 21. The next topic covers translating the statements of foreign operations for consolidation. November 2025 Question 1 included a foreign property revaluation and a foreign subsidiary.
In 30 seconds
Every entity records its transactions in its functional currency, the currency of its main economic environment. At first recognition, translate a foreign currency item at the spot rate on the transaction date (an average rate is allowed if rates do not move much).
At each year end:
- monetary items (cash, receivables, payables, loans) are retranslated at the closing rate
- non-monetary items at cost keep the original rate
- non-monetary items at fair value use the rate on the date the fair value was set
Exchange differences on monetary items go to profit or loss, both at the year end and on settlement.
If a gain on a non-monetary item is in other comprehensive income, its exchange part goes there too. Forward contracts follow International Financial Reporting Standard (IFRS) 9, not IAS 21.
Key terms in plain English
| Term | What it means |
|---|---|
| Functional currency | The currency of the primary economic environment in which the entity operates |
| Presentation currency | The currency in which the statements are presented |
| Foreign currency | Any currency other than the functional currency |
| Spot rate | The rate on the date of the transaction |
| Closing rate | The rate at the end of the reporting period |
| Monetary item | Cash and items to be received or paid in a fixed or determinable amount of money |
| Non-monetary item | Anything else, such as plant, inventory, investments and deferred tax |
| Exchange difference | The gain or loss when the same item is translated at different rates |
Syllabus check
IAS 21 is examinable under syllabus area C. This topic covers:
- functional and presentation currency, and a change of functional currency;
- translation of transactions, retranslation at the year end, settlement, and monetary and non-monetary items.
CAMA 2020 and foreign currency
The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow International Financial Reporting Standards (IFRS) and give a true and fair view.
| Section | What it says | Link to this topic |
|---|---|---|
| s. 377(1) and s. 378 | Directors prepare statements that follow IFRS and give a true and fair view | Foreign currency items follow IAS 21 |
| ss. 379 to 381 | The provisions on group accounts, as ICAN teaches them | Foreign subsidiaries are translated before they are consolidated |
| s. 374(1) | The company keeps accounting records | Rates used and the dates of transactions are recorded |
| s. 385 | The directors\u2019 report covers performance and risk | Currency risk and exposures may need comment |
| s. 404(7) | The audit committee reviews policies and internal control | It can review the rates used and hedging policy |
Functional and presentation currency
The functional currency is not always the currency of the country. IAS 21 looks at the currency that mainly influences (a) sales prices and (b) labour, material and other costs, and also at the currency in which funds are raised and in which operating receipts are kept. The presentation currency can be any currency. If it differs from the functional currency, the statements are translated (see the next topic).
Change of functional currency
It results from a change in circumstances, not a change in policy, so it is applied prospectively from the date of change. All items are translated into the new currency at the rate on that date, and the translated amounts of non-monetary items become their historical cost. Disclose the change, its date and the reason.
Initial recognition
Translate at the spot rate on the date of the transaction. For practical reasons an average rate for a week or month may be used if rates do not fluctuate significantly. If there is more than one rate, use the rate at which the balance could be settled on the measurement date.
If a currency cannot be exchanged, use the rate on the first later date on which exchange is possible.
Retranslation at the reporting date
| Item | Rate used at the year end |
|---|---|
| Monetary items | Closing rate |
| Non-monetary at historical cost | Not retranslated: keep the original rate |
| Non-monetary at fair value | The rate on the date the fair value was determined |
The exchange difference is the difference between the original and retranslated amounts. An exchange gain arises when an asset rises or a liability falls in the functional currency, and a loss when an asset falls or a liability rises. The difference on a monetary item goes to profit or loss in the period.
When the gain or loss on a non-monetary item is in other comprehensive income (for example a revaluation surplus), the exchange part is too.
Settlement
Settlement is recorded at the spot rate on the settlement date. A further difference arises between the carrying amount (after year-end retranslation) and the cash actually paid or received. It goes to profit or loss of the year of settlement. IAS 21 does not cover forward contracts and other derivatives, which follow IFRS 9.
The rules in more depth
Why monetary and non-monetary items differ
A receivable in a foreign currency will turn into a fixed amount of that currency, so its value in naira moves with the rate. A machine bought with foreign money is worth what it cost. The currency used to pay for it is irrelevant once it is bought.
Why the difference goes to profit or loss
For a monetary item the change in rate is a real gain or loss in the entity’s own currency, because cash will be paid or received at the new rate.
Why the functional currency is not simply the local one
An oil refinery that prices sales in dollars and buys equipment in dollars lives in a dollar economy, even though it is in Nigeria.
Effect on analysis
Exchange differences in profit can be large for a company with foreign loans. Analysts separate them from operating profit.
Worked examples
Example 1: functional currency. Entity A runs a refinery in Nigeria. All sales are priced in US dollars. Costs: 20% salaries payable in dollars, 25% imported parts invoiced in dollars, 55% local costs in naira. Depreciation is calculated in dollars because the assets were funded in dollars.
- Sales and receipts are wholly in dollars. 45% of costs are in dollars. Depreciation is ignored because it is not a current cash cost.
- Financing and the retention of cash also point to dollars.
- The functional currency is the US dollar. If it presents in naira, it translates from dollars.
Example 2: change of functional currency. A Belgian entity used the euro. By 2017, 75% of its activity was in the UK and in pounds. Management decided that the pound would be its functional currency from 1 January 2018. At 31 December 2017 its net assets were €80,000,000 and the closing rate was £1 = €1.59.
- Apply prospectively on 1 January 2018.
- Opening net assets.
€80,000,000 ÷ 1.59 = £50,314,465. - Disclose the change, its date and the reason (most revenue and cash flow now arises in the UK).
Example 3: initial recognition. Brianco buys goods from Germany for €127,875 on 1 May. The rate is €1.50 = CU1.
- CU = 127,875 ÷ 1.50 = CU85,250.
- Dr purchases 85,250; Cr trade payables 85,250.
Example 4: a foreign currency loan. A sterling company borrows $900,000 on 3 June at $1.80 = £1. It pays interest of $18,500 on 3 December at $1.85. The closing rate at 31 December is $1.90.
- Loan on 3 June = $900,000 ÷ 1.80 = £500,000.
- Interest paid.
$18,500 ÷ 1.85 = £10,000 (a finance cost). - At 31 December the loan is monetary: $900,000 ÷ 1.90 = £473,684.
- Exchange gain = £500,000 − £473,684 = £26,316 in profit or loss.
Example 5: a machine on credit. A UK company buys a machine for €260,000 on 1 March at €1.30 = £1 and has not paid at 31 December (€1.20 = £1).
- Machine = €260,000 ÷ 1.30 = £200,000.
It is non-monetary at cost, so it is not retranslated. - The payable is monetary.
€260,000 ÷ 1.20 = £216,667.
Exchange loss = £16,667 in profit or loss.
Example 6: settlement in the same year. A UK company sells goods to Saudi Arabia for $72,000 on 12 September at $1.80 = £1 and is paid on 19 November at $2.00 = £1.
- Sale and receivable.
$72,000 ÷ 1.80 = £40,000. - Cash received.
$72,000 ÷ 2.00 = £36,000.
Exchange loss on settlement = £4,000 in profit or loss.
Example 7: settlement in the next year. A UK company buys goods for $30,000 on 30 November Year 1 at $1.50 = £1. The year end rate is $1.80 and payment is made on 16 March Year 2 at $1.60.
- Initial.
$30,000 ÷ 1.50 = £20,000.
Inventory held is non-monetary and not retranslated. - Year 1 end: payable = $30,000 ÷ 1.80 = £16,667.
Gain = £3,333 in Year 1 profit. - Settlement.
$30,000 ÷ 1.60 = £18,750.
Loss = 18,750 − 16,667 = £2,083 in Year 2 profit.
Note: the ICAN text gives the payment date as both 16 March and 19 March. The figures use the rate on the payment date, so the date does not change the answer.
Example 8: a foreign currency bond. A sterling company buys a bond for RU 1,000 on 1 January at RU 1 = £1.50. The coupon is 6%. The average rate for the year is £1.75 and the closing rate £2.00. It is at amortised cost.
- Interest income.
RU 60 × £1.75 = £105 (a weighted average is used because interest accrues evenly and rates moved sharply). - The bond is a monetary asset, so it is retranslated: principal gain = RU 1,000 × (2.00 − 1.50) = £500.
Accrued interest of RU 60 is retranslated to £120, a gain of £15. - Carrying amount.
RU 1,060 × 2.00 = £2,120 = 1,500 + 105 + 515 (exchange gains of £500 + £15 in profit or loss).
Example 9: a foreign property revalued. A Nigerian company (functional currency naira) bought a property in Ghana on 1 January for GH¢45m when GH¢6 = ₦1. It depreciates it over 20 years. At 31 December it is revalued to GH¢52.5m and the closing rate is GH¢5 = ₦1.
- Cost = GH¢45m ÷ 6 = ₦7.5m.
Depreciation = 7.5 ÷ 20 = ₦0.375m.
Carrying amount = ₦7.125m. - The revalued amount is non-monetary at fair value, translated at the rate on the date of the valuation: GH¢52.5m ÷ 5 = ₦10.5m.
- Revaluation surplus.
10.5 − 7.125 = ₦3.375m, in other comprehensive income (the exchange part is included in it).
Example 10: instalments across a year end. White Cliffs Co (year end 31 December) buys goods for \u20ac40,000 on 30 September at \u20ac1.60 = \u00a31. It pays half on 30 November and half on 31 January. Rates: \u20ac1.80 on 30 November, \u20ac1.90 on 31 December, \u20ac1.85 on 31 January.
- 30 September: payable = 40,000 \u00f7 1.60 = \u00a325,000.
- 30 November: \u20ac20,000 paid = \u00a311,111. The half of the payable was \u00a312,500, so the gain is \u00a31,389.
- 31 December: the remaining \u20ac20,000 is retranslated to \u00a310,526. Gain = 12,500 \u2212 10,526 = \u00a31,974. The year\u2019s gain is \u00a33,363 in profit or loss.
- 31 January: \u20ac20,000 paid = \u00a310,811. Loss = 10,811 \u2212 10,526 = \u00a3285, in the next year\u2019s profit or loss.
How to score full marks
- Say which currency is functional and why, using the IAS 21 indicators.
- Translate every item at the right rate and show the working.
- Classify each item as monetary or non-monetary before you retranslate.
- Show exchange differences for the year end and for settlement separately.
- Say where each difference goes (profit or loss, or other comprehensive income).
- Leave forward contracts to IFRS 9.
Common mistakes in the exam
- Retranslating non-monetary items at cost at the closing rate.
- Not retranslating the payable on a machine bought on credit.
- Putting the difference on a monetary item in other comprehensive income.
- Using the closing rate for the initial recognition.
- Choosing the functional currency by the country alone.
- Using a simple average when rates moved sharply and a weighted average is available.
- Applying a change of functional currency retrospectively.
Quick revision
- Spot rate at the date. Average if rates are stable.
- Year end: monetary at closing rate; cost items unchanged; fair value items at the rate on the valuation date.
- Monetary differences to profit or loss at the year end and on settlement.
- Functional currency change: prospective.
- CAMA 2020: ss. 377(1), 378, 379 to 381, 374(1), 385, 404(7).
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.
Recall check: multiple choice
The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.
Question 1. On initial recognition, a foreign currency transaction is translated at:
- The closing rate
- The spot rate on the transaction date
- The average of the year
- The prior year rate
Show the answer
B. An average rate is allowed if rates are stable.
Question 2. A foreign currency trade payable at the year end is retranslated at:
- The original rate
- The closing rate
- The average rate
- Not at all
Show the answer
B. It is a monetary item.
Question 3. Plant bought in a foreign currency and carried at cost is:
- Retranslated at the closing rate
- Kept at the original rate
- Retranslated at the average rate
- Written off
Show the answer
B. It is non-monetary.
Question 4. Exchange differences on monetary items are recognised in:
- Other comprehensive income
- Profit or loss
- Equity
- Inventory
Show the answer
B. At the year end and on settlement.
Question 5. A change in functional currency is applied:
- Retrospectively
- Prospectively
- Never
- Over five years
Show the answer
B. From the date of the change.
Question 6. The functional currency is the currency of:
- The country of incorporation
- The primary economic environment
- The parent
- The bank
Show the answer
B. Not necessarily the local currency.
Question 7. A forward contract to buy dollars is accounted for under:
- IAS 21
- IFRS 9
- IAS 2
- IAS 16
Show the answer
B. IAS 21 excludes derivatives.
Question 8. A revalued foreign property is translated at the rate on:
- The purchase date
- The date the fair value was determined
- The year end always
- The average date
Show the answer
B. Non-monetary at fair value.
Question 9. A liability rising in functional currency on retranslation gives:
- A gain
- A loss
- No effect
- A reserve
Show the answer
B. The entity must pay more.
Question 10. Which section of CAMA 2020 requires the statements to follow IFRS?
- Section 378
- Section 400
- Section 405
- Section 409
Show the answer
A. IAS 21 is part of IFRS.
Written questions
Question 11 (10 marks). (a) State the factors that determine the functional currency. (5 marks) (b) Explain how monetary and non-monetary items are treated at the year end. (5 marks)
Question 12 (20 marks). A Nigerian company (year end 31 December) has these transactions. (a) It buys goods for $60,000 on 1 November at ₦1,500 = $1. The closing rate is ₦1,560 and it pays on 15 January at ₦1,540. Show the entries for both years. (8 marks) (b) It borrows $200,000 on 1 March at ₦1,480. It pays interest of $10,000 on 1 September at ₦1,520. The closing rate is ₦1,560. Calculate the loan balance and the exchange difference.
(6 marks) (c) It buys equipment for $50,000 on 1 July at ₦1,500. State the treatment at the year end. (3 marks) (d) Explain how a change in functional currency is accounted for. (3 marks)
Question 13 (10 marks). Zeta Ltd (functional currency naira) sells goods for $40,000 on 10 October at ₦1,500 = $1 and is paid on 20 December at ₦1,480. It also sells goods for $30,000 on 1 December at ₦1,490, not paid at the year end when the rate is ₦1,470. (a) Calculate the exchange difference on the first sale. (3 marks) (b) Calculate the amount of the receivable and the exchange difference on the second sale at the year end. (4 marks) (c) Explain why the receivable is retranslated. (3 marks)
Model answers
Show the model answer to Question 11
(a) Functional currency (5 marks). The currency that mainly influences sales prices. (1.5) The currency that mainly influences labour, material and other costs. (1.5) The currency in which funds are raised. (1) The currency in which operating receipts are kept. (1)
(b) Year end (5 marks). Monetary items are retranslated at the closing rate, with the difference in profit or loss. (2) Non-monetary items at historical cost are not retranslated. (1.5) Non-monetary items at fair value are translated at the rate on the date the fair value was determined. (1.5)
Show the model answer to Question 12
(a) Goods (8 marks).
- Year 1: purchase = 60,000 × 1,500 = ₦90,000,000. (2)
- Payable at year end.
60,000 × 1,560 = ₦93,600,000. - Exchange loss = ₦3,600,000 in Year 1 profit or loss. (3)
- Year 2: payment = 60,000 × 1,540 = ₦92,400,000.
- Exchange gain.
93,600,000 − 92,400,000 = ₦1,200,000 in Year 2 profit or loss. (3)
(b) Loan (6 marks).
- Initial = 200,000 × 1,480 = ₦296,000,000. (1.5)
- Interest paid.
10,000 × 1,520 = ₦15,200,000, a finance cost. (1.5) - Closing loan.
200,000 × 1,560 = ₦312,000,000. (1.5) - Exchange loss = ₦16,000,000 in profit or loss. (1.5)
(c) Equipment (3 marks).
- It is non-monetary and at cost.
- It is recorded at 50,000 × 1,500 = ₦75,000,000 and is not retranslated. (3)
(d) Change of functional currency (3 marks). It is applied prospectively from the date of change. (1) All items are translated at the rate on that date, and non-monetary items’ translated amounts become their cost. (1) The change, its date and the reason are disclosed. (1)
Show the model answer to Question 13
(a) First sale (3 marks).
- Receivable = 40,000 × 1,500 = ₦60,000,000.
- Cash = 40,000 × 1,480 = ₦59,200,000.
- Exchange loss = ₦800,000 in profit or loss. (3)
(b) Second sale (4 marks).
- Initial = 30,000 × 1,490 = ₦44,700,000. (1.5)
- Year-end receivable.
30,000 × 1,470 = ₦44,100,000. (1.5) - Exchange loss = ₦600,000. (1)
(c) Why retranslated (3 marks). A receivable is a monetary item. (1) It will be settled in a fixed amount of dollars, so its naira value moves with the rate. (1) The difference is a real gain or loss and goes to profit or loss. (1)
Pathfinder on Foreign currency transactions
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
The solution translates the cost at the spot rate on the purchase date, depreciates it, then translates the revalued amount at the closing rate and takes the surplus to other comprehensive income. Worked example 9 shows the layout.
Revise first: Worked examples
Questions test which items are retranslated. See the table in the section on retranslation.
Revise first: Retranslation at the reporting date
Source: ICAN Pathfinder, Strategic Business Reporting. Diets covered: November Diet, 2025.
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