IAS 21 Translating Financial Statements of a Foreign Operation and Reporting Exchange Differences

A Nigerian company owns a subsidiary in the United States that keeps its books in dollars. To prepare group statements in naira, the dollar statements must be translated. If every item were translated at one rate, the statement of financial position would not balance with the statement of profit or loss. The group would show gains and losses that did not come from trading.

International Accounting Standard (IAS) 21 The Effects of Changes in Foreign Exchange Rates sets out which rate applies to each item and where the resulting exchange difference goes. This topic covers the translation of a foreign operation, the exchange difference that arises, its treatment in other comprehensive income, and the special cases of goodwill, a net investment in the operation and disposal. The next topic covers accounting policies, estimates and errors.

In the diets reviewed for this page, the compulsory accounts question in May Diet, 2023 included a gain on translation of foreign operations in the trial balance, taken to a foreign exchange reserve in the statement of changes in equity. Read foreign currency transactions first.

Translating a foreign operation

A foreign operation is a subsidiary, associate, joint arrangement or branch whose activities are based in a country or currency other than those of the reporting entity. If its functional currency is different from the group’s presentation currency, its results and financial position are translated into the presentation currency as follows:

• Assets and liabilities in each statement of financial position presented (including comparatives) are translated at the closing rate at the date of that statement.
• Income and expenses for each statement of profit or loss and other comprehensive income are translated at the exchange rates at the dates of the transactions. For practical reasons, an average rate for the period is used if rates do not fluctuate significantly.
• Equity items at the date of acquisition (share capital and pre-acquisition reserves) are carried at the historical rates from the date of acquisition. Post-acquisition retained earnings are the accumulated translated profits less dividends at the rate when paid.
• All resulting exchange differences are recognised in other comprehensive income.

Where the exchange difference comes from

The difference arises because the opening net assets are translated at the opening rate in the previous statements and the closing rate now. Profit is earned at the average rate but included in net assets at the closing rate. It is calculated as the closing net assets less the opening net assets (at the opening rate) less the profit for the year (at the average rate), or by components.

For example, a subsidiary with the dollar as its functional currency has opening net assets of US$2,000,000, a profit of US$400,000 and closing net assets of US$2,400,000 (no dividends). The rates are ₦1,450 at the start, ₦1,520 average and ₦1,600 at the end.

The exchange difference of ₦332 million is the sum of the gain on opening net assets, US$2,000,000 × (₦1,600 − ₦1,450) = ₦300 million, and on profit, US$400,000 × (₦1,600 − ₦1,520) = ₦32 million. It is recognised in other comprehensive income. The credit is carried in the translation reserve, which appears as a separate column in the statement of changes in equity.

Where the differences are reported

• In the consolidated statement of profit or loss and other comprehensive income: translation differences on a foreign operation are shown under other comprehensive income as items that may later be reclassified to profit or loss.
• In the statement of financial position: the cumulative amount is a separate component of equity, the translation or foreign exchange reserve.
• Where the foreign operation is not wholly owned, the part of the translation difference attributable to the non-controlling interest is allocated to it. If the exchange difference is ₦332 million and the non-controlling interest holds 30%, ₦99.6 million is allocated to it.
• When the foreign operation is disposed of, the cumulative exchange differences in equity for that operation are reclassified to profit or loss as part of the gain or loss on disposal.

Goodwill, net investment and other cases

Goodwill and fair value adjustments

Goodwill arising on acquiring a foreign operation, and fair value adjustments to the carrying amounts of its assets and liabilities, are treated as assets and liabilities of the foreign operation. They are expressed in its functional currency and translated at the closing rate. For example, goodwill of US$300,000 arose when the rate was ₦1,300, so it was recorded at ₦390,000,000.

At the end of the period at ₦1,600 it is ₦480,000,000, and the difference of ₦90,000,000 is a translation gain in other comprehensive income.

A net investment in a foreign operation

A monetary item, such as a loan from the parent, that is receivable from or payable to a foreign operation, the settlement of which is neither planned nor likely to occur in the foreseeable future, is in substance part of the net investment.

Exchange differences on it arise in the parent’s (or the subsidiary’s) own statements in profit or loss, but in the consolidated statements they are recognised initially in other comprehensive income and are reclassified on disposal. A loan of US$500,000 to a subsidiary when the rate moves from ₦1,450 to ₦1,600 gives a gain of US$500,000 × ₦150 = ₦75,000,000 in the parent’s profit or loss and in other comprehensive income on consolidation.

A different functional currency

If the foreign operation’s functional currency is the same as the parent’s, because it is an extension of the parent’s business, its transactions are translated as foreign currency transactions as in the previous topic, with monetary items at the closing rate and the differences in profit or loss.

The ideas in more depth

Why the difference goes to equity

The parent holds its investment in the subsidiary for the long term. A rise or fall in the dollar changes the naira value of the net assets, but it is not a gain realised through trading and does not affect cash flows that the group can use. Showing it in other comprehensive income keeps profit free of it until the operation is sold.

Why historical rates for equity

The acquisition price was paid at a rate then in force. Translating pre-acquisition equity at that rate keeps it matched with the investment eliminated on consolidation, so that goodwill and the reserve are not distorted by later movements.

Sources and references

• IAS 21 The Effects of Changes in Foreign Exchange Rates: translation to a presentation currency, goodwill and fair value adjustments, net investment, and disposal of a foreign operation.

These points are stated as at 5 November 2026.

Worked examples

1. Closing net assets.
   US$2,400,000 × ₦1,600 = ₦3,840 million.
2. Opening and profit.
   US$2,000,000 × ₦1,450 = ₦2,900 million
   US$400,000 × ₦1,520 = ₦608 million.
3. Exchange difference.
   ₦3,840m − ₦2,900m − ₦608m = ₦332 million, in other comprehensive income.

1. At acquisition.
   US$300,000 × ₦1,300 = ₦390,000,000.
2. At the year end.
   US$300,000 × ₦1,600 = ₦480,000,000.
3. Difference. ₦90,000,000, a gain in other comprehensive income (shared with the non-controlling interest if goodwill includes their share).

1. Reclassification. The ₦332 million is moved from equity to profit or loss on disposal, increasing the gain.

How to answer in the exam

• State the three rates. Closing for assets and liabilities, average for income and expenses, historical for equity.
• Calculate the difference as a balance. Closing net assets less opening net assets less profit, each at its own rate. Check by components.
• Say where it goes. Other comprehensive income and the translation reserve; reclassified on disposal.
• Remember goodwill at the closing rate.

Common mistakes in the exam

• Translating the profit at the closing rate, so that the difference is understated.
• Taking the translation difference to profit or loss instead of other comprehensive income.
• Translating goodwill at the historical rate.
• Translating share capital and pre-acquisition reserves at the closing rate.
• Forgetting to allocate part of the difference to the non-controlling interest.
• Not reclassifying the reserve on disposal.

Quick revision

• Assets and liabilities: closing rate. Income and expenses: average rate. Equity at acquisition: historical rate.
• Difference: other comprehensive income; translation reserve; reclassified on disposal.
• Goodwill and fair value adjustments: closing rate.
• Net investment loans: profit or loss in the entity, other comprehensive income on consolidation.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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