Financial Reporting · Foreign currency transactions

Exchange Differences in Profit or Loss (IAS 21)

Updated 11 October 2026 · Fact-checked

An exchange difference arises when a foreign currency item is settled or retranslated at a rate different from the one used before. Under IAS 21, you recognise it in profit or loss. Compare the old and new amounts in the functional currency, then decide whether it is a gain or a loss.

Understand Exchange Differences in Profit or Loss

A foreign currency transaction is recorded in your functional currency at the spot rate on the transaction date. A purchase of goods priced in euros is translated at the rate on the day the risks and rewards pass to you. Rates move. So the amount you finally pay or receive can differ from the amount first recorded. That difference is an exchange difference.

There are two points at which a difference arises. The first is settlement: you pay a payable or collect a receivable at the spot rate on that day. The difference between the settlement amount and the carrying amount is a realised gain or loss. The second is the reporting date: monetary items still open are retranslated at the closing rate. The difference is an unrealised gain or loss at that date.

Under IAS 21, both kinds go to profit or loss for transactions. The exam term "realised" or "unrealised" does not change where the amount is shown. Only monetary items (receivables, payables, cash, loans) are retranslated. Non-monetary items carried at historical cost, such as inventory and property, plant and equipment, stay at the original rate and create no difference.

To decide gain or loss, ask what happens to cash in your own currency. A payable that costs you less to settle is a gain. A receivable that brings in less is a loss. The reverse applies if the amounts go the other way. Exchange gains and losses are usually included in other income or expenses, or in operating items, depending on the nature of the item.

Key rules to remember

Initial recognition: Functional currency amount = foreign currency amount ÷ spot rate on transaction date; Use the rate quoted as foreign units per one unit of functional currency. If the rate is the other way round, multiply instead.
Exchange difference on settlement: Settlement amount at settlement-date rate − carrying amount at earlier rate; Recognise in profit or loss. For a payable, a lower amount paid is a gain. For a receivable, a lower amount received is a loss.
Retranslation at reporting date: Closing carrying amount = foreign currency balance ÷ closing rate; Applies to monetary items only. The difference from the previous carrying amount goes to profit or loss.
Non-monetary items at cost: Carried at the rate on the transaction date; Not retranslated. No exchange difference arises.
Total effect across two periods: Year-end difference + settlement difference = total settlement amount − original amount; Use this to check that your two entries add up to the overall movement.

How to solve Exchange Differences in Profit or Loss questions

Use the same method for any question on foreign currency transactions and exchange differences.

1Identify the items: which are monetary (payables, receivables, cash, loans) and which are non-monetary.
2Record the initial transaction at the spot rate on the transaction date, using divide for foreign units per one functional unit.
3At the reporting date, retranslate each open monetary item at the closing rate and find the difference from the carrying amount.
4Decide gain or loss from the effect on your functional currency. Post the difference to profit or loss.
5On settlement, translate the cash paid or received at the settlement date rate. Compare it with the carrying amount at the last reporting date.
6Post the settlement difference to profit or loss in the period of settlement.
7Check: total of all differences equals final cash amount less the original amount recorded.

Quickest way: Three-column balance check

When to use it: Use in Section A and OT case questions where you need one number fast.

Write the foreign currency amount once.
Divide it by the two relevant rates and note the two functional currency figures.
Subtract them. Larger payable or smaller receivable than before means a loss. Smaller payable or larger receivable means a gain.
If the item is inventory or property at cost, stop: there is no exchange difference.
If a year-end is in between, only the movement since the last date is recognised in the later period.

Common mistakes in Exchange Differences in Profit or Loss

Retranslating inventory or non-current assets at the closing rate.
Students assume every foreign item is retranslated.
Fix: Only monetary items are retranslated. Non-monetary items at cost keep the transaction date rate.
Multiplying when you should divide, or the reverse.
The rate is quoted as foreign units per one unit of functional currency, and students forget to read the direction.
Fix: State the rate direction first. Check that the answer is sensible: if the foreign currency is weaker, the functional amount is smaller.
Getting gain and loss the wrong way round.
Students work on the rate movement rather than the effect on cash.
Fix: Ask what it costs you or what you receive. Less paid on a payable is a gain. Less received on a receivable is a loss.
Recognising the whole difference in the settlement period.
Students ignore the year-end retranslation.
Fix: At settlement compare with the last carrying amount, not the original amount. The earlier part was already recognised.
Taking exchange differences to other comprehensive income or equity.
This confuses transactions with the translation of a foreign operation.
Fix: For ordinary transactions in this topic, differences on monetary items go to profit or loss.

Worked examples

Example 1

Alpha, with the dollar ($) as functional currency, buys goods on credit from a supplier on 1 November for €120,000 when the rate is €1.20 = $1. Alpha's year-end is 31 December, when the rate is €1.25 = $1. Alpha pays the supplier on 31 January at €1.10 = $1. Calculate the exchange differences in each period and the entries.

Show the solution

Initial: €120,000 ÷ 1.20 = $100,000. Dr Purchases (inventory) $100,000, Cr Payables $100,000.
Year-end: €120,000 ÷ 1.25 = $96,000. The payable falls by $4,000, so there is a gain of $4,000 in profit or loss for the year. Dr Payables $4,000, Cr Profit or loss $4,000.
Settlement: €120,000 ÷ 1.10 = $109,090.91, which is about $109,091. The carrying amount is $96,000.
The payable has increased by $13,091. This is a loss in the following period. Dr Profit or loss $13,091, Cr Payables $13,091, then Dr Payables $109,091, Cr Cash $109,091.
Check: total paid $109,091 less original $100,000 = $9,091 net loss. Gain $4,000 less loss $13,091 = $9,091 net loss.

Answer: Year-end gain $4,000 in the first period; settlement loss $13,091 in the next period (net loss $9,091). Inventory stays at $100,000.

Example 2

Beta, with the dollar ($) as functional currency, sells goods to a customer on 1 March for 90,000 dinars when the rate is 3 dinars = $1. At the year-end of 30 June the rate is 2.5 dinars = $1. The customer pays on 15 August when the rate is 3.6 dinars = $1. Show the exchange differences and the amount of cash received.

Show the solution

Initial: 90,000 ÷ 3 = $30,000. Dr Receivables $30,000, Cr Revenue $30,000.
Year-end: 90,000 ÷ 2.5 = $36,000. The receivable increases by $6,000, so there is a gain of $6,000 in profit or loss. Dr Receivables $6,000, Cr Profit or loss $6,000.
Settlement: 90,000 ÷ 3.6 = $25,000 received. The carrying amount is $36,000.
Loss on settlement = $36,000 − $25,000 = $11,000, recognised in the next period. Dr Cash $25,000, Dr Profit or loss $11,000, Cr Receivables $36,000.
Check: cash $25,000 less original $30,000 = $5,000 net loss. Gain $6,000 less loss $11,000 = $5,000 net loss.

Answer: Gain $6,000 at the year-end; loss $11,000 on settlement; cash received $25,000. Revenue remains $30,000.

Exam tips

Write down the rate direction before any calculation. Most lost marks come from dividing or multiplying the wrong way.
In OT cases, the question often asks for the amount in profit or loss for the year. That means only the year-end retranslation, not the settlement that happens later.
Check each item is monetary before you retranslate it. Inventory, property, plant and equipment, and deferred income are classic traps.
In Section C, show each entry with a clear debit and credit and label gains and losses. Marks are given for method even if the arithmetic slips.
Round only at the end, and cross-check your two differences against the total movement from first to last amount.

Practice questions from Foreign currency transactions

Exchange Differences in Profit or Loss in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Exchange Differences in Profit or Loss: frequently asked questions

Are exchange differences on transactions recognised in profit or loss or in OCI?

For ordinary foreign currency transactions, differences on monetary items go to profit or loss under IAS 21. Differences on translating a foreign operation into the group presentation currency are treated differently and go to other comprehensive income.

What is the difference between realised and unrealised exchange differences?

A realised difference arises when the item is settled. An unrealised difference arises when an open monetary item is retranslated at the reporting date. Both are recognised in profit or loss.

Do I retranslate inventory bought in a foreign currency at the year-end?

No. Inventory is a non-monetary item, so it stays at the rate on the transaction date. You only consider net realisable value separately if it applies.

How do I know if an exchange difference is a gain or a loss?

Compare what you owe or will receive in your functional currency before and after. A payable that is now smaller, or a receivable that is now larger, is a gain. The opposite is a loss.