Financial Reporting · Ind AS 21 The Effects of Changes in Foreign Exchange Rates

Ind AS 21: Initial Recognition and Subsequent Reporting of Foreign Currency Transactions

Updated 5 October 2026 · Fact-checked

A foreign currency transaction is recorded in the functional currency at the spot rate on the transaction date. At each reporting date, translate monetary items at the closing rate, non-monetary items at historical cost at the transaction-date rate, and fair-valued non-monetary items at the rate on the fair value date. Exchange differences on monetary items go to profit or loss.

Understand Initial Recognition and Subsequent Reporting of Foreign Currency Transactions

A foreign currency transaction is one that is denominated, or requires settlement, in a currency other than the entity's functional currency. Examples are buying goods from a foreign supplier, selling to a foreign customer, or borrowing in dollars. Ind AS 21 tells you which rate to use and where the resulting gain or loss goes.

On initial recognition, you record the transaction in the functional currency by applying the spot exchange rate between the functional currency and the foreign currency on the date of the transaction. The date of the transaction is the date when the transaction first qualifies for recognition under Ind AS. For practical reasons, an average rate for a week or month may be used if rates do not fluctuate significantly. It cannot be used when rates fluctuate significantly.

At the end of each reporting period, the treatment depends on the type of item. Monetary items are units of currency held, and assets and liabilities to be received or paid in a fixed or determinable number of currency units. Examples are cash, receivables, payables, loans and provisions to be settled in cash. A non-monetary item has no right to receive or deliver a fixed or determinable number of currency units. Examples are PPE, inventory, intangibles, prepaid expenses and advances paid for goods or services.

Monetary items are translated at the closing rate. Non-monetary items carried at historical cost are kept at the rate on the date of the transaction. Non-monetary items carried at fair value are translated at the rate on the date when the fair value was measured.

Exchange differences arising on settling monetary items, or on translating them at rates different from those used earlier, are recognised in profit or loss in the period they arise. The exception is a monetary item that forms part of a net investment in a foreign operation, covered in a separate topic. When a gain or loss on a non-monetary item goes to OCI, any exchange component of it also goes to OCI. If it goes to profit or loss, the exchange component goes there too.

Key rules to remember

Initial recognition: Functional currency amount = Foreign currency amount × Spot rate on transaction date; Average rate is allowed only if rates do not fluctuate significantly.
Monetary items at reporting date: Carrying amount = Foreign currency amount × Closing rate; Includes cash, receivables, payables and loans to be settled in cash.
Non-monetary items at historical cost: Carrying amount = Foreign currency cost × Rate on transaction date; No retranslation. No exchange difference arises.
Non-monetary items at fair value: Carrying amount = Foreign currency fair value × Rate on date fair value was measured; Exchange component follows the fair value gain or loss (OCI or profit or loss).
Exchange difference on monetary item: Exchange difference = Foreign currency amount × (Closing or settlement rate − Previous rate); Recognise in profit or loss. Gain or loss depends on whether it is an asset or a liability.
Inventory at lower of cost and NRV: Compare cost (at transaction-date rate) with NRV (at rate when the value was determined); Write-down is made only if the comparison in functional currency shows NRV is lower.

How to solve Initial Recognition and Subsequent Reporting of Foreign Currency Transactions questions

Use this sequence for any question on foreign currency transactions and year-end reporting.

1Identify the functional currency of the entity. All amounts are to be shown in it.
2List each foreign currency item and classify it as monetary or non-monetary. Advances paid or received for goods and services are non-monetary.
3Record the initial transaction at the spot rate on the transaction date. Note the date carefully.
4At the reporting date, translate monetary items at the closing rate. Keep historical cost non-monetary items at the old rate. Translate fair-valued items at the rate on the fair value date.
5Compute exchange difference on each monetary item as foreign amount × change in rate. Decide gain or loss from the nature: an asset gains when the rate rises, a liability loses when the rate rises.
6If an item is settled during the year, compute the difference between the settlement rate and the previous carrying rate. Recognise it in profit or loss.
7Pass the journal entries and state the amount in profit or loss and the carrying amount in the balance sheet. Mention the Ind AS 21 reason in one line.

Quickest way: Rate-ladder method

When to use it: Use in a time-pressed written answer or MCQ with several items and dates.

Write three rates in a row: transaction date, closing date and settlement date.
Tag each item M (monetary) or NM (non-monetary) and apply the rule: M uses closing rate, NM at cost uses transaction rate.
For each M item, multiply the foreign amount by the difference between the two latest rates.
Mark the sign with a rule: asset and rate up means gain, liability and rate up means loss. Reverse if the rate falls.
Add up all gains and losses to get the net amount for profit or loss.

Common mistakes in Initial Recognition and Subsequent Reporting of Foreign Currency Transactions

Capitalising or taking to OCI all exchange differences on monetary items.
Students remember that some exchange differences can be capitalised and apply this to all monetary items.
Fix: Ind AS 21 requires exchange differences on monetary items to go to profit or loss. Only the portion of exchange differences on foreign currency borrowings that is regarded as an adjustment to interest cost is treated as a borrowing cost under Ind AS 23. That portion may be capitalised for qualifying assets. This is an Ind AS 23 matter, not an exception within Ind AS 21.
Treating advances paid to a foreign supplier as monetary and retranslating them at closing rate.
Students see money paid and assume it is a receivable in currency.
Fix: An advance for goods or services is a non-monetary item. The related asset or expense is recorded at the rate on the date the advance was paid.
Retranslating PPE or inventory at the closing rate when carried at cost.
Students apply the closing rate to every balance sheet item.
Fix: Closing rate applies to monetary items. Non-monetary items at historical cost stay at the transaction-date rate.
Reversing the direction of gain or loss.
Students do not tie the sign to asset or liability.
Fix: Ask whether you will receive or pay. A rising rate increases the rupee value of both, so a receivable gains and a payable loses.
Computing the exchange difference against the closing rate of the previous year instead of the transaction-date rate in the first year.
The opening rate is confused with the previous reference rate.
Fix: In the year of the transaction, compare with the transaction-date rate. In later years, compare with the previous closing rate.

Worked examples

Example 1

Alpha Ltd, whose functional currency is the rupee, imported raw materials from a US supplier on 1 February 2027 for USD 10,000 on credit. The rate on that date was ₹83.00 per USD. On 31 March 2027 the closing rate was ₹84.50. The payable was settled on 30 April 2027 at ₹85.00. The materials were unsold at year end. Ignore import duty and other costs, so the inventory cost is the purchase price at the transaction-date rate only. Show the treatment in the year ended 31 March 2027 and in the year ending 31 March 2028.

Show the solution

Initial recognition: 10,000 × ₹83.00 = ₹8,30,000. Debit inventory ₹8,30,000, credit trade payable ₹8,30,000.
The payable is monetary. At 31 March 2027: 10,000 × ₹84.50 = ₹8,45,000.
Exchange loss = ₹8,45,000 − ₹8,30,000 = ₹15,000. Recognise it in profit or loss. Debit exchange loss ₹15,000, credit payable ₹15,000.
Inventory is non-monetary at historical cost. Its cost (purchase price only, excluding duties and other costs) stays at ₹8,30,000 and is not retranslated. Compare with NRV separately under Ind AS 2.
Settlement on 30 April 2027: 10,000 × ₹85.00 = ₹8,50,000. Additional loss = ₹8,50,000 − ₹8,45,000 = ₹5,000, recognised in profit or loss of the year ending 31 March 2028.

Answer: Inventory stays at ₹8,30,000 (purchase price only). Exchange loss of ₹15,000 goes to profit or loss for the year ended 31 March 2027, with a payable of ₹8,45,000. A further loss of ₹5,000 is recognised on settlement in the year ending 31 March 2028, when ₹8,50,000 is paid.

Example 2

Beta Ltd (functional currency: rupee) sold goods to a UK customer for GBP 5,000 on 10 March 2027 when the rate was ₹100 per GBP. On 31 March 2027 the closing rate was ₹102. On 15 March 2027 Beta paid a foreign supplier an advance of USD 2,000 for machinery at ₹83 per USD. The closing USD rate on 31 March 2027 was ₹84. Beta also holds a machine imported earlier for USD 20,000 at ₹80 per USD, carried at cost. Show how each item is reported at 31 March 2027 and the exchange difference in profit or loss.

Show the solution

Sale on 10 March 2027: 5,000 × ₹100 = ₹5,00,000. Debit receivable, credit revenue.
The receivable is monetary. At closing: 5,000 × ₹102 = ₹5,10,000. Exchange gain = ₹10,000, recognised in profit or loss.
The advance of USD 2,000 paid on 15 March 2027 is non-monetary. It is recorded at 2,000 × ₹83 = ₹1,66,000 and not retranslated. No exchange difference arises.
The USD closing rate of ₹84 on 31 March 2027 differs from the ₹83 rate on the advance date, but it is not used for the advance, because the advance is non-monetary and is not translated at the closing rate. It is a distractor here.
The machine is non-monetary at historical cost. Carrying amount stays at 20,000 × ₹80 = ₹16,00,000 before depreciation. No exchange difference arises.
Net exchange difference in profit or loss = ₹10,000 gain.

Answer: Receivable is reported at ₹5,10,000 and the exchange gain of ₹10,000 goes to profit or loss. The advance remains ₹1,66,000 and the machine remains ₹16,00,000 before depreciation. No exchange difference arises on these two non-monetary items.

Exam tips

Begin every answer by classifying items as monetary or non-monetary. Examiners often award marks for this step.
Always state that exchange differences on monetary items go to profit or loss, and quote Ind AS 21 as the basis.
In case-scenario MCQs, check whether an advance, deposit or prepaid expense is involved. These are usually non-monetary traps.
Write the date next to every rate you use. It shows the reasoning and reduces rate-selection errors.
Show a journal entry for each exchange difference with the amount and the direction, and finish with the balance sheet carrying amount.

Practice questions from Ind AS 21 The Effects of Changes in Foreign Exchange Rates

Initial Recognition and Subsequent Reporting of Foreign Currency Transactions in other exams

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

Initial Recognition and Subsequent Reporting of Foreign Currency Transactions: frequently asked questions

What is the difference between monetary and non-monetary items in Ind AS 21?

A monetary item gives a right to receive or an obligation to deliver a fixed or determinable number of currency units, such as cash, receivables, payables and loans. A non-monetary item has no such right or obligation, such as PPE, inventory, intangibles and advances for goods or services. The distinction decides which rate you use at the reporting date.

Where are exchange differences on monetary items recognised?

They are recognised in profit or loss in the period in which they arise. This covers differences on settlement and on translation at the closing rate. The exception is a monetary item forming part of a net investment in a foreign operation, which is dealt with separately.

Can an average rate be used for recording transactions?

Yes, for practical reasons, an average rate for a week or month may approximate the spot rate. This is acceptable only if exchange rates do not fluctuate significantly. If they do, use the actual spot rate on the transaction date.

Which rate applies to non-monetary items measured at fair value?

Use the exchange rate on the date when the fair value was measured. Any exchange component of the gain or loss follows the fair value gain or loss, so it goes to OCI if that gain or loss goes to OCI, and to profit or loss otherwise.