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

Ind AS 21: Scope, Definitions and Functional Currency

Updated 5 October 2026 · Fact-checked

Ind AS 21 governs foreign currency transactions and foreign operations. Functional currency is the currency of the primary economic environment in which the entity operates. To determine it, apply the primary indicators (sales prices, competition, costs), then secondary indicators (financing, retained receipts), then extra factors for foreign operations. Presentation currency is only the currency of the financial statements.

Understand Scope, Definitions and Functional Currency

Every entity must measure its books in one currency. Ind AS 21 calls it the functional currency. All transactions in other currencies are foreign currency transactions and must be translated into the functional currency. The standard does not let management simply pick a currency. It must be the currency of the primary economic environment, which is usually where the entity mainly generates and spends cash.

Presentation currency is different. It is the currency in which the financial statements are shown. Ind AS 21 in general allows an entity to present in any currency. But for Indian companies it is not a free choice: Schedule III of the Companies Act mandates Indian rupees as the presentation currency. If the presentation currency differs from the functional currency, the entity translates its results and position into it. Many Indian companies have the rupee as both, so no translation is needed.

A foreign operation is a subsidiary, associate, joint arrangement or branch whose activities are based in a country or currency other than the reporting entity's. Each entity within a group determines its own functional currency. A parent in India can have a US subsidiary with a USD functional currency, and the consolidated statements are presented in rupees.

The standard applies to: accounting for transactions and balances in foreign currencies, translating the results and financial position of foreign operations included by consolidation or the equity method, and translating an entity's results and position into a presentation currency.

It does not apply to derivatives that are within the scope of Ind AS 109, or to hedge accounting for foreign currency items, including hedges of a net investment in a foreign operation. Ind AS 109 covers those. Ind AS 21 still applies to foreign currency derivatives that are not within the scope of Ind AS 109. It also does not apply to the presentation in the statement of cash flows of cash flows from foreign currency transactions, or to the translation of cash flows of a foreign operation. Ind AS 7 covers those.

Other key terms: closing rate is the spot rate at the end of the reporting period. Spot exchange rate is the rate for immediate delivery. Exchange difference arises from reporting the same units of a foreign currency at different rates. Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency. Net investment in a foreign operation is the reporting entity's interest in the net assets of that operation. It includes monetary items receivable from or payable to the foreign operation whose settlement is neither planned nor likely to occur in the foreseeable future.

Key rules to remember

Functional currency: Currency of the primary economic environment in which the entity operates; That environment is normally the one in which it primarily generates and expends cash.
Primary indicators: (a) currency influencing sales prices; (b) currency of the country whose competitive forces and regulations mainly determine sales prices; (c) currency mainly influencing labour, material and other costs; Consider these first. They carry more weight than the secondary indicators.
Secondary indicators: (a) currency in which funds from financing are generated; (b) currency in which receipts from operating activities are usually retained; Use as supporting evidence when the primary indicators are mixed.
Additional factors for a foreign operation: Autonomy from the reporting entity; volume of transactions with the reporting entity; whether cash flows directly affect the reporting entity and are available for remittance; whether cash flows are sufficient to service debt without parent funds; These are considered together with the primary and secondary indicators. If the operation is an extension of the parent, its functional currency is usually the parent's.
Presentation currency: Currency in which financial statements are presented (Ind AS 21 in general allows any currency; for Indian companies Schedule III mandates Indian rupees); It is not determined from the entity's economic environment. For Indian companies it is mandated as INR, not chosen. Functional currency is a determination from facts.
Priority rule: Primary indicators first, then secondary and foreign operation factors; when indicators are mixed and the answer is not obvious, management uses judgement to pick the currency that most faithfully represents the economic effects; Management gives priority to the primary indicators first.

How to solve Scope, Definitions and Functional Currency questions

Use this sequence for any question that asks you to identify the functional currency or state whether Ind AS 21 applies.

1Identify the reporting entity and any foreign operations. Decide the functional currency of each entity separately.
2Check scope: is it a foreign currency transaction or a foreign operation translation, or is it a derivative or hedge (Ind AS 109)?
3List the primary indicators: currency of selling prices, competitive forces and regulation, and the currency of main costs.
4If the primary indicators clearly point to one currency, conclude. Do not let financing or cash retention override them.
5If they are mixed, apply the secondary indicators: currency of financing and the currency in which operating receipts are retained.
6For a foreign operation, test the extra factors together with the indicators: autonomy, volume of dealings with the parent, cash flow impact on the parent, and ability to service debt.
7If the answer is still not obvious, use judgement and choose the currency that most faithfully represents the economic effects of the underlying transactions. State your reasoning.
8Separate the functional currency from the presentation currency. State that translation is needed only if the two differ, then close with a clear conclusion.

Quickest way: Costs and prices first

When to use it: Use in case-scenario MCQs and short written answers where time is limited.

Underline the currency of selling prices and the currency of main costs in the case.
If both match one currency, that is the functional currency. Stop there.
If they differ, look at financing and retained receipts as supporting evidence.
For a subsidiary, ask: is it an extension of the parent or does it run on its own? Extension means parent's currency.
Write the conclusion, then add one line distinguishing presentation currency.

Common mistakes in Scope, Definitions and Functional Currency

Treating functional currency as a free choice of management or the currency in which shares are listed or the books are kept.
Ind AS 21 in general lets an entity choose its presentation currency, and students carry this over to functional currency.
Fix: State that functional currency is determined from facts about the primary economic environment. It is not chosen. Presentation currency is a separate matter, and for Indian companies Schedule III mandates the rupee.
Giving financing currency or the currency of retained cash priority over sales prices and costs.
Borrowing in dollars looks like strong evidence.
Fix: Financing and retained receipts are secondary indicators. Use them only to support or when the primary indicators are mixed.
Assuming a foreign subsidiary always has the local currency as its functional currency.
Students link a foreign country automatically with its local currency.
Fix: Test the additional factors. A subsidiary that is merely an extension of the parent, with sales and costs in the parent's currency, has the parent's functional currency.
Saying all entities in a group must have the same functional currency.
Confusion with consolidated presentation currency.
Fix: Each entity, including each foreign operation, determines its own functional currency. Only the consolidated statements use one presentation currency.
Including hedge accounting for foreign currency items within the scope of Ind AS 21.
Both topics deal with exchange rates.
Fix: Hedge accounting, including a hedge of a net investment, falls under Ind AS 109. Ind AS 21 covers translation and exchange differences.
Calling any loan to a foreign operation part of the net investment.
The terms are used loosely.
Fix: Only a monetary item receivable from or payable to the foreign operation whose settlement is neither planned nor likely in the foreseeable future forms part of the net investment.

Worked examples

Example 1

Case: Kaveri Ltd, an Indian company, manufactures software hardware for export. Sales are invoiced and priced mainly in US dollars because global competition sets the price in dollars. Most raw materials are imported and priced in dollars. Wages and local overheads in India are paid in rupees. It has taken a rupee loan from an Indian bank and keeps its export receipts in dollars in an EEFC account. Determine its functional currency and say whether presentation currency must be the same.

Show the solution

Primary indicators: selling prices are influenced by global competition in dollars, and major costs (materials) are in dollars. Both point to the US dollar.
Wages and overheads in rupees are a lesser part of costs and do not override the main costs.
Secondary indicators: financing is in rupees (points to INR) and receipts are retained in dollars (points to USD). They are mixed and cannot override clear primary indicators.
Conclusion: the primary indicators prevail, so functional currency is the US dollar.
Presentation currency need not be the same as functional currency. Ind AS 21 in general allows any presentation currency, but for Indian companies Schedule III mandates rupees, so Kaveri Ltd must present in rupees. Since this differs from the functional currency, the results and position are translated into rupees.

Answer: Functional currency is the US dollar, based on the primary indicators. Presentation currency need not be the same. As an Indian company, Kaveri Ltd must present in rupees as mandated by Schedule III, with translation from the functional currency.

Example 2

Case: Alpha India Ltd (INR functional) has a wholly owned subsidiary, Alpha UK, which sells Alpha India's products in the UK. Alpha UK buys all its goods from Alpha India at prices in rupees. Alpha India sets Alpha UK's selling prices in rupee terms and decides its credit policy, and Alpha UK remits its sales proceeds to Alpha India every month. It has no independent financing. Determine the functional currency of Alpha UK.

Show the solution

Identify Alpha UK as a foreign operation. For a foreign operation, the primary and secondary indicators and the additional factors are considered together, not one after the other.
Autonomy: low, because Alpha India decides prices and credit policy. This suggests an extension of the parent.
Volume of transactions with the parent: high, since all purchases are from Alpha India.
Cash flows: they directly affect Alpha India and the sales proceeds are remitted every month.
Debt servicing: Alpha UK has no independent financing and depends on the parent.
Primary indicators: selling prices are set by Alpha India in rupee terms, and the main cost (goods) is priced in rupees. Customers pay in pounds, but the pound does not drive pricing or costs.
Weigh the evidence: the indicators and the additional factors all point the same way. Alpha UK is an extension of the parent, so the parent's currency applies.

Answer: Alpha UK's functional currency is the Indian rupee, the same as its parent, because it operates as an extension of Alpha India. Its pound transactions are foreign currency transactions to be translated into rupees.

Exam tips

In case MCQs, find the currency of sales prices and main costs first. Most options can be eliminated on that alone.
In written answers, name the indicators as primary and secondary. Use a short list and then a conclusion line.
Always write one sentence that functional currency is determined from facts, and that presentation currency is separate: for Indian companies it is mandated as INR by Schedule III.
For foreign operations, quote the extension-of-parent test. Examiners often build a subsidiary case around it.
Check whether a question mentions a derivative or hedge. If so, say that Ind AS 109 governs it.

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

Scope, Definitions and Functional Currency in other exams

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

Scope, Definitions and Functional Currency: frequently asked questions

What is the difference between functional and presentation currency in Ind AS 21?

Functional currency is the currency of the primary economic environment in which the entity operates. It is determined from facts. Presentation currency is the currency in which financial statements are presented. Ind AS 21 in general lets an entity choose any presentation currency, but for Indian companies Schedule III mandates Indian rupees.

Which indicators decide the functional currency?

Primary indicators come first: the currency of sales prices and the currency of main costs, together with the competitive forces and regulations that set prices. Secondary indicators are the currency of financing and the currency in which operating receipts are retained. Foreign operations have extra factors such as autonomy and cash flow dependence on the parent.

Can a group have different functional currencies?

Yes. Each entity in the group determines its own functional currency. The consolidated financial statements are then presented in one presentation currency, with the foreign operations translated into it.

Does Ind AS 21 cover hedge accounting?

No. Hedge accounting for foreign currency items, including hedges of a net investment in a foreign operation, is covered by Ind AS 109. Ind AS 21 covers transactions, translation of foreign operations and exchange differences.