Full explanation
Overview
Meridian buys inventory from a US supplier for one hundred and twenty thousand dollars. At the exchange rate that day, that's one hundred thousand pounds on the books. By year end, without one cent changing hands, that same debt is worth ninety-six thousand pounds. Nobody negotiated a discount. The exchange rate just moved.
IAS twenty-one covers the effects of changing foreign exchange rates. IAS twenty-nine covers something rarer and more extreme — accounting when a currency itself is collapsing under hyperinflation.
Who does what
IAS twenty-one: which currency should you even be measuring in, and how do you translate transactions in a different one. IAS twenty-nine: what happens once a currency is losing value so fast that historical cost stops meaning anything.
Functional vs presentation
Functional currency isn't a choice — it's a fact-finding exercise. Ask what currency mainly drives the entity's sales prices, and what currency mainly drives its labour and material costs. For Meridian's UK parent, that's pounds. Presentation currency, by contrast, IS a choice — a group can present in a currency different from any entity's functional currency, for investors' convenience.
Primary, then secondary
How you actually determine it. Two PRIMARY indicators lead: the currency that mainly influences SALES prices — usually the one they're denominated and settled in — and the currency that mainly influences LABOUR, material and other costs. If those two don't point the same way, two SECONDARY indicators break the tie: the currency funds are raised in from financing, and the currency operating receipts are usually retained in. Management judgement, not a formula — but a genuinely structured one.
A four-thousand-pound gain
Meridian's inventory purchase, worked through. On the transaction date, the spot rate is one point two zero dollars to the pound: one hundred and twenty thousand dollars translates to one hundred thousand pounds payable. At year end, unpaid, the rate has moved to one point two five: that same one hundred and twenty thousand dollars now translates to only ninety-six thousand pounds. Because this is a PAYABLE — a liability owed to the supplier — needing FEWER pounds to settle it is an FX GAIN, straight to profit or loss. Flip it around: if this had been a RECEIVABLE from a customer instead, the exact same rate move would produce a LOSS — the same fewer pounds now coming IN, not going out. Same rate movement, opposite answer, depending purely on which side of the balance sheet the monetary item sits.
Not everything on the balance sheet gets that treatment — the rate you use depends entirely on what kind of item you're looking at.
Monetary vs non-monetary
Monetary items — cash, receivables, payables, loans — are retranslated at the closing rate every single reporting date, and the movement hits profit or loss. Non-monetary items — inventory, property, plant and equipment carried at cost — stay frozen at the HISTORICAL rate on the transaction date and are never retranslated. In practice, most systems use an AVERAGE rate for translating income and expense lines through the year, as a reasonable approximation of the spot rate on each transaction date — but that shortcut breaks down and is NOT acceptable when rates moved sharply or unevenly during the period.
Buying, selling, or mid?
One practical question trips up almost every preparer: WHICH rate, when your bank quotes you a buying rate and a selling rate, not one number? Neither, strictly. The standard just says the spot rate — and in practice, when several rates are quoted, entities use the MID rate: the midpoint between the buying and selling quotes. Not the rate you'd actually get cash at, but the reasonable, consistent number used for reporting. Closing rate for the balance sheet, average rate for profit or loss — both usually taken as mid-market.
Weighted, not straight-line
And that average rate isn't one number pulled from thin air. The standard approach: take each month's closing rate across the year, then weight it by that month's actual income and expense volume — not a simple straight-line average. Suppose three months quote one point two eight, one point two five, and one point two two dollars to the pound, and sales split forty, thirty, thirty percent across those months. The weighted average comes out to one point two five three — different from the simple average of one point two five, and it's this weighted figure that goes into translating the income statement.
A transaction, or a whole operation
Notice something about Meridian's four-thousand-pound gain: it went straight to profit or loss, because it came from a transaction the entity itself entered into. That's the general rule. But translating an entire FOREIGN OPERATION for consolidation follows a completely different path — and that's where most of the real complexity actually sits.
Four million expected
Meridian's US subsidiary, translated for the group accounts. Opening net assets: five million dollars, at an opening rate of one point two five, gives four million pounds. The subsidiary earns five hundred thousand dollars of profit during the year, translated at the average rate of one point two five: four hundred thousand pounds added through the income statement. So far, that's four million four hundred thousand pounds expected. But the closing rate has moved to one point one zero — the dollar has strengthened — and closing net assets of five million five hundred thousand dollars translate to a full five million pounds.
£600,000 translation reserve
Five million pounds actual, against four million four hundred thousand expected: a six-hundred-thousand-pound gap. That's the foreign currency translation reserve — and unlike the four-thousand-pound transaction gain, it does NOT go through profit or loss. It sits in OTHER COMPREHENSIVE INCOME, inside equity, purely because exchange rates moved while translating someone else's functional-currency results into the group's presentation currency. It stays there — until the day the subsidiary is SOLD, at which point the accumulated reserve is recycled out of equity and INTO profit or loss as part of the gain or loss on disposal.
Goodwill moves too
One more piece of the consolidation puzzle, and it catches people out. When Meridian acquired that US subsidiary, any GOODWILL that arose, and any FAIR-VALUE ADJUSTMENTS to the subsidiary's assets and liabilities on acquisition, are treated as assets and liabilities OF THE FOREIGN OPERATION itself — expressed in the subsidiary's functional currency, dollars, and then retranslated at the CLOSING rate every reporting date, right alongside everything else. Goodwill isn't frozen at the historical rate it was measured at. It moves with the currency, and the difference feeds that same translation reserve.
Now take a currency where the number on the price tag changes before you've finished shopping.
Roughly 100% in 3 years
IAS twenty-nine applies once an economy is judged hyperinflationary — the standard's own trigger is CUMULATIVE inflation approaching or exceeding one hundred percent over three years, alongside qualitative signs: prices quoted in a stable foreign currency, wages linked to a price index, interest rates tracking inflation day to day. Argentina, Lebanon and several other economies have qualified in recent years — this isn't a purely theoretical scenario.
A 2.5× multiplier
The mechanics: restate NON-monetary items using a general price index. If the index has moved from one hundred to two hundred and fifty over the period — a two-and-a-half-times multiplier — then property carried at ten million in local currency is restated to twenty-five million, just to express it in year-end purchasing power. MONETARY items are NOT restated this way — they're already stated in year-end currency units. But holding monetary assets through a hyperinflationary period is itself a loss: cash sitting still while prices race ahead loses real purchasing power, and that net monetary loss is recognised directly in profit or loss.
Restated every year
Comparatives don't get left alone either. Say last year's revenue was reported as five million, in last year's terms. If the price index has risen a further fifty percent since then, THIS year's comparative column shows that same revenue restated to seven million five hundred thousand — not because the business grew, but because the measuring stick shrank. Every prior-period figure is re-expressed in the CURRENT period-end measuring unit, every single year, for as long as the economy stays hyperinflationary.
When growth is an illusion
From an investor's chair, this is where nominal growth becomes dangerous. A hyperinflation-economy subsidiary can show forty percent revenue growth that's entirely index-driven — zero real growth once restated income is compared like-for-like. Analysts strip out the net monetary gain or loss line and focus on the RESTATED trend, not the eye-catching nominal percentage a headline might quote.
IFRIC 22 & a 2025 amendment
Two more pieces sit alongside these standards. IFRIC twenty-two settles a genuinely common question: pay or receive money in a foreign currency BEFORE the related revenue or expense is recognised, and the transaction date for translation is the date of that ADVANCE payment or receipt — not the date of the sale or purchase it eventually relates to. And a real, currently-effective amendment: IAS twenty-one's Lack of Exchangeability rules, effective from January twenty twenty-five, require an entity to assess whether a currency can actually be exchanged into another — and if not, to ESTIMATE the spot rate and disclose how, directly relevant to the same hyperinflationary and sanctioned economies already on screen.
You just stop restating
And when an economy finally comes OUT of hyperinflation? You simply STOP restating. The last set of figures — already expressed in the measuring unit current at that final period end — becomes the new historical cost baseline going forward. No reversal, no unwinding of everything already restated: that adjustment is locked in, and ordinary historical-cost accounting resumes from there.
None of this stays trapped in a note at the back of the accounts — it moves real numbers on real statements.
Follow the item
Under IFRS eighteen, FX gains and losses follow the item they relate to — Meridian's four-thousand-pound gain on a trade payable sits in OPERATING, because the underlying payable is operating. Exchange differences on borrowings sit in FINANCING. The translation reserve movement itself is presented within other comprehensive income, outside the new categories entirely.
What has to be shown
IAS twenty-one disclosure: the amount of exchange differences recognised in profit or loss, the net amount in other comprehensive income with a RECONCILIATION of that reserve from opening to closing, and the functional currency used where it differs from the presentation currency, with the reason why. And if the functional currency itself CHANGES during the period — that fact, the reason, and the date of change must all be disclosed. IAS twenty-nine disclosure: the fact that the financial statements have been restated for changing purchasing power, the identity of the price index used and its movement over the period, and whether the figures are based on a historical cost or a current cost approach.
Three real exposures
Where this actually bites. Importers and exporters carry FX exposure on every unsettled invoice, exactly like Meridian's four-thousand-pound swing. Multinational groups with subsidiaries in several currencies watch the translation reserve move every single reporting period, sometimes by more than that year's actual profit. And any group with an operation in a hyperinflationary economy — Argentina, Lebanon, and others that have qualified in recent years — must restate that subsidiary's entire set of financial statements before it's even translated into the group's currency.
Put Meridian's own numbers together, start to finish.
Trading, or currency
Meridian's US subsidiary, reconciled. Opening net assets, four million pounds. Plus profit for the year at the average rate, four hundred thousand pounds. Plus the foreign currency translation reserve, six hundred thousand pounds, recognised in other comprehensive income because the closing rate moved. Closing net assets: five million pounds — a figure built from trading results AND from currency movement, and IAS twenty-one is what tells you which is which.