Auditing foreign currency balances
How to audit foreign currency transactions and balances under IAS 21: functional currency, year-end rates and currencies that are hard to exchange.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A Kenyan flower exporter invoices buyers in euro. A Nigerian manufacturer owes a supplier in US dollars. A South African importer holds a dollar bank account to pay for shipments. In each case, the figure in the financial statements depends on an exchange rate someone chose, on a date someone chose, and on a view about which currency the business really operates in.
Foreign currency balances look mechanical: take the balance, multiply by a rate. The audit risk lies in the choices behind the multiplication. This article covers how to audit foreign currency transactions and balances under IAS 21, including what to do when a currency cannot readily be exchanged.
Functional currency first
The IFRS Foundation describes IAS 21 as setting out how an entity accounts for foreign currency transactions, translates the statements of a foreign operation into its functional currency, and translates its own statements into a presentation currency if that is different. It identifies the principal issues as which exchange rates to use and how to report the effects of changes in rates.
Everything starts with the functional currency. IAS 21 defines it as the currency of the primary economic environment in which the entity operates, the environment in which it primarily generates and spends cash. Any other currency is a foreign currency.
For most clients the answer is obvious: a Johannesburg retailer's functional currency is the rand. But not always. A Nigerian oil services company that prices contracts, earns and pays mainly in dollars may have the dollar as its functional currency, even though it is based in Lagos. Test the client's conclusion:
- In which currency are sales prices set and settled?
- In which currency are the main costs, such as labour and materials, incurred?
- In which currency is finance raised and are operating receipts kept?
If the functional currency is wrong, every translation that follows is wrong too.
Transactions in a foreign currency versus foreign operations
The IFRS Foundation's summary explains that an entity may carry on foreign activities in two ways: through transactions in foreign currencies, or through foreign operations. The audit work differs.
Foreign currency transactions are the client's own purchases, sales, loans and bank accounts in another currency. Test these on the client's own books.
Foreign operations are subsidiaries, branches or associates whose activities are based in another country or currency. Their statements are translated as a whole, usually on consolidation or for inclusion of a branch. A Kenyan company with a Ugandan branch has a foreign operation; a Kenyan company that only buys from Uganda has foreign currency transactions.
Identify which situation applies before choosing procedures.
Rates at the transaction date and at year end
The client's accounting policy should state which rate applies to which items. Test the client against its policy and the standard:
- Transactions in the year. For a sample of foreign currency sales, purchases and payments, agree the rate used to an independent source for that date, and recompute the amount recorded.
- Balances at year end. List the foreign currency receivables, payables, loans and bank accounts, and agree the rate used at year end to an independent source. Recompute each translated balance.
- Exchange differences. Agree the gains and losses recognised in profit or loss to the recalculations, and check whether any were taken elsewhere without a basis in the policy.
- Settled items. For balances settled after year end, compare the amount actually paid or received with the year-end figure, which is a useful reasonableness check.
For the bank accounts themselves, foreign currency bank confirmations and statements should be agreed in the original currency before translation. Our article on auditing bank and cash covers those confirmations.
When a currency cannot readily be exchanged
The IFRS Foundation states that Lack of Exchangeability, the amendments to IAS 21 issued in August 2023, requires an entity to apply a consistent approach in assessing whether a currency is exchangeable into another currency and, when it is not, in determining the exchange rate to use and the disclosures to provide.
This matters for clients with operations or balances in currencies where access to foreign exchange is restricted. Where a client says it could not obtain foreign currency at the official rate, or used a rate other than the published one, the audit work should cover:
- the client's assessment of whether the currency was exchangeable at the measurement date, and the evidence behind it;
- the rate the client used where it concluded the currency was not exchangeable, and how it was estimated;
- the disclosures the client provides about the situation.
Treat the rate as an accounting estimate, with the same challenge and scepticism; our guide to auditing accounting estimates sets out the approach. Confirm from the IFRS Foundation's page when the amendments apply to the client's period.
Recalculations and adjustments in Achekam
In Achekam, a working paper can carry a spreadsheet workbook whose figures refresh from the engagement's trial balance, and any figure the workbook could not read is listed. That suits a year-end retranslation: list the foreign currency balances, apply the rates you obtained independently, and compare with the trial balance. Refreshing is refused on a locked file or on a paper under review, so a reviewed retranslation does not move.
The foreign currency lines in the lead schedules trace back to the trial balance lines behind them. Where the recalculation shows an error, such as a balance left at the transaction-date rate, staff record an audit adjustment on the line with a reason and raise a finding from the working paper, closed or withdrawn later.
Disclosure checks
- The functional currency and, if different, the presentation currency are stated.
- The accounting policy for foreign currency transactions and translation describes what the client does.
- Exchange differences recognised in profit or loss are disclosed where the framework requires.
- Where a currency was not exchangeable, the required information about the situation and the rate used is given.
The IFRS Foundation's summary of IAS 21 covers the functional currency, the two kinds of foreign activity and the Lack of Exchangeability amendments, and is the place to confirm requirements and effective dates.
On your next client with foreign currency balances, ask at planning for a list of every account held or owed in another currency and the rate source the client uses. Agreeing the rates is quick; finding a forgotten dollar account after the report is signed is not.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
