Amendments to Ind AS 21: Lack of exchangeability

Amendments to Ind AS 21: Lack of exchangeability

Indian Accounting Standard (Ind AS) 21, The Effects of Changes in Foreign Exchange Rates, among other matters, prescribes principles to determine exchange rates for recording foreign currency transactions in an entity's functional currency and for translating the financial statements of a foreign operation into a different presentation currency. Generally, it requires entities to use the spot exchange rate for this purpose.

In most cases determining an exchange rate is a relatively straightforward exercise, but this is not always the case, particularly where there are restrictions on entities wishing to exchange one currency for another, typically a local currency for a foreign currency. For example:

• Legal restrictions might permit sales of local currency only at an official rate rather than a rate that reflects more fully market participants’ views of the currency’s relative value or its underlying economics. Those official rates might or might not be pegged to another country’s currency, for example the US Dollar (USD).
• Exchange rates set by governments might vary according to the nature of the underlying transaction.
• The volume of currency that can be exchanged through official mechanisms may be limited by formal or informal restrictions imposed by the government, often designed to help manage the government’s sometimes scarce foreign exchange reserves.

These situations are often encountered in countries that have more of a closed economy and which may be experiencing a degree of economic strain. High inflation or even hyperinflation and devaluations can be indicators of these situations as can the development of a so called ‘black market’ in foreign currencies, the use of which could to some extent be unlawful. Determining an appropriate exchange rate to use in these circumstances can be difficult.

Until recently, Ind AS 21 set out the exchange rate to be used when exchangeability between two currencies is temporarily lacking, It stated that if exchangeability between two currencies is temporarily lacking, the rate used is the first subsequent rate at which exchanges could be made. However, it did not state what should be done when lack of exchangeability is not temporary.

To address the above issue, the Ministry of Corporate Affairs (MCA), on 7 May 2025, notified an amendment to Ind AS 21. The amendment will add requirements to Ind AS 21 that help entities determine whether a currency is exchangeable into another currency, and the spot exchange rate to use when it is not.

The amendment applies to a financial year beginning on or after 1 April 2025.

Amendment to Ind AS 21

This amendment clarifies how an entity should assess whether a currency is exchangeable and how it should determine a spot exchange rate when exchangeability is lacking, as well as require the disclosure of information that enables users of financial statements to understand the impact of a currency not being exchangeable.

Two-step approach

The amendment provides a two-step approach to determine the exchange rate to be applied when translating a foreign currency transaction, as illustrated below:

Assessing exchangeability and estimating a spot exchange rate

Step 1: Assessing whether a currency is exchangeable

Under the amendment, a currency is considered to be exchangeable into another currency when an entity is able to obtain the other currency:

• Within a timeframe that allows for a normal administrative delay, and
• Through a market or exchange mechanism in which the transaction would create enforceable rights and obligations.

An exchange transaction might not always complete instantaneously because of legal or regulatory requirements, or for practical reasons such as public holidays, but such normal administrative delays do not preclude a currency from being exchangeable into the other currency. What constitutes a normal administrative delay will depend on facts and circumstances. Thus, when an entity cannot obtain a specified currency immediately, it will need to assess the time period required in the context of the customary provisions in the market or country to determine whether it can be considered ‘normal’. In making this assessment, an entity may also consider past precedents, if any. For example, in some countries, the relevant authority may require an administrative process to be completed before making a particular currency available. If the authority typically takes a fixed number of days to complete this administrative step, one may argue that this period of time is a normal administrative delay.

An entity assesses whether a currency is exchangeable into another currency at a measurement date and for a specified purpose. In making that assessment, an entity must consider its ability to obtain the other currency, rather than its intention or decision to do so. A currency is not exchangeable into the other currency if the entity is able to obtain no more than an insignificant amount of the other currency at the measurement date for the specified purposes. Furthermore, in making the assessment, an entity only considers markets or exchange mechanisms in which a transaction to exchange the currency for the other currency would create enforceable rights and obligations, meaning that so-called unofficial, parallel or black markets would not be considered. Enforceability is a matter of law and depends on facts and circumstances.

The amendment notes that different exchange rates may be available for different uses of a currency (e.g., imports of specific goods and distribution of dividends). Therefore, an entity is required to assess whether a currency is exchangeable into another currency separately for each particular purpose. In assessing exchangeability:

• When an entity reports foreign currency transactions in its functional currency, the entity is required to assume its purpose in obtaining the other currency is to realize or settle individual foreign currency transactions, assets or liabilities.
• When an entity uses a presentation currency other than its functional currency, the entity assumes its purpose in obtaining the other currency is to realize or settle its net assets or net liabilities.
• When an entity translates the results and financial position of a foreign operation into the presentation currency, the entity assumes its purpose in obtaining the other currency is to realize or settle its net investment in the foreign operation.
  
  

This assessment of whether a currency is exchangeable into another currency is required to be performed separately for each of the three purposes specified above. For example, an entity assesses exchangeability for the purpose of reporting foreign currency transactions in its functional currency separately from exchangeability for the purpose of translating the results and financial position of a foreign operation.

This assessment of whether a currency is exchangeable into another currency is required to be performed separately for each of the three purposes specified above. For example, an entity assesses exchangeability for the purpose of reporting foreign currency transactions in its functional currency separately from exchangeability for the purpose of translating the results and financial position of a foreign operation.

Step 2: Estimating the spot exchange rate when a currency is not exchangeable

The objective of estimating the spot exchange rate at a measurement date is to determine the rate at which an orderly exchange transaction would take place at that date between market participants under prevailing economic conditions. The amendment does not specify how an entity estimates the spot exchange rate to meet the objective, but it notes that an entity can use an observable exchange rate without adjustment or another estimation technique. Judgement is required to determine the most appropriate method to meet the objective of the requirements.

Using an observable exchange rate without adjustment

An entity can use an observable rate if that rate satisfies the estimation objective, i.e., the rate reflects the price at which an orderly exchange transaction would take place at the measurement date between market participants under prevailing economic conditions.

Examples of observable rates that might be used as an estimate of the spot exchange rate are:

• Using an observable exchange rate for another purpose:
  A currency that is not exchangeable into another currency for one purpose might be exchangeable into that currency for another purpose. For example, an entity might be able to obtain a currency to import specific goods but not to pay dividends. In such situations, the entity might conclude that an observable exchange rate for another purpose meets the objective in the standard. If the rate meets that objective, an entity may use that rate as the estimated spot exchange rate. In assessing whether such a rate meets the objective above, an entity is required to consider factors such as:
  • Whether multiple observable exchange rates exist –
    The existence of more than one observable exchange rate might indicate that exchange rates are set to encourage, or deter, entities from obtaining the other currency for particular purposes. These observable exchange rates might include an ‘incentive’ or ‘penalty’ and therefore might not reflect the prevailing economic conditions.
  • The purpose for which the currency is exchangeable
    – If an entity is able to obtain the other currency only for limited purposes (such as to import emergency supplies), the observable exchange rate might not reflect the prevailing economic conditions.
  • The nature of the exchange rate –
    A free-floating exchange rate is more likely to reflect prevailing economic conditions than one set through reg
  • The frequency of updates to the exchange rates -
    If an observable exchange rate remains unchanged over a period of time, it is less likely to reflect prevailing economic conditions than one that is updated regularly.
• Using the first subsequent exchange rate:
  A currency that is not exchangeable into another currency at the measurement date for a specified purpose might subsequently become exchangeable into that currency for that purpose. In such situations, an entity might conclude that the first subsequent exchange rate meets the objective in the standard. If the rate meets that objective, an entity may use that rate as the estimated spot exchange rate. In assessing whether such a rate meets the objective above, an entity is required to consider factors such as:
  • The period of time between the measurement date and the date that exchangeability is restored –The longer this period, the less likely the first subsequent rate reflects the economic conditions at the measurement date.
  • Inflation – When an economy is subject to high inflation, including when an economy is hyperinflationary, prices often change quickly, perhaps several times a day. Accordingly, the first subsequent exchange rate for a currency of such an economy might not reflect the prevailing economic conditions.

Using another estimation technique

An entity using another estimation technique may use any observable exchange rate, including rates from exchange transactions in markets or exchange mechanisms that do not create enforceable rights and obligations, and adjust that rate, as necessary, to meet the objective stated above. In other words, in contrast to the position in Step 1, entities are not prohibited from considering many so-called unofficial, parallel or black markets in Step 2.

If both exchange rates and inflation rates are required to be estimated for a currency that is hyperinflationary, consistent assumptions should be used in making both estimates.

Disclosure requirements

When an entity estimates a spot exchange rate because a currency is not exchangeable into another currency, it discloses information that enables users of its financial statements to understand how the currency not being exchangeable into the other currency affects, or is expected to affect, the entity’s financial performance, financial position and cash flows. To meet this objective, an entity is required to disclose information about:

• The nature and financial effects of the currency not being exchangeable into the other currency
• The spot exchange rate(s) used
• The estimation process, and
• The risks to which the entity is exposed because of the currency not being exchangeable into the other currency. An entity is required to consider how much detail is necessary to satisfy the above disclosure objective. The amendments also specify minimum disclosures to be made including when a foreign operation’s functional currency is not exchangeable into the presentation currency and vice versa.

Effective date and transition

The amendment is effective for the financial year beginning on or after 1 April 2025. The date of initial application is the beginning of the annual reporting period in which an entity first applies the amendment. When an entity first applies the amendment, it is not permitted to restate comparative information. Instead, the entity is required to translate the affected amounts at estimated spot exchange rates at the date of initial application, with an adjustment to retained earnings (if between foreign and functional currency) or to the reserve for cumulative translation differences (if between functional and presentation currency).

How we see it

A lack of exchangeability might arise when a government imposes currency controls in response to macro-economic instability and balance-of-payments problems. In addition, the currencies of hyperinflationary economies often experience a lack of exchangeability. The amendments provide helpful guidance on accounting for a lack of exchangeability and are expected to reduce the existing diversity in practice.

The application of the amendments requires a significant degree of judgement and a good understanding of the facts and circumstances regarding the currencies that suffer from a lack of exchangeability. In addition, the amendments introduce detailed new disclosure requirements. Therefore, it is important for entities to start evaluating the potential impact of these amendments in a timely manner.