Common errors in currency risk sensitivity analysis

If an entity is exposed to risk from a financial instrument, it must disclose summary quantitative data about its exposure to that risk at the end of the reporting period (paragraph 34(a) of IFRS 7 Financial Instruments: Disclosures). This would include exposure to all types of market risk.

The entity is then required to disclose a sensitivity analysis for market risk to which the entity is exposed at the end of the reporting period, showing how profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at that date.

What is market risk?

IFRS 7 defines ‘market risk’ as comprising three types of risk: currency risk, interest rate risk and other price risk (refer to the table below for definitions).

Types of risk	Definition
Currency risk	The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates.
Interest rate risk	The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates.
Other price risk	The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than those arising from interest rate risk or currency risk), whether those changes are caused by factors specific to the individual financial instrument or its issuer or by factors affecting all similar financial instruments traded in the market.

What disclosures are required about market risk?

IFRS 7, paragraph 40, requires entities to disclose the following information about market risk:

Sensitivity analysis: This is required for each type of market risk to which the entity is exposed at the end of the reporting period. Entities must show how profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at that date (both positive and negative changes).
Methods and assumptions: Which ones were used in preparing the sensitivity analysis?
Changes from the previous period: What were the changes to methods and assumptions used, and the reasons for such changes?

This article focuses on common errors we see in practice when entities prepare their foreign currency sensitivity analysis.

Common errors

#1: Sensitivity must be based on the entity’s year-end exposure to currency risk for each class/type of financial instrument, not the average exposure during the reporting period.

#2: The sensitivity impact on profit or loss and equity must be based on a reasonably possible change in the relevant risk variable (currency rates). Therefore, the change used in the sensitivity analysis for a particular currency should not necessarily be the same from year to year, particularly if currency movements are expected to be more or less volatile.

#3: When determining a reasonably possible change in the relevant risk variable, entities must consider changes over the period until the entity next presents its disclosures (usually 12 months).

#4: There is no currency risk on the translation of investments in foreign operations because they are not monetary items.

#5: There is no currency risk on translation of net investment loans where settlement is neither planned nor likely to occur in the foreseeable future.

#6: Loans and derivatives used to hedge translation risk on foreign operations are monetary items and should be included in the sensitivity analysis.

Example

XYZ Limited’s functional and presentation currency is Australian dollars (AUD). It has the following foreign currency exposures at 30 June 2026 (year-end), assuming a reasonably possible five per cent change in all currencies.

	Foreign currency exposure	Foreign currency	Impact on profit or loss (AUD strengthens by 5%)	Impact on profit or loss (AUD weakens by 5%)
Cash	600,000	US dollars (USD)	(30,000)	30,000
Trade creditors	1,500,000	Euro	75,000	(75,000)
Loan to Subsidiary A (repayable by 30 June 2031)	400,000 (average exposure during the period was $200,000)	New Zealand dollars (NZD)	10,000	(10,000)
Investment in foreign subsidiaries, Subsidiary A and Subsidiary B, converted into AUD in consolidated financial statements	1,000,000	New Zealand dollars (NZD)	(50,000)	50,000
Loan to subsidiary B (considered part of XYZ Limited’s net investment because settlement is neither planned nor likely to occur in the foreseeable future)	300,000	US dollars (USD)	(15,000)	15,000
New Zealand denominated loan to hedge its exposure to its investments in New Zealand subsidiaries A and B	1,000,000	New Zealand dollars (NZD)	Nil	Nil

Analysis

The above currency risk sensitivity disclosures apply only to cash and trade creditors. Corrected sensitivity disclosures for the remaining items are shown below.

	Foreign currency exposure	Foreign currency	Impact on profit or loss (AUD strengthens by 5%)	Impact on profit or loss (AUD weakens by 5%)
Cash	600,000	US dollars (USD)	(30,000)	30,000
Trade creditors	1,500,000	Euro	75,000	(75,000)
Loan to Subsidiary A (repayable by 30 June 2031) ^{Note 1}	400,000 (average exposure during the period was $200,000)	New Zealand dollars (NZD)	(20,000)	20,000
Investment in foreign subsidiaries, Subsidiary A and Subsidiary B, converted into AUD in consolidated financial statements ^{Note 2}	1,000,000	New Zealand dollars (NZD)	N/A	N/A
Loan to subsidiary B (considered part of XYZ Limited’s net investment because settlement is neither planned nor likely to occur in the foreseeable future) ^{Note 3}	300,000	US dollars (USD)	N/A	N/A
New Zealand denominated loan payable to hedge its exposure to its investments in New Zealand subsidiaries A and B ^{Note 4}	1,000,000	New Zealand dollars (NZD)	50,000	(50,000)

Note 1: Loan to Subsidiary A – Not considered a net investment loan

The loan to Subsidiary A is not considered a net investment loan and is, therefore, subject to the currency risk sensitivity disclosures.

The amount disclosed for currency sensitivity of $200,000 X 0.5% = $10,000 is incorrect because it is based on the average currency exposure during the period, rather than the year-end exposure (see common error #1). The correct exposure is $400,000 X 5% = $20,000.

In addition, the direction of the profit or loss impact is incorrect. That is, if there is a 5 per cent strengthening of the AUD against the NZD, XYZ Limited will receive AUD 20,000 less for the proceeds of its loan (and a debit to profit or loss), whereas a 5 per cent weakening of the AUD against the NZD will result in additional proceeds of AUD 20,000 (a credit to profit or loss).

Note 2: Investment in foreign subsidiaries, Subsidiary A and Subsidiary B, converted into AUD in consolidated financial statements

Translating the financial statements of a foreign subsidiary from its functional currency into the presentation currency of XYZ Limited (translation-related risk) is not included in the sensitivity analysis because foreign currency risk can only arise on financial instruments that are denominated in a currency other than the functional currency in which they are measured. IFRS 7.B23 also states that for the purposes of IFRS 7, currency risk does not arise from financial instruments that are non-monetary items. The investments in Subsidiary A and Subsidiary B (the foreign operations) are not monetary items. See common error #4.

‘Monetary items’ are defined in IAS 21 as being units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.

Note 3: Net investment loan to Subsidiary B

A net investment loan is considered to be part of XYZ Limited’s investment in Subsidiary B and is, therefore, not included in the sensitivity analysis as it is a translation-related risk. See common error #5.

Note 4: New Zealand denominated loan to hedge its exposure to its investments in New Zealand subsidiaries A and B

Loans and derivatives used to hedge translation risk on foreign operations are monetary items and should be included in the sensitivity analysis. This means that the loan/derivative used to hedge a foreign operation is included in the sensitivity analysis, but the foreign operation translation risk is not included. See common errors #4 and #6.

However, in such cases, additional information may be provided to explain how the entity is managing its translation-related risks together with its currency risks from transactions, i.e. how the hedge loan/derivative relates to the translation of the foreign operation.

What if interest rate changes are more volatile?

In our example, at 30 June 2026, XYZ Limited considers a five per cent strengthening and weakening of all currencies against the Australian dollar to be reasonably possible over the next 12 months. To avoid common error #2, XYZ Limited should review expectations for individual currencies and assume different variations (where relevant). In addition, XYZ Limited must consider changes over the period until the entity next presents its disclosures (usually 12 months). See common error #3.

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