Functional Currency

Functional Currency

Popular with multinationals, functional currency represents the primary economic environment in which an entity generates and expends cash. With international operations comes the tough choice of selecting a functional currency, which must address several financial reporting issues, including determining appropriate functional currencies, accounting for foreign currency transactions, and converting financial statements of foreign subsidiaries into a parent company’s currency for consolidation. The guidelines for translating foreign currencies for financial statements are laid out in the International Accounting Standards (IAS) and generally accepted accounting principles (GAAP), and the functional currency does not necessarily have to be the currency of the country in which the company is headquartered. As the financial statements of a business are reported in only one currency, the dealings or transactions that are done in another currency must be converted back to the principal currency used on the financial statements. Other times, the functional currency may be a separate currency from the currency in which a firm is headquartered.

A functional currency is the main currency that a company conducts its business.

What Is a Functional Currency?

Popular with multinationals, functional currency represents the primary economic environment in which an entity generates and expends cash. It is the main currency used by a business in its business dealings.

A functional currency is the main currency that a company conducts its business.
As companies transact in many currencies but report their financial statements in one currency, the foreign currencies have to be translated into the functional currency.
The guidelines for translating foreign currencies for financial statements are laid out in the International Accounting Standards (IAS) and generally accepted accounting principles (GAAP), and the functional currency does not necessarily have to be the currency of the country in which the company is headquartered.

Understanding a Functional Currency

As the financial statements of a business are reported in only one currency, the dealings or transactions that are done in another currency must be converted back to the principal currency used on the financial statements. The International Accounting Standards (IAS) and generally accepted accounting principles (GAAP) offer guidance on the translation of foreign currency transactions.

The Financial Accounting Standards Board (FASB) was the first regulatory body to present the idea of a functional currency under their Statement of Financial Accounting Standards (SFAS) No. 52.

Choosing a Functional Currency

The world's economies have grown increasingly interdependent. Multinational corporations recognizing the integration of world markets, including the trade of commodities and services and the flow of international capital, are thinking global to remain competitive. 

With international operations comes the tough choice of selecting a functional currency, which must address several financial reporting issues, including determining appropriate functional currencies, accounting for foreign currency transactions, and converting financial statements of foreign subsidiaries into a parent company’s currency for consolidation.

Factors may include finding the currency that most affects sales price. For retail and manufacturing entities, the currency in which inventory, labor, and expenses are incurred may be most relevant. Ultimately, it’s often management's judgment between a local currency, that of a parent, or the currency of a primary operational hub.

It can be difficult to ascertain overall business performance when a variety of currencies are involved. Therefore, both U.S. GAAP and IAS outline procedures for how entities can convert foreign currency transactions into the functional currency for reporting purposes.

At times, a company’s functional currency may be the same currency as the country where it does most of its business. Other times, the functional currency may be a separate currency from the currency in which a firm is headquartered. 

When converting a currency, the exchange rates can positively or adversely impact a company's performance. Most often conversions are done at the spot rate on the date that the transaction occurred. There may be some instances in which a standard rate is used, such as a peak rate or average rate for a period.

Related terms:

Accounting Currency

Accounting currency is the monetary unit used when recording transactions in a company's general ledger. read more

Accounting Principles

Accounting principles are the rules and guidelines that companies must follow when reporting financial data. read more

Accounting

Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more

Conversion Rate

The conversion rate is used to calculate how much of one currency can be exchanged for another. read more

Cumulative Translation Adjustment – CTA

A cumulative translation adjustment in a translated balance sheet summarizes the gains and losses from varying exchange rates. read more

Currency Translation

Currency translation is the process of converting the financial results of a parent company's foreign subsidiaries into its primary currency. read more

Currency

Currency is a generally accepted form of payment, including coins and paper notes, which is circulated within an economy and usually issued by a government. read more

Current Rate Method

The current rate method is a method of foreign currency translation where most financial statement items are translated at the current exchange rate. read more

Financial Accounting Standards Board (FASB)

The Financial Accounting Standards Board (FASB) is an independent organization that sets accounting standards for companies and nonprofits in the United States. read more

Financial Statements , Types, & Examples

Financial statements are written records that convey the business activities and the financial performance of a company. Financial statements include the balance sheet, income statement, and cash flow statement. read more