Functional Currency
Functional Currency is the main currency used by the company, it is the currency that represents the company’s main economic operation such as revenue and expense.
Most of the transactions will make through the functional currency. It reflects the transaction, event, and condition relevant to the entity. It represents the economic surrounding of the business’s transaction.
The company may have business transactions in other currency such as purchases from oversea, investments from foreign investors, and so on. They can conduct the transaction as normal but they must be converted to functional currency and recorded into the accounting system. These transactions will generate the exchange gain/loss in the report.
The transaction in other currencies must translate to functional currency and be present in the financial statement. The financial statement only presents one currency so it must be the main one.
The functional currency can be different from one entity to another. It depends on many factors which will be discussed below.
Determine the Functional Currency
There are several factors that determine the functional currency of the company:
- The majority of revenue and expense in the company. The company may generate income and expenses in various currencies. The functional currency is the one that represents a major part of the company transactions. The other currencies are considered foreign currency transactions.
- The currency impacts to product or service of the company. The main currency will have influence over the company product or service’s price which will result in revenue amount.
- The currency of the countries has a direct influence on the company’s policy. Most of the time, the currency of the country where the company is located will represent the company’s functional currency.
Local Currency
The local currency is the currency of the country in which the company/subsidiary is operating. It may be the same or different from the company’s functional currency. There is no requirement for the company to use the local currency as the functional currency. However, the local government may require the company to prepare the regulation report in local currency. The people in that country will mostly use the local currency to pay for goods, services, and so on.
It is very highly likely that the local currency and the functional currency are the same. When company operates in one country, the revenue and expense will be in that currency. They will receive most of the sales in local currency if their customers are local people. The same to expense, the supplier will use the local currency as well.
However, there is some situation where the company is the subsidiary of the parent entity that uses a different currency. So the local company may need to comply with the parent entity.
Functional Currency Vs Presentation Currency
| Functional Currency | Presentation Currency |
|---|---|
| It is the currency that represents the company’s business economy. It depends on the factors above. | It is the currency that we used to record the transaction in the financial statement. It is the currency in which financial statements are presented. |
| The company cannot select a functional currency. It is a matter of fact which best fit the company. | The company can choose the currency which they want to present in addition to functional currency. |
Change in Functional Currency
Once the functional currency has been decided, we should not have to change it frequently. The change can happen only when there are changes in the nature of the transaction, event, or relevant condition which impacts the entity.
Functional currency change should be applied from the date of the change to the financial statement. The change should only apply prospectively. And it will impact a whole set of financial statements.
The company needs to translate all the assets, liabilities, and equities into a new functional currency on the date of the change. The new transactions must be translated and recorded with the functional currency.