IAS 21 defines functional currency as the currency of the primary economic environment in which the entity operates, and defines presentation currency as the currency in which the financial statements are presented. The Standard permits the presentation currency to differ from the functional currency, in which case the entity's results and financial position are translated into the presentation currency using specified procedures.
How Is the Functional Currency Determined?
The Standard provides that the primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash, and that an entity considers several factors in determining its functional currency, including the currency that mainly influences the sales prices of goods and services, and the currency of the country whose competitive forces and regulations mainly determine the sales prices of those goods and services.
How Are Foreign Currency Transactions Translated at the End of the Reporting Period?
The Standard provides that at the end of each reporting period:
- foreign currency monetary items are translated using the closing rate;
- non-monetary items measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction; and
- non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined.
How Are Financial Statements Translated Into a Different Presentation Currency?
The Standard provides that, when translating an entity's results and financial position into a different presentation currency (where the functional and presentation currencies are those of non-hyperinflationary economies), the following procedures apply:
- assets and liabilities for each statement of financial position presented (including comparatives) are translated at the closing rate at the date of that statement of financial position;
- income and expenses for each statement presenting profit or loss and other comprehensive income (including comparatives) are translated at exchange rates at the dates of the transactions; and
- all resulting exchange differences are recognised in other comprehensive income.
Illustrative Example (with Assumed Figures)
Suppose a subsidiary's functional currency is the US dollar, while its parent group presents its financial statements in euros (the presentation currency). If the subsidiary's assets total USD 1,000,000 at the end of the period and the closing rate is EUR 0.90 per USD, the value of those assets translated into the presentation currency is 1,000,000 × 0.90 = EUR 900,000. This is a purely illustrative example.
Why Might Presentation Currency Differ From Functional Currency?
Some groups, particularly international groups with subsidiaries in different countries, choose to present their consolidated financial statements in a currency that differs from each subsidiary's own functional currency, to make the statements easier to read for investors and creditors in a particular capital market, or to standardise the language of financial reporting across the group. In that case, as the Standard provides, the original transactions are not remeasured in the new presentation currency; rather, each entity's results and financial position, already prepared in its functional currency, are translated using the exchange rates specified for each type of item, and the resulting translation differences are recognised in other comprehensive income rather than passing through profit or loss. It is important to distinguish this translation for presentation purposes only from actual foreign currency transactions that are recorded in the entity's books in its functional currency in the first place; the former is merely an arithmetical re-expression of the financial statements in a different currency, while the latter consists of real economic transactions subject to the Standard's ordinary recognition and measurement rules.
Legal References
- IAS 21 — The Effects of Changes in Foreign Exchange Rates — Paragraphs 8, 9, 23 and 39.
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