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What is Functional Currency?

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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 17 September 2016
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Functional currency is the currency which is used in the business operations of a company. Usually, a company uses the legal tender of the country where it centers its operations as a functional currency. This is different from presentation or reporting currency, the currency used in the company's financial reports. In accounting it is not uncommon for a firm to use the same currency for functional and presentation currency.

A company which does business in Germany, generating the bulk of its income in Germany and spending most of its money there, would use the currency of Germany as its functional currency. However, the company might, for example, report its earnings in United States Dollars even though the Euro is its functional currency. In cases where companies are subsidiaries of foreign firms, sometimes the functional currency of the parent firm is considered the currency of the daughter firm.

Many international firms do business in a wide variety of currencies, but they have a currency which they prefer to use and in which most of their expenses and income are generated. Thanks to differing exchange rates and economic pressures, there may be time when a company's functional currency is weaker or stronger in contrast with other currencies. Some companies in fact make a business out of manipulating differences in exchange rates to generate income by buying and selling in various foreign currencies.

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The country in which a company does most of its business is sometimes referred to as the primary environment. The legal tender of a company's primary environment is most commonly used as its functional currency. A company doing business in Australia, for example, would use Australian Dollars as its functional currency even if it also accepted and made payments in other currencies when dealing with international customers.

When a company's functional and reporting currency differ, it is important to be aware of this while examining financial reports. During the conversion from one unit of currency to another, various problems may be covered up. Although this is not intentional, it can mean that a company's public disclosures are not an entirely accurate reflection of its finances as a result of differing exchange rates. Because exchange rates also fluctuate, reports can provide an incomplete picture of what is going on inside the company, depending on when the report was generated and how the conversion was calculated by the accounting team.

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burcinc
Post 3

@ddljohn-- No, not really. The article talked about the primary environment, a company's functional currency is determined by this.

The company has to consider the currency in which they buy the goods and services they use; if they have loans, the currency of those loans and even the currency of their receipts. All of these different factors determine what the functional currency will be.

fify
Post 2

In some countries, companies select different functional currencies simply so that they won't have to pay certain taxes to the government. This used to be a problem in the UK. Recently though, the government there passed a law that won't allow companies to avoid these taxes anymore.

I actually don't think that it's the companies' fault. It is normal for them to try and reduce their costs if they can. I think the government policies were wrong before. Why should some functional currencies have benefits that the others don't? That definitely doesn't make business more fair.

I'm glad that the UK government sorted it out. A company's selection of a currency should have to do with where they do business and where their parent company is, not taxes.

ddljohn
Post 1

If I was a firm doing business with an international firm that uses a different and stronger functional currency, I think I would want to have the same functional currency as that firm.

I read recently about something called translation exposure. This is when a firm loses money because of the value of its money in currency exchange. It's possible to lose a lot of money, even to the point of going bankrupt if you do business with a firm that has a stronger currency. If your money devalues, you will end up paying much more than you expected.

I guess a good way to prevent this from happening would be to have the same functional currency as

the firm you are working with. Or you could only choose to work with firms that have the same functional currency.

But is this possible? Can you select any currency as your functional currency and can you change it if it is not working out for you?

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