Functional currency refers to the main currency used by a business or unit of a business. It is the
monetary unit
A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins.
A more general def ...
of account of the principal economic environment in which an economic entity operates.
International Accounting Standards (IAS) and U.S.
Generally Accepted Accounting Principles
Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
(GAAP)
provide rules for translation of foreign currency transactions and financial statements. SFAS 52 introduced the concept of functional currency, defined as "the currency of the primary economic environment in which the entity operates; normally, that is, the currency of the environment in which an entity primarily generates and expends cash."
Businesses may enter into transactions (sales, payments, etc.) in multiple currencies. Each qualified business unit (QBU) of the business translates these items to its functional currency at an appropriate
exchange rate
In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...
. It then prepares periodic reports of its position (balance sheet) and activity (income and cash flow statements) in that functional currency. When various QBUs are combined, these reports are translated and consolidated to become financial statements. Translation of statements may result in translation differences, which are accounted for as a cumulative translation adjustment.
Transactions are often translated at the spot rate, i.e., the rate of exchange between the transaction currency and the functional currency on the date of the transaction. Example: Jim is traveling on business and pays a hotel bill for SFR 200. Jim's home currency is the GBP. On the date Jim pays the bill, the exchange rate is SFR2 = GBP 1. Jim records an expense of GBP 100. Alternatively, businesses may record transactions in another currency using some sort of standard rate for some period, such as the average rate for the month.
Businesses using the
accrual method
A basis of accounting is the time various financial transactions are recorded. The cash basis (EU VAT vocabulary ''cash accounting'') and the accrual basis are the two primary methods of tracking income and expenses in accounting.
Both can ...
of accounting may recognize revenue or expense in one period and receive or pay it in another. In the intervening period the exchange rate may have changed. When an accrued item is settled, the difference due to exchange rate movement in the amount accrued and the amount settled is treated as foreign exchange gain or loss. This gain or loss is recognized in the same manner as the underlying transactions, such as an ordinary travel expense.
See also
* although
Base currency
A currency pair is the dyadic quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market. The currency that is used as the reference is called the counter currency, quote currency, o ...
is sometimes used as a synonym, 'functional currency' is the more precise term
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Inflation accounting
Inflation accounting comprises a range of accounting models designed to correct problems arising from historical cost accounting in the presence of high inflation and hyperinflation. For example, in countries experiencing hyperinflation the Intern ...
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Inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
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Accounting
Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...
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Economics
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
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Money
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money ar ...
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Banking
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.
Because ...
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Business
Business is the practice of making one's living or making money by producing or buying and selling products (such as goods and services). It is also "any activity or enterprise entered into for profit."
Having a business name does not separ ...
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Hyperinflation
In economics, hyperinflation is a very high and typically accelerating inflation. It quickly erodes the real value of the local currency, as the prices of all goods increase. This causes people to minimize their holdings in that currency as t ...
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Historical cost
In accounting, an economic item's historical cost is the original nominal monetary value of that item. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' v ...
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Money illusion
In economics, money illusion, or price illusion, is a cognitive bias where money is thought of in nominal, rather than real terms. In other words, the face value (nominal value) of money is mistaken for its purchasing power (real value) at a prev ...
References
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Currency