Functional currency refers to the main currency used by a business or unit of a business. It is the
monetary unit 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 t ...
(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 ...
. 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 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 is sometimes used as a synonym, 'functional currency' is the more precise term
*
Inflation accounting
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Inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
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Accounting
Accounting, also known as accountancy, is the process of recording and processing information about economic entity, economic entities, such as businesses and corporations. Accounting measures the results of an organization's economic activit ...
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Economics
Economics () is a behavioral science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services.
Economics focuses on the behaviour and interac ...
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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 are: m ...
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Banking
A bank is a financial institution that accepts Deposit account, 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 m ...
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Business
Business is the practice of making one's living or making money by producing or Trade, buying and selling Product (business), products (such as goods and Service (economics), services). It is also "any activity or enterprise entered into for ...
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Hyperinflation
In economics, hyperinflation is a very high and typically accelerating inflation. It quickly erodes the real versus nominal value (economics), real value of the local currency, as the prices of all goods increase. This causes people to minimiz ...
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Historical cost
The historical cost of an asset at the time it is acquired or created is the value of the costs incurred in acquiring or creating the asset, comprising the consideration paid to acquire or create the asset plus transaction costs. Historical cost ...
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Money illusion
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List of countries by foreign-exchange reserves
Foreign exchange reserves, also called Forex reserves, in a strict sense, are foreign-currency deposits held by nationals and monetary authority, monetary authorities. However, in Populism, popular usage and in the list below, it also includes ...
References
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Currency