What’s Functional Currency in Accounting?
In accounting, multinationals often use functional currency to reflect the principal economic environment for cash generation and expenditure. Businesses primarily use this money for their transactions.
Understanding Functional Currency
A firm’s financial accounts are reported in one currency; thus, transactions in another currency must be changed back. The International Accounting Standards (IAS) and generally recognized accounting principles (GAAP) provide forex transaction translation guidelines.
FASB introduced the functional currency concept in Statement of Financial Accounting Standards (SFAS) No. 52.
Choose a Functional Currency
The global economy is linked. To stay competitive, multinational firms embrace globalization, including the trade of goods and services and the flow of finance.
When choosing a functional currency for international operations, you need to think about things like which currencies are suitable, how to account for transactions that happen in foreign currencies, and how to convert the financial statements of a foreign subsidiary into the currency of the parent company so that they can be consolidated.
Discovering the currency that most impacts sales pricing may be necessary. The currency of inventory, labor, and costs may be crucial for retail and manufacturing businesses. Management can choose between a local currency, a parent currency, or a critical operational hub currency.
Multiple currencies make it hard to assess corporate performance. Thus, U.S. GAAP and IAS specify how entities can report foreign currency transactions in the functional currency.
Occasionally, a company’s functional currency matches that of its primary market. Sometimes, a firm’s functioning currency is different from its headquarters currency.
Exchange rates can affect a company’s success when converting currencies. Conversions often occur at the current rate on the transaction date. Some situations may need a peak or average rate.
Conclusion
- The main currency a corporation uses is functional.
- Companies that interact in many currencies but report financial statements in one must convert foreign currencies into functional currencies.
- International Accounting Standards (IAS) and generally accepted accounting principles (GAAP) provide guidelines for translating foreign currencies for financial statements. The functional currency need not be the company’s home currency.
