## **Learning Outcomes**

After completing this article, you will be able to distinguish between functional and presentation currency as required by IAS 21. You will understand how to identify an entity’s functional currency, explain what the presentation currency is, and appreciate why this distinction matters for recording and presenting foreign currency transactions in the financial statements for the ACCA Financial Reporting (FR) exam.

## **ACCA Financial Reporting (FR) Syllabus**

For ACCA Financial Reporting (FR), you are required to understand and apply IAS 21 The Effects of Changes in Foreign Exchange Rates, with particular attention to how foreign currency transactions are measured, and the difference between functional and presentation currency. In this article, ensure you can:

- Explain the difference between functional currency and presentation currency, and why it is important
- Identify the principal factors that determine an entity’s functional currency
- Understand the implications when functional and presentation currency differ
- Describe the impact on financial statements when translating foreign currency transactions

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. According to IAS 21, what is the primary factor that should determine an entity’s functional currency?
2. True or false? The presentation currency must always be the same as the functional currency.
3. Entity A operates in Country X, but prepares its financial statements for external users in US dollars. What is Entity A’s presentation currency?
4. If an entity’s functional currency is different from its presentation currency, what must happen to the financial statements?

## **Introduction**

International businesses regularly transact in multiple currencies, but their financial statements must report results in a single currency. IAS 21 The Effects of Changes in Foreign Exchange Rates establishes the rules for determining which currency is used to measure and present financial information. A clear distinction must be made between an entity’s **functional currency** and its **presentation currency**.

> **Key Term: Functional currency**
> The currency of the primary economic environment in which an entity operates; the currency that mainly influences sales prices and costs.
>
> **Key Term: Presentation currency**
> The currency in which an entity presents its financial statements.

### The Importance of Currency Identification

Selecting the correct functional currency ensures that transactions reflect the fundamental economic reality of the business and are reported consistently. The presentation currency may differ, especially in groups with international operations or where entities report to overseas investors.

## Determining the Functional Currency

IAS 21 requires that each entity determines its own functional currency based on the environment in which it primarily generates and expends cash. To determine this, consider the following:

- The currency that mainly influences sales prices for goods and services
- The currency of the country whose competitive forces and regulations mainly determine sales prices
- The currency that primarily influences labour, materials, and other costs of providing goods or services

If the above are not clear, then consider:

- The currency in which funds from financing activities are generated
- The currency in which receipts from operating activities are usually retained

The functional currency is a matter of fact, not choice.

### **Worked Example 1.1**

**SimCo manufactures computer parts in Turkey and sells mainly in euros to European customers, although it also has some sales in US dollars and pays some of its suppliers in Turkish lira. Most of SimCo’s sales contracts are denominated in euros and its main costs (payroll and components) are typically negotiated and paid in euros. What is SimCo’s functional currency?**

> **Answer:**
> SimCo’s functional currency is the euro, as its sales prices and principal costs are primarily determined and settled in euros.

## The Presentation Currency

The presentation currency is the currency in which the entity presents its financial statements. While often the same as the functional currency, a company may choose a different presentation currency. For example, a Turkish company with a euro functional currency might present its financial statements in US dollars for foreign investors.

If financial statements are presented in a currency different from the functional currency, the entity must translate all amounts into the presentation currency, following IAS 21’s guidelines.

### **Worked Example 1.2**

**Entity B operates in Brazil, with the Brazilian real as its functional currency, but prepares financial statements for a US-based parent. What is the presentation currency?**

> **Answer:**
> The presentation currency is the US dollar. However, Entity B’s source records are maintained in Brazilian real, and the financial statements must be translated to US dollars for reporting.

## Why the Distinction Matters

Choosing the correct functional currency is essential because:

- Measurement of assets, liabilities, income, and expenses is based on the functional currency
- Foreign currency transactions (i.e., those not in functional currency) will be subject to exchange gains or losses
- Presentation currency is about how the results are reported, not how transactions are accounted for

If the financial statements are presented in a currency other than the functional currency, every asset, liability, income, and expense item must be translated using the appropriate exchange rates per IAS 21.

> **Key Term: Foreign currency**
> A currency other than the entity’s functional currency.
>
> **Key Term: Exchange rate**
> The ratio of exchange between two currencies. IAS 21 distinguishes between spot (historic), average, and closing rates.

## Functional Currency vs Presentation Currency

- The functional currency is fixed for each entity unless significant changes occur in the economic environment.
- The presentation currency can be chosen by the entity or required by law or group policy.

A subsidiary may have a different functional currency from its parent, particularly where it operates independently in another economic environment.

### **Worked Example 1.3**

**Rozza Ltd is a UK subsidiary of a US-based parent. Rozza Ltd operates in the United Kingdom, and its main transactions (sales, purchases, wages) are denominated in GBP. However, the parent company requires reporting in US dollars. What is the functional currency and what is the presentation currency?**

> **Answer:**
> The functional currency is GBP, as it reflects Rozza Ltd’s main economic environment. The presentation currency for group reporting is US dollars, so Rozza Ltd’s financial statements must be translated into US dollars for consolidation.

### **Exam Warning**

A frequent mistake is to assume an entity’s presentation currency dictates its functional currency, or to believe management can select whichever currency is most convenient. For the exam, be careful: functional currency is determined by economic factors, not by choice or group reporting preferences.

## **Summary**

- The functional currency is the principal currency of the business environment in which the entity primarily operates.
- The presentation currency is the currency in which the financial statements are reported.
- If the presentation currency is different from the functional currency, amounts must be translated following IAS 21 procedures.
- The distinction ensures that results and financial position are measured and presented in a way that is both relevant and comparable for users.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Describe the difference between functional and presentation currency
- State the main factors that determine an entity’s functional currency under IAS 21
- Explain why the functional and presentation currency may differ, and what this means for translation
- Identify the impact of currency decisions on the preparation and reporting of financial statements

## **Key Terms and Concepts**

- Functional currency
- Presentation currency
- Foreign currency
- Exchange rate

Foreign currency transactions (IAS 21) - Functional vs presentation currency