## **Learning Outcomes**

After completing this article, you will be able to explain the difference between an entity’s functional currency and presentation currency, set out the key criteria for determining the functional currency, and describe how the use of a different presentation currency affects financial reporting and disclosures under IAS 21. You will also be prepared to apply these concepts to practical ACCA-style scenarios.

## **ACCA Strategic Business Reporting (SBR) Syllabus**

For ACCA Strategic Business Reporting (SBR), you are required to understand the correct application of IAS 21 in relation to foreign currency translation. This includes both conceptual and practical aspects. Focus your revision on:

- The definitions and differences between functional and presentation currency
- The criteria and process for determining an entity’s functional currency
- How to translate financial information when the presentation currency differs from the functional currency
- Disclosure requirements under IAS 21 relating to both currencies

## **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. Which of the following most accurately describes functional currency according to IAS 21?  
   a) The currency of the country where the parent entity is incorporated  
   b) The currency in which the financial statements are presented  
   c) The currency of the primary economic environment in which the entity operates  
   d) The currency in which most of the group’s borrowings are denominated

2. True or false? An entity can freely choose any presentation currency, regardless of its functional currency.

3. Briefly outline the principal factors considered when determining an entity’s functional currency.

4. If an entity’s functional currency is different from its presentation currency, which exchange rate is used to translate:  
   a) Monetary items in the statement of financial position  
   b) Income and expenses in the statement of profit or loss

## **Introduction**

Entities often engage in transactions denominated in foreign currencies or operate in countries with different currencies. IAS 21 The Effects of Changes in Foreign Exchange Rates provides guidance on how to identify the correct currency for measurement (functional currency), how to deal with financial statements prepared in other currencies (presentation currency), and the translation procedures that must be applied. Understanding the difference between functional and presentation currency is essential for accurate reporting and compliance with IFRS.

> **Key Term: functional currency**
> The currency of the primary economic environment in which an entity operates and generates cash flows.
>
> **Key Term: presentation currency**
> The currency in which an entity presents its financial statements.

## Determining the Functional Currency

IAS 21 requires every entity to identify its functional currency. This is not simply a matter of what currency an entity chooses to use — it must reflect the actual economic environment in which the entity principally generates and expends cash.

### Primary Factors

The following indicators are considered primary when assessing functional currency:

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

If these factors do not clearly indicate the functional currency, secondary factors provide further guidance.

### Secondary Factors

Secondary considerations include:

- The currency in which financing activities are raised (e.g., borrowings, equity)
- The currency in which receipts from operating activities are retained

For foreign operations, additional factors may be relevant, such as whether the operation acts independently, the extent of transactions with the parent, and cash flow autonomy.

### **Worked Example 1.1**

**Scenario:**  
A UK company manufactures goods in Poland, selling 80% of its output to customers in the Eurozone, with 20% sold in Poland. Purchase costs, labour, and overheads are mainly in Polish zloty. Bank loans are denominated in Euros. Most cash receipts are held in euros, but some local expenses are settled in zloty.

**Question:**  
What is the functional currency of the Polish subsidiary?

> **Answer:**  
> The functional currency will depend on relative significance. If the majority of sales and cash flows are generated and settled in euros, and euro currency most influences prices, the euro is likely to be the functional currency—even though cost base and some local transactions are denominated in zloty. Management must justify their judgement based on facts.

### **Exam Warning**

Some candidates assume that the local currency or the parent’s currency is always the functional currency. This is incorrect. You must use the specific IAS 21 criteria and justify your conclusion with objective evidence.

## Selecting the Presentation Currency

While every entity must determine its functional currency, IAS 21 allows the financial statements to be presented in any currency (the “presentation currency”). This enables parent companies to present consolidated results in a currency that matches the needs of investors or group reporting requirements.

If the presentation currency is different from the functional currency, the entire set of financial statements must be translated into the presentation currency using IAS 21’s translation rules.

### Translation Process

- Assets and liabilities are translated at the **closing exchange rate** at the reporting date.
- Income and expenses are translated at **rates at the dates of transactions** (or an appropriate average rate if exchange rates do not fluctuate significantly).
- Equity items (other than retained earnings) are translated at historical exchange rates.
- All resulting exchange differences are recognised in other comprehensive income and accumulated in a **translation reserve** within equity.

> **Key Term: translation reserve**
> A component of equity where cumulative exchange differences arising from translating foreign operations are recorded.

## Changing the Functional or Presentation Currency

Changing an entity’s functional currency is rare and only justified by significant changes in economic events or operating conditions. Such a change must be applied **prospectively** from the date of change.

An entity may decide to change its presentation currency for practical or investor-oriented reasons. If so, prior period comparative amounts must be translated into the new presentation currency using closing exchange rates for assets and liabilities, and historical or average rates for income and expenses.

### **Worked Example 1.2**

**Scenario:**  
A Turkish entity with functional currency TRY prepares financial statements in US dollars as its presentation currency for international investors. At year-end:

- TRY/USD closing rate: 25.0
- Average rate for the year: 22.0

It has:

- Assets: TRY 5,000,000
- Liabilities: TRY 3,000,000
- Revenue: TRY 20,000,000
- Expenses: TRY 15,000,000

**Question:**  
Translate the statement of financial position and profit or loss into USD for group consolidation.

> **Answer:**  
> Assets: 5,000,000 / 25.0 = USD 200,000  
> Liabilities: 3,000,000 / 25.0 = USD 120,000  
> Revenue: 20,000,000 / 22.0 = USD 909,091  
> Expenses: 15,000,000 / 22.0 = USD 681,818  
> Exchange differences arising from translation are recorded in the translation reserve.

## Disclosure Requirements

IAS 21 requires specific disclosures when the functional and presentation currencies differ or when the presentation currency is changed:

- The functional and presentation currencies used
- The reason for using a different presentation currency (if applicable)
- The method used for translation, including key exchange rates applied
- The amount of exchange differences recognised in other comprehensive income and accumulated in equity

Full transparency is expected so users can understand the currency context and any significant foreign exchange effects on reported figures.

### **Worked Example 1.3**

**Scenario**:  
A UK-based company has GBP as its functional currency but presents its consolidated statements in USD for international investor reporting. During the period, a weakening GBP resulted in a large translation loss within equity.

**Question**:  
What disclosures must be made concerning currencies and foreign exchange differences?

> **Answer:**  
> The statements must disclose both functional (GBP) and presentation (USD) currencies, describe the translation methods, report closing and average exchange rates used, and state the amount of cumulative translation differences included in equity. IAS 21 also requires an explanation for any change in presentation currency.

## Importance to ACCA SBR Candidates

The ACCA SBR exam expects you to:

- Judge the appropriate functional currency for given scenarios
- Explain and justify the presentation currency selected by an entity
- Apply the correct translation rules under IAS 21
- Disclose requirements, especially when mismatches arise

Misclassification of currencies or incorrect application of translation procedures can materially misstate the financial statements and lead to significant errors in both numerical and discursive exam answers.

## **Summary**

Functional currency reflects the primary economic environment in which the entity operates, determined by objective criteria. Presentation currency is the currency chosen for external reporting and may differ from the functional currency, requiring complete translation of the accounts under set rules. Both must be clearly disclosed along with methods and effects of translation differences, to ensure users have a transparent understanding of the performance and position reported.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the difference between functional currency and presentation currency under IAS 21
- Identify the primary and secondary factors for determining functional currency
- Describe the process for translating financial statements into a presentation currency
- Recognise disclosure requirements when different currencies are used
- Apply translation rules and identify required disclosures in practical scenarios

## **Key Terms and Concepts**

- functional currency
- presentation currency
- translation reserve

Foreign currency translation (ias 21) - Functional vs presentation currency