What Is an Accounting Currency?
The accounting currency is the monetary unit used when recording transactions in a company's general ledger, also commonly referred to as the company's "books" or accounting records. The accounting currency may also be called the reporting currency.
The accounting (reporting) currency is not necessarily the same as the functional or transactional currency. The functional currency is what employees and customers use when conducting a transaction, such as a sale. The difference is especially important for large, multinational companies that do business in many different countries.
- The accounting currency is that which is used for a company's official bookkeeping.
- The accounting currency is often the same as the local currency of the company's HQ, but it may differ from the transactional currency used.
- Subsidiaries that use different currencies in their day-to-day operations must convert their financial statements into the accounting currency so the financial statements can be consolidated.
- The temporal method and current rate method are the two common methods of translating the currency of a foreign subsidiary into the currency of the parent company.
Understanding Accounting Currency
Operating in several countries often requires doing business transactions in a variety of currencies. When this is the case, the currency of the company's headquarters or parent company where the financial statements are prepared is considered the accounting currency. For companies operating in countries with a major currency, such as the U.S. dollar (USD), euro (EUR), or British pound sterling (GBP), the accounting currency may be the same as the functional currency. Companies operating in smaller markets with "minor" currencies are more likely to have a domestic accounting currency and a foreign functional currency.
For example, a Japanese electronics company based in Tokyo will likely use the Japanese yen (JPY) for its accounting currency, as that is the local currency where the company is headquartered and operates. Companies are likely to use their home country's currency, or local currency, when recording transactions, even if the sale was denominated in a foreign currency. Therefore, a Japanese firm conducting business in China will use the yen as the accounting currency, even if sales transactions are conducted using the Chinese Yuan Renminbi (CNY).
Translation to Accounting Currency
For companies or investors managing multiple currencies, the interplay of foreign exchange rates and conversions can make the maintenance of the accounting records a complicated task. Other satellite locations or subsidiaries that use different currencies in their day-to-day operations must convert their financial statements into the accounting currency so the statements can be consolidated. This is accomplished using either the temporal or current rate method of currency translation.
In the temporal method, also known as the historical method, assets, and liabilities are divided into monetary and non-monetary categories. Highly liquid assets such as cash, investments, and accounts receivable are considered to be monetary assets. Likewise, liabilities due to be paid out in the short-term such as accounts payable and salaries payable are considered to be monetary liabilities.
Under this method, monetary assets and liabilities are converted using the exchange rate in effect as of the balance sheet date. On the other hand, the exchange rate values for non-monetary assets and liabilities are based on the time those assets and liabilities were acquired or incurred. An example of a non-monetary asset would be a fixed asset purchase, such as a piece of equipment or plot of land.
Current Rate Method
Using the current rate method, assets, and liabilities on the balance sheet are translated at the exchange rate as of the balance sheet date. This can create a higher degree of translation risk, as the current exchange rate may change drastically prior to the end of the accounting period.