What is a 'Functional Currency'

Popular with multinationals,  functional currency represents the primary economic environment in which an entity generates cash and expends cash. Functional currency is the primary currency used by a business or business unit. As a monetary unit of account, a functional currency represents the primary economic environment in which that entity operates.

BREAKING DOWN 'Functional Currency'

At times, a company’s functional currency may be the same currency as the country where it does most its business. Other times, the functional currency may be a separate currency from the currency in which a firm is headquartered. 

Example of Functional Currency

For example, a Canadian company with the bulk of its operations in the United States would consider the U.S. dollar its functional currency, even if financial figures on its balance sheet and income statement are expressed in Canadian dollars.

International Accounting Standards (IAS) and U.S. Generally Accepted Accounting Principles (GAAP) offer guidance for the translation of foreign currency transactions and financial statements. Perhaps, SFAS 52 which introduced the concept, best sums up functional currency: "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."

Now, the world's economies have grown increasingly interdependent. Multinational corporations recognizing the integration of world markets, including the trade of commodities and services and the flow of international capital are thinking global to remain competitive. 

With international operations comes the tough choice of selecting a functional currency, which must address several financial reporting issues, including determining appropriate functional currencies, accounting for foreign currency transactions, and converting financial statements of subsidiaries into a parent company’s currency for consolidation.

Factors may include finding the currency that most affects sales price. For retail and manufacturing entities, the currency in which inventory, labor, and expenses are incurred may be most relevant. Ultimately, it’s often managements’ judgment between a local currency, that of a parent, or the currency of a primary operational hub.

It can be difficult to ascertain overall business performance when a variety of currencies are involved. Therefore, both U.S. GAAP and IAS outline procedures for how entities can convert foreign currency transactions into the functional currency for reporting purposes.

RELATED TERMS
  1. Currency ETF

    Currency ETFs (exchange-traded funds) aim to replicate movements ...
  2. Base Currency

    The first currency quoted in a currency pair on forex. It is ...
  3. Currency Board

    A currency board is a monetary authority that makes decisions ...
  4. Reciprocal Currency

    In the foreign exchange market, a currency pair that involves ...
  5. Quote Currency

    The quote currency is the second currency in both a direct and ...
  6. Currency Convertibility

    Currency convertibility is the degree to which a country can ...
Related Articles
  1. Trading

    Currency fluctuations: How they effect the economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies.
  2. Trading

    Profiting From a Weak U.S. Dollar

    Learn how to allocate your investments when the U.S. dollar is down.
  3. Investing

    5 Ways To Invest In Currencies

    As the economies of some countries sputter and former third-world countries are beginning to emerge, currency investing is becoming more intriguing. Learn ways to make money on money with the ...
  4. Trading

    Top 5 Hardest-Hit Currencies

    The value of a country's currency is dependent on many factors that will cause it to fluctuate, relative to other world currencies.
  5. Insights

    The Currency Board: Understanding The Government's Bank

    Currency board or central bank - what's the difference? Find out more about this little-known monetary authority.
  6. Trading

    Top 5 Reasons To Invest In Currencies

    Here's why you should get into the forex market.
  7. Investing

    Protect your foreign investments from currency risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  8. Personal Finance

    Currency Principle vs. Banking Principle: How Different?

    Understanding the difference between the currency principle and the banking principle helps to illustrate the most basic functions of money.
  9. Trading

    Popular Forex Currencies

    Learn about the most traded currencies and the strategies used to trade them.
RELATED FAQS
  1. What is foreign exchange?

    Foreign exchange is the conversion of a country's currency into another. In a free economy, a country's currency is valued ... Read Answer >>
  2. What is a currency converter and how do I use one?

    A currency converter is a calculator that converts the value or quantity of one currency into the relative values or quantities ... Read Answer >>
Hot Definitions
  1. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  2. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  3. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  4. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  5. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  6. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
Trading Center