The two definitions in functional currency and presentation currency to start with:
- Presentation currency is the currency that a group reports its consolidated profits in. This is a free choice available to a group and directly affects the headline reported profit. Functional currency and Presentation currency
- Functional currency is the currency of the local environment in which each individual member company of a global group operates. In other words, functional currency is determined by what drives that specific member company. This is factual, and is therefore not a choice. Functional currency and Presentation currency
Relevance on consolidation
These two concepts interact through the consolidation process. Each member company first determines its profits in its own individual functional currency. Then, to determine consolidated group profit, each member company’s income statement and balance sheet is translated into the presentation currency of the group. Functional currency and Presentation currency
Functional currency is the currency (IAS 21 9): Functional currency and Presentation currency
- That mainly influences sales prices (i.e. often currency in which revenue is denominated)
- Of the country whose competitive forces and regulations determine the sales prices
- That mainly influences labour, material and other costs
Sometimes the functional currency may be the one in which Functional currency and Presentation currency
- Funds from financing activities are generated Functional currency and Presentation currency
- Receipts from operating activities are usually retained Functional currency and Presentation currency
Example disclosures Functional currency and Presentation currency
See next the disclosure by BP Plc, BP is a UK headquartered Gas & Oil business, and uses the USD as its functional and presentation currency. As follows from the above definitions, presentation currency is a free choice, and functional currency is a fact, the latter makes sense the Gas & Oil industry is a USD denominated business all around the world. Functional currency and Presentation currency
BP Plc – Annual Report and Form 20-F 2017
Foreign currency translation
The functional and presentation currency of the financial statements is US dollars. Transactions in foreign currencies are initially recorded in the functional currency by applying the spot exchange rate on the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated into the functional currency at the spot exchange rate on the balance sheet date. Any resulting exchange differences are included in the income statement. Non-monetary assets and liabilities, other than those measured at fair value, are not retranslated subsequent to initial recognition.
Exchange adjustments arising when the opening net assets and the profits for the year retained by a non-US dollar functional currency branch are translated into US dollars are recognized in a separate component of equity and reported in other comprehensive income. Income statement transactions are translated into US dollars using the average exchange rate for the reporting period.
Total, the French Oil company, discloses it quite different with the consolidated functional currency being USD and the parent company functional currency as EUR, as follows: Functional currency and Presentation currency
TOTAL S.A. – Registration document 2018 including the annual financial report
C) Foreign currency translation
The presentation currency of the Group’s Consolidated Financial Statements is the US dollar. However the functional currency of the parent company is the euro. The resulting currency translation adjustments are presented on the line “currency translation adjustment generated by the parent company” of the consolidated statement of comprehensive income, within “items not potentially reclassifiable to profit and loss”. In the balance sheet, they are recorded in “currency translation adjustment”.
The financial statements of subsidiaries are prepared in the currency that most clearly reflects their business environment. This is referred to as their functional currency.
Since 1st July 2018, Argentina is considered to be hyperinflationary. IAS 29 “Financial Reporting in Hyperinflationary Economies” is applicable to entities whose functional currency is the Argentine peso. The functional currency of the Argentine Exploration & Production subsidiary is the US dollar, therefore IAS 29 has no incidence on the Group accounts. Net asset of the other business segments is not significant.
Transactions denominated in currencies other than the functional currency of the entity are translated at the exchange rate on the transaction date. At each balance sheet date, monetary assets and liabilities are translated at the closing rate and the resulting exchange differences are recognized in the statement of income.
(ii)Translation of financial statements
Assets and liabilities of entities denominated in currencies other than dollar are translated into dollar on the basis of the exchange rates at the end of the period. The income and cash flow statements are translated using the average exchange rates for the period. Foreign exchange differences resulting from such translations are either recorded in shareholders’ equity under “Currency translation adjustments” (for the Group share) or under “Non-controlling interests” (for the share of non-controlling interests) as deemed appropriate.
Shell Plc – Annual report and Form 20-F 2018
Foreign exchange risk
Many of the markets in which Shell operates are priced, directly or indirectly, in dollars. As a result, the functional currency of most Integrated Gas and Upstream entities and those with significant cross-border business is the dollar. For Downstream entities, the functional currency is typically the local currency.
Consequently, Shell is exposed to varying levels of foreign exchange risk when an entity enters into transactions that are not denominated in its functional currency, when foreign currency monetary assets and liabilities are translated at the balance sheet date and as a result of holding net investments in operations that are not dollar-functional. Each entity is required to adopt treasury policies that are designed to measure and manage its foreign exchange exposures by reference to its functional currency.
Foreign exchange gains and losses
Foreign exchange gains and losses arise in the normal course of business from the recognition of receivables and payables and other monetary items in currencies other than an entity’s functional currency. Foreign exchange risk may also arise in connection with capital expenditure. For major projects, an assessment is made at the final investment decision stage whether to hedge any resulting exposure.
Assuming other factors (principally interest rates and commodity prices) remained constant and that no further foreign exchange risk management action were taken, a 10% appreciation against the dollar at December 31 of the main currencies to which Shell is exposed would have the following effects:
The above sensitivity information was calculated by reference to carrying amounts of assets and liabilities at December 31 only. The effect on income before taxation arises in connection with monetary balances denominated in currencies other than an entity’s functional currency; the effect on net assets arises principally from the translation of assets and liabilities of entities that are not dollar-functional.
Foreign exchange gains and losses included in income are presented in Note 5.
A CASE: What are the functional currencies of the various entities?
The situation at hand: Functional currency and Presentation currency
- The US operating subsidiaries run a local shipping company in the US
- The US Holding: Functional currency and Presentation currency
- Holds the investments in the US operating subsidiaries Functional currency and Presentation currency
- Borrows money to fund the US operations Functional currency and Presentation currency
- Employees staff working for the US operating subsidiaries Functional currency and Presentation currency
- Shipco Inc. has leased a boat from a US bank on behalf of German Shipping A.G. Lease payments are in USD
- Single Ship GmbH has borrowed EUR from a Swiss bank to finance a ship that operated on the Rhine between Rotterdam and Basel
- German Shipping AG provides shipping services mainly to EU customers and owns a fleet of ships that operate in Europe and around the world
- Treasury (Netherlands) BV arranges borrowings around the group and hedges financial risk on behalf of the UK parent
The outcome:Functional currency and Presentation currency
- US operating subsidiaries – USD
- US Holding
- Either appears to perform a number of tasks on behalf of the parent – GBP
- Or has an operational role by providing services to the US group – USD
- German Shipping AG – EUR
- ShipCo. Inc – EUR (owns ship on behalf of AG)
- Treasury (Netherlands) BV – GBP (is an extension of the parent)
Functional currency and Presentation currency
See also: The IFRS Foundation