Functional currency and presentation currency
How to work out a client's functional currency under IAS 21, when statements may be presented in another currency, and how to prepare the trial balance.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
Most clients never raise the question. A Pretoria plumbing business earns rand, pays rand and keeps its books in rand, and nobody wonders which currency its statements should be in. The question arrives with the clients who do not fit: the Nairobi lodge that sells to foreign tour operators in US dollars, the Lagos engineering firm whose contracts are priced in dollars but whose staff are paid in naira, the Cape Town software house whose customers are almost all overseas.
For these clients two separate decisions are often blurred into one. The first is the functional currency: the currency the business actually lives in. The second is the presentation currency: the currency the statements are shown in. IAS 21 treats them differently, and the order in which a preparer answers them matters.
The primary economic environment test
IAS 21 defines an entity's functional currency as the currency of the primary economic environment in which it operates, meaning the environment in which it primarily generates and expends cash. Every other currency is a foreign currency for that entity.
The definition is a question of fact about the business, not a choice. Management does not pick its functional currency because it would be convenient, and the currency of the bank account or the accounting system does not settle it either. In practice the preparer asks questions such as:
- In which currency are the client's selling prices set, and in which currency do customers pay?
- In which currency are wages, rent and most suppliers paid?
- Which economy's conditions, competition and price movements actually drive the client's margins?
- In which currency does the client borrow, and in which does it keep the cash it earns?
When the answers all point the same way, the decision is quick. When they split, the preparer has to judge which environment is primary and should read the standard's fuller guidance before concluding. Write the conclusion and the reasons in the working papers, because the functional currency drives every measurement that follows.
Foreign transactions versus foreign operations
The IFRS Foundation's summary of IAS 21 says an entity may carry on foreign activities in two ways: it may have transactions in foreign currencies, or it may have foreign operations. The distinction tells the preparer which part of the standard is in play.
A South African importer that buys stock in euros has foreign currency transactions. Its functional currency is still the rand; each purchase is a foreign currency transaction recorded in rand, and the euro amount still owed at year end raises the question of which rate to use. A Kenyan holding company with a subsidiary in Uganda has a foreign operation, whose own statements are kept in its own functional currency and then translated when they are brought into the group. The IFRS Foundation describes IAS 21 as covering all of this: foreign currency transactions, translating a foreign operation into the entity's functional currency, and translating the entity's own statements into a presentation currency if that differs from the functional currency.
Presenting in another currency
IAS 21 permits an entity to present its financial statements in any currency, or in more than one. The presentation currency is therefore a genuine choice, unlike the functional currency, although a lender, a parent company, a regulator or local law may narrow it.
When the presentation currency differs from the functional currency, the statements are translated from one to the other. The IFRS Foundation notes that the principal issues IAS 21 deals with are which exchange rates to use and how to report the effects of changes in rates in the financial statements. Those are the questions to settle with the client before any figures are produced: which rate applies to which balances, and where translation differences will appear.
Local rules sit on top of the standard. Nigerian preparers should read naira presentation under FRC Rule 8 before agreeing a presentation currency with a Nigerian client, and the choice of reporting framework itself is covered in IFRS for SMEs or full IFRS.
Clients that price in dollars and spend locally
The hard cases are businesses whose income and costs live in different currencies. Take the Nairobi lodge: its room rates are quoted in dollars and paid in dollars by foreign operators, but its staff, food, fuel and maintenance are paid in shillings, and its competitors are other Kenyan lodges.
There is no shortcut here. The definition asks where the client primarily generates and spends cash, and the lodge does both, in different currencies. The preparer weighs which environment really determines the business's prices and costs, records the evidence on both sides, and takes the conclusion to the engagement partner. Once made, the conclusion should not move from year to year unless the underlying facts change, so the file note is worth writing carefully the first time.
A related trap is the client that keeps its books in dollars because its owner thinks in dollars. If the business actually lives in the local economy, the functional currency is the local currency, and the books may need to be restated on that basis before the year-end work can start.
Translating before the trial balance is uploaded, and the policy wording
Achekam's Studio builds a draft set of statements from a mapped trial balance, with every figure calculated in code. It works with the figures it is given, so for a client whose presentation currency differs from its functional currency, load a trial balance that is already in the presentation currency. Do the translation in the working papers first, using the rates agreed with the client, and keep the translation schedule with the file so a reviewer can trace each balance back to the functional-currency books.
The policies need the same care. The Studio's standard policy wording is based on IFRS for SMEs and is labelled for review before issue, and staff can write the client's own policies where the standard text does not fit. For a client with any foreign currency exposure, the policy should state the functional currency and why, the presentation currency if different, and how transactions and balances in foreign currencies are measured. Notes take their figures from the mapped trial balance; a fact it cannot supply, such as the closing rate used, is left as "[to be completed]" for a person to fill.
The IFRS Foundation's IAS 21 page explains how foreign currency transactions are accounted for and how statements are translated into a functional or presentation currency, and is the place to start before a first meeting with a client whose currencies are mixed.
The order of work is the whole lesson: decide the functional currency on the facts, agree the presentation currency with the client, then translate and load.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
