A parent entity might have subsidiaries that are located in a foreign country. In many cases, the financial statements of the foreign subsidiary are prepared in the currency of the foreign country. In order for the financial statements of the foreign operation to be included in the consolidated financial statements of the parent entity , it is necessary to translate the foreign operation’s financial statements to the currency used by the parent entity for reporting purposes.
Functional Currency And Presentation Currency
Para 3 of IAS 21 notes that its two areas of application are:
• translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation or the equity method
• translating an entity’s results and financial position into a presentation currency.
Note that there are two different translation processes here. In order to understand this, it is necessary to distinguish between three different types of currency: local currency, functional currency and presentation currency. Not all foreign subsidiaries experience all three currencies.
Difference Between Functional Currency And Presentation Currency
• Local currency. This is the currency of the country in which the foreign operation is based. For example, an Australian Company domiciled in Canada will prepare financial statements in Canadian dollars.
• Functional currency. According to the para 8 of IAS 21, ‘the currency of the primary economic environment in which the entity operates’. As is explained in more detail later, this is the currency of the country in which the foreign operation is based. This term is not defined in IAS 21.
• Presentation currency. According to the para 8 ‘the currency in which the financial statements are presented’.
To illustrate, Freshchoice Limited is a subsidiary of Woolworths Limited. Woolworths Limited is an Australian company and Freshchoice Limited is based, for an example, in Singapore. The operations in Singapore are to sell goods manufactured in France. In this case, Freshchoice Limited would most likely maintain its accounts in Singaporean dollars, the local currency, while the functional currency could be the euro, reflecting the major economic operations in France. However, for presentation in the consolidated financial statements of Woolworths Limited, the presentation currency could be the Australian dollar. As the accounts are maintained in Singaporean dollars, they may firstly have to be translated into the functional currency, the euro, and then translated again into the Australian dollar for presentation purposes.