Discuss what is meant by the concept of an entity’s functional currency and how it may be determined in accordance with IAS 21: The Effects of Changes in Foreign Exchange Rates. (5 marks)
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The functional currency of an entity can be understood literally as the currency in which the entity functions. The choice of functional currency is a judgment which must be made under IAS 21. The judgment involves assessing the facts, and deciding the currency on which the entity is most dependent economically. For most entities, the functional currency is a clear judgment, in that most entities operate primarily within a single economy or currency zone.
However IAS 21 does offer some guidance should the judgment prove difficult. This can happen if more than one currency is important to the entity and it is not clear which is the most significant.
IAS 21 requires that the entity consider:
- The currency which most affects sales prices; and
- The currency in which purchases and other costs are incurred.
- The currency of the most significant providers of capital; and
- The currency in which operating receipts are retained.
(Explanation of functional currency 2 marks)
(Any 3 factors @ 1 mark 3 marks)