Functional currency vs presentation currency

IAS 21 draws a sharp line between two concepts. Functional currency is the currency of the primary economic environment in which the entity generates and spends cash. Presentation currency is the currency in which the entity publishes its statements. They may be the same — or they may differ.

For a Ukrainian IT exporter, the functional currency often turns out to be the US dollar, not the hryvnia — even if the company is legally registered in Ukraine.

How to determine the functional currency

IAS 21 provides a set of indicators. The main ones: the currency in which prices for goods and services are denominated; the currency that mainly influences labour, material and other costs; the currency in which funds from financing activities are generated. If most indicators point to one currency, that is the functional currency.

For a Ukrainian SaaS that earns 90% of its revenue in dollars from foreign customers, prices subscriptions in dollars and pays engineers salaries pegged to a dollar equivalent, the functional currency is the dollar. The hryvnia is merely the currency of settlement with employees and the state budget.

Accounting for individual transactions

Each foreign currency transaction is initially recognised in the functional currency at the spot rate on the transaction date. In practice this means the NBU rate on the date of revenue recognition, asset receipt or payment. For repeated transactions an average rate can be used if it does not differ materially from the daily rate.

Date precision matters: if payment is received on the 25th but the invoice is issued on the 30th, an FX difference arises between those dates.

Translating monetary and non-monetary items

At the reporting date, monetary items (cash, receivables, payables, loans) are translated at the closing rate. Non-monetary items measured at historical cost (PP&E, inventory, prepayments) remain at the rate of initial recognition.

Non-monetary items measured at fair value are translated at the rate on the date the fair value was determined.

FX differences in profit or loss

Exchange differences from retranslating monetary items are generally recognised in profit or loss for the period. The exception is FX differences on items that form part of a net investment in a foreign operation: those are recognised in other comprehensive income.

For Ukrainian IT exporters, switching the functional currency to the dollar materially reduces volatility — hryvnia swings against other currencies no longer hit the bottom line.

Multi-jurisdiction groups

If a group has a Ukrainian operating entity and a holding company in Delaware or Cyprus, each entity determines its own functional currency. On consolidation, the results of the foreign operation are translated into the group's presentation currency: assets and liabilities at the closing rate, income and expenses at the transaction date rate (or an average).

Exchange differences from this translation accumulate in a separate component of equity — the foreign currency translation reserve.

Disclosures

In the notes the entity discloses: the amount of FX differences recognised in profit or loss; the functional currency of the parent and main subsidiaries; the rationale for any change in functional currency; the net amount of FX differences in other comprehensive income.

Auditors traditionally pay close attention to the justification of functional currency — it is one of the most judgemental areas of IAS 21.