Functional currency of an entity can be understood literally as the currency in which the entity functions. The choice of functional currency is a judgement which must be made under IAS 21 The effect of changes in foreign exchange rates. The judgement 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 judgement, in that most entities operate primarily within single economy or currency zone.
However, IAS 21 The effect of changes in foreign exchange rates does offer some guidance should the judgement prove difficult. This can happen if more than one currency is important to the entity and it is not clear which is most significant.
IAS 21 requires that entity consider:
- the currency which most affects sales price; and
- the currency in which purchases and other cost are incurred
- the currency of the most significant provider of capital ; and
- The currency in which operating receipt are retained.