3. Determining the Functional Currency
The AASB 121 Para 8 defined functional currency of a foreign entity as
follows:
An entity’s functional currency is the currency of the primary economic
environment in which the entity operates.
According to FASB Guidelines, Economic factors should be considered when
determining the functional currency are:
Cash flow indicators.
Sales price indicators.
Sales market indicators.
Expense indicators.
Financing indicators.
Intercompany transactions indicators.
5. Determining the Functional
Currency (AASB 121)
Para 12---on determining the functional currency, management should use
judgment and gives priority to the indicators in Para 9 before considering the
indicators in Para 10 and Para 11.
Para 9--- normally the one in which it primarily generates and expands cash
consider the currency:
in which sales prices are denominated or which influences sales prices
of the country whose competitive forces and regulations influence sales prices
In which input costs- labor, materials-are denominated and settled, or which
influences such costs
Pare 10---consider two factors:
the currency in which funds from financing activities are generated
the currency in which receipts from operating activities are retained
6. Determining the Functional
Currency (AASB 121)
Para 11--- consider other factors:
Whether the activities of the foreign operation are carried out as an extension of the
reporting entity
Whether transactions with the reporting entity are a high or low proportion of the foreign
operation’s activities
Whether cash flow from the activities of the foreign operation directly affected the cash
flow of the reporting entity and are readily available for remittance to it
Whether cash flows from the foreign operation are sufficient to service existing and
expected debt obligations without funds being made available by the reporting entity
Para 13---Once determined, the functional currency is not changed unless there is
a change in those underlying transactions, events and conditions.
7. Case Analysis
Topsy Tursy GmbH is an entity located in Germany. This entity sells
and distributes the Jolly Lolly group’s patented climbing equipment
in Europe.
Jolly Lolly Limited 70% control Topsy Turvy GmbH
Parent Subsidiary
As Jolly Lolly has acquired 70% interest in Topsy Tursy GmbH (TTG), TTG is
considered to be a foreign subsidiary of Jolly Lolly group.
In determining the functional currency of a foreign subsidiary. Generally, if
1) the subsidiary is acting as an intermediary for the parent’s activities.
functional currency = parent currency
2) the subsidiary is acting as a free standing unit.
functional currency = local currency
8. Case Analysis
In past years, all products are sourced from Jolly Lolly, and sales
prices are determined based on a margin over the acquisition cost.
For this situation, the products being sold are made in Australia, and the selling
price is determined by its acquisition cost. Therefore, Australian currency
denominates the production costs and sale prices.
During the current year however, a major competitor has entered the
European market and the pricing of the good is becoming
increasingly subject to European competitive forces.
In current year, the sales prices are not responsive in short term to exchange rate
changes and they are determined mainly by local conditions. Therefore, the
sales price depend on the local currency.
9. Case Analysis
All European sales are handled by Topsy Turvy and pricing is
standard throughout the European distribution network, except
distribution costs.
Operating expenses are determined primarily by local conditions. There is
not an extensive interrelationship between the operations of the foreign
subsidiary and those of the parent.
All profits generated by Topsy Turvy branch are retained to
fund the group’s European operations.
Low volume of intergroup transactions and the receipts are retained in local
currency to fund European operations.
10. Case Analysis
Economic Indicators Past Current
Sales Prices A$ EURO
Sales Market EURO EURO
Production Costs A$ A$
Operating Expenses EURO EURO
Intragroup Transactions LOW LOW
11. Case Analysis
1) For past years, the functional currency is Australian currency.
TTG is considered to be an intermediary for the parent.
According to AASB121, Para 9-12, the functional currency is normally the one
in which it primarily generates and expends cash. As the products were sourced
from Australia and selling prices were determined by margin over acquisition
costs, the input costs and the sales prices are primarily determined by
Australian currency.
2) For the current year, the functional currency is local currency
–Euro. TTG is considered to be a free standing unit.
As there is a change in sales market conditions, the sales prices are determined
primarily by local competition. This caused the currency of the major economic
environment changes from Australian to European currency.(AASB121, Para 9-
13)
12. Accounting Treatment (AASB 121)
Para 35:
When there is a change in an entity’s functional currency, the
entity shall apply the translation procedures applicable to the
new functional currency prospectively from the date of the
change.
Para 36
As noted in paragraph 13, once the functional currency is
determined, it can be changed only if there is a change to those
underlying transactions, events and conditions. For example, a
change in the currency that mainly influences the sales prices
of goods and services may lead to a change in an entity’s
functional currency.
13. Accounting Treatment (AASB 121)
Para 37:
The effect of a change in functional currency is accounted for
prospectively. In other words, an entity translates all items into
the new functional currency using the exchange rate at the date
of the change. The resulting translated amounts for non-
monetary items are treated as their historical cost.
Exchange differences arising from the translation of a foreign
operation previously recognized in other comprehensive
income in accordance with paragraphs 32 and 39(c) are not
reclassified from equity to profit or loss until the disposal of the
operation.
14. Accounting Treatment (AASB 121)
Past Current
(local–function) (function - presentation)
Non-monetary items Para 23(b) of AASB 121 Para 39(a) of AASB 121
Using the historical Using the closing exchange
exchange rate rate
Exchange gain/loss Para 28 of AASB 121 Para 39(c)of AASB121
In P&L classified as other As a separate component of
comprehensive of income equity, Foreign Currency
Translation Reserve(FCTR)
15. Disclosure (AASB 121)
Para 53
When the presentation currency is different from the functional
currency, that fact shall be stated, together with disclosure of
the functional currency and the reason for using a different
presentation currency.
Para 54
When there is a change in the functional currency of either the
reporting entity or a significant foreign operation, that fact and
the reason for the change in functional currency shall be
disclosed.
16. Conclusion
During the year ended 30 June 2011:
GGT has changed its functional currency from Australian
dollar to Euro, because of the change in sales market makes the
sale prices are determined mainly by local condition.
