Functional currency

What it means

Functional currency is the currency of the primary economic environment in which a business operates, meaning the one in which it mostly sells, buys and pays wages. The concept comes from IFRS, specifically the standard on the effects of changes in exchange rates, and determines the currency in which the business measures its results.

Slovak companies must keep their books in euros and translate foreign currency transactions into euros. Functional currency matters under IFRS and in groups with foreign subsidiaries, however, where each entity may have a different functional currency, such as the koruna for a Czech subsidiary.

It differs from the presentation currency in which the consolidated financial statements are prepared. A group with a euro-based parent translates its subsidiaries' statements from their functional currency into euros and records the resulting differences in equity.

How it works in practice

Determining the functional currency involves assessing the currency in which sales prices are set, in which the main costs arise and in which financing is raised. Where indicators are mixed, management judgement decides, and it should be documented.

Transactions in a currency other than the functional currency are translated at the rate on the transaction date, such as the ECB rate, and monetary items are retranslated at the balance sheet date. Differences are booked as exchange differences in profit or loss.

Slovak subsidiaries of foreign groups often keep two sets of accounts: under Slovak rules in euros and under IFRS for the group. If the IFRS functional currency is another currency, such as the dollar, differences arise that must be properly reconciled in group reporting.

What to watch out for

Functional currency does not change according to which currency is currently more favourable. A change is possible only when underlying conditions change, for example when the company shifts its sales to another market, and it applies prospectively from the date of change.

A mismatch between the functional currency and the currencies of income and costs creates currency risk. A company selling in dollars and paying costs in euros should consider hedging so that exchange rate movements do not wipe out its margin.