Key Points
- An entity may choose any currency as its presentation currency, but the functional currency is determined by the underlying economic environment and cannot be freely selected.
- Assets and liabilities translate at the closing rate, while income and expenses translate at the rate on the date of each transaction (or a period average as a practical approximation).
- Translation differences arising from this process go to other comprehensive income, not to profit or loss.
- Selecting a presentation currency that differs from the functional currency adds a full layer of translation work to every reporting period.
What is Presentation Currency?
IAS 21.38 permits an entity to present its financial statements in any currency. When the presentation currency differs from the functional currency, the entity translates results and financial position using the method in IAS 21.39. Balance sheet items (assets and liabilities) are translated at the closing rate on the reporting date. Income statement items (revenue and expenses) are translated at exchange rates on the dates of the transactions, although IAS 21.40 accepts an average rate for the period when exchange rates do not fluctuate significantly.
The difference between net assets translated at the closing rate and the income statement translated at transaction-date (or average) rates creates an exchange difference. IAS 21.39(c) requires the entity to recognise that difference in other comprehensive income. The cumulative amount sits in a separate component of equity (often called the "foreign currency translation reserve") until the entity disposes of the foreign operation, at which point IAS 21.48 reclassifies the accumulated amount to profit or loss.
For group reporting, the distinction between functional and presentation currency matters at two levels. The parent determines each subsidiary's functional currency based on IAS 21.9-14. It then translates every subsidiary's results into the group's presentation currency before preparing the consolidated financial statements. ISA 600.25 expects the group engagement team to understand these translation procedures, because exchange differences can be material enough to affect the group opinion.