Determining the functional currency for a company is one of the most important steps of company setup. Usually it’s a simple process, but when the company is a foreign operation of a larger organization, and needs to be rolled up as part of a consolidated set of financial statements, it can get tricky.
Let’s take a common scenario. Company A is a Canadian company that issues its financial statements in CAD. Company B is a Company A subsidiary and that operates in the U.S. and does its business in U.S. dollars. Should Company B’s functional currency be CAD or USD? The answer depends on whether the Company B is integrated or self-sustaining foreign operation.
If Company B is integrated the functional currency should be set as CAD. Here’s how it would work in GP:
For all USD and other non-CAD transactions, GP will look for an exchange rate between that currency and CAD and calculate the amount in CAD. If there’s any foreign exchange differences (for example on a payment applied to an invoice), GP automatically calculates it and posts to the GL as a realized gain or loss on foreign exchange. At month end, a revaluation process can be run to calculate and book any unrealized gain or loss (for example on outstanding receivables). When the subsidiary is rolled up in Company A’s consolidated financial statements, no foreign exchange differences are recorded as the company is already in CAD.
If the Company B is self-sustaining the functional currency should be set as USD. Here’s how it would work in GP:
As transactions is in USD and the functional currency of the company is in USD, there is no foreign exchange gain or loss from operations. The translation is done at period end when the subsidiary is rolled up in Company A’s consolidated financial statements. Management Reporter is used to calculate the gain or loss during consolidation and to move the amount into other comprehensive income (OCI) as per IFRS standards.
It is very important to determine the type of foreign operations before setting up a company as this determines the functional currency in GP and how foreign currency is translated. The easiest way to do this is to look at the two methods I’ve outlined above and see which model fits with your accounting practices and presentation of consolidated financial statements.
Note: The functional currency affects foreign exchange translation, but it does not limit reporting in different currencies. GP has two other types of currencies, reporting and originating that can always be used to view transactions and reports in the currency of your choice.