CFM64110 - Foreign exchange: accounts drawn up in a foreign currency: functional currency and presentation currency

CTA10/S17(4)

Current accounting standards

The accounting standards that may currently be applied by UK companies are as follows.

  • FRS 102, ‘The Financial Reporting Standard applicable in the UK and Republic of Ireland’. FRS 102 came into effect for periods of account beginning on or after 1 January 2015. Foreign currency translation is dealt with in Section 30.
  • International Accounting Standards (IAS). Normally companies quoted on a regulated EU or UK stock exchange are required to use IAS in their consolidated financial statements. Other UK companies are normally free to choose to apply IAS as an alternative to FRS 102. Foreign currency translation is dealt with in IAS 23. For the meaning of IAS as used in tax legislation, see BIM31025.
  • FRS 101 can normally be applied by UK companies in single entity financial statements, as an alternative to FRS 102. It is similar to IAS, but with a reduced disclosure framework. Foreign currency translation is dealt with in IAS 23.
  • FRS 105, ‘The Financial Reporting Standard applicable to the Micro-entities Regime’ may only be applied by qualifying micro-entities. It applied from 1 January 2016, with early adoption permitted. Section 30 contains brief guidance on with foreign currency translation. However, a micro-entity is required to refer to the requirements of FRS 102.30 to determine if the foreign branch has a different functional currency, and how to account for such a branch.

Each of Section 30 of FRS 102, IAS 23 and Section 30 of FRS 105 are consistent with each other and there are not expected to be any differences between them. In addition, FRS 23 which applied to some companies before 2015, is equivalent to IAS 23 and is therefore also consistent.

SSAP 20, which many UK companies applied before 2015, had different requirements and is explained at the end of this page.

Functional currency

This is defined for tax purposes at CTA10/S17(4). The functional currency is the currency of the primary economic environment in which the company operates. This may be sterling or another currency.

Under IAS 21 and FRS 102 companies are permitted to draw up financial statements in any currency. A distinction is drawn between this currency, the presentation currency, and the company’s functional currency.

This is consistent with the accounting approach. In particular, the accountancy standards (paragraph 8 of IAS 21.8 and section 30.2 of FRS 102) define functional currency as “the currency of the primary economic environment in which the entity operates”. However, the accounting standards contain further guidance as to how this should be determined.

The primary economic environment in which an entity operates normally will be the one in which it primarily generates and expends cash. The most important factors influencing this are:

  • The currency that mainly influences sales prices for goods and services, which is often the currency in which sales prices for its goods and services are denominated and settled.
  • The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
  • The currency that mainly influences labour, material and other costs of providing goods or services, which again is often the currency in which such costs are denominated and settled.

There are also two subsidiary factors:

  • The currency in which funds from financing activities, in terms of issuing debt and equity instruments, are generated.
  • The currency in which receipts from operating activities are usually retained.

Where the indicators give mixed results, the management of the company must make a judgement.

If a company would not have been regarded as a foreign operation on consolidation with its parent (in particular, where the company does not operate autonomously), that company will have the same functional currency as the parent. This not only applies in the group’s consolidated financial statements, but also in the company’s own single entity financial statements. Accordingly, the functional currency of the company might differ from the one that might be determined were it viewed in isolation. This is particularly relevant for a financing company and other special purpose company which operates as a mere extension of its parent.

Note that the accountancy concept of functional currency can also be applied to part of a company. If the functional currency of part of the company is not the same as that of the reporting entity taken as a whole, that part is referred to as a ‘foreign operation’. See CFM64140 for further details.

Presentation currency

Under the current accounting standards, a company can present its financial statements in any currency. The currency in which the financial statements are prepared is known as the presentation currency. Where the functional currency differs from the presentation currency, the functional currency must be disclosed in the accounts.

The effect of the tax rules is that whatever the presentation currency, corporation tax profits or losses must be calculated by reference to the functional currency. This is subject to any valid election by an investment company to apply a designated currency.

The term presentation currency is not defined in the CTA10 - instead the rules refer to the currency in which the accounts are prepared.

Translation of items into a company’s presentation currency

A company (or foreign operation) should record its transactions in its functional currency. This is the currency by reference to which its profits and losses are calculated. When an amount denominated in a particular currency is translated into the company’s (or foreign operation’s) functional currency, the resulting exchange difference will typically be an item of profit or loss.

But where the results for a period, measured in the functional currency, are translated into the company’s presentation currency, any resulting exchange difference will be recognised as an item of “other comprehensive income” (OCI).

This difference is very important from a CT perspective. In particular, exchange gains and losses on monetary debts will normally be taxed under the loan relationship rules. As a result, amounts recognised as items of profit or loss are taxed but those recognised as items of OCI are not. CTA09/S328(3) specifically provides that these amounts are not amounts of profit or loss to be brought into account under the loan relationship regime.

SSAP 20

Before 2015, many UK companies adopted SSAP 20. The requirements under SSAP 20 differed from the other accounting standards dealing with foreign currency. SSAP 20 was withdrawn for periods beginning on or after 1 January 2015.

SSAP 20 did not have the concept of an entity’s functional currency and presentation currency. However, it did have the concept of a ‘local currency’ which is similarly defined as the currency of the ‘primary economic environment’ in which the entity operates. However, the guidance on how this is to be determined differs in some respect from the guidance in IAS 21 on determining functional currency.

In many cases, the company’s functional currency under the current accounting standards will be the same as the ‘local currency’ that it would have had under SSAP 20. This is likely to be the case for most trading companies. However, SSAP 20 did not contain a requirement that an entity’s local currency should be the same as that of its parent, in cases where the entity was not operating with sufficient autonomy. By way of example, under IAS 21 and FRS 102 the functional currency of a financing company may be determined by the functional currency of its parent, whereas under SSAP 20 their local currencies could differ.

This may, in practice, lead to a change of functional currency for accounting and therefore tax purposes on cessation of the application of SSAP 20.

Further guidance

For more about accounting for foreign operations, see CFM26200+.