Currency Types

Accounting Currency Types

Functional Currency is used to record the transactions and report their financial results for the company. Typically, the company conducts a majority of its business activities in the functional currency (often it’s the local currency where the company operates).

For example, a Japanese company operating in Japan would likely use the Japanese Yen as its functional currency.

Reporting Currency is the functional currency of the parent organization. We have introduced this term to clarify which functional currency is ultimately being used for the financial reporting of the parent company.

Foreign Currency is recorded for specific transactions that are not in the functional currency. For example, if a Japanese company purchases computer chips from a Singapore supplier priced in Singapore dollars, the foreign currency would be Singapore dollars.

Risks

Hedging Risks: Accounting standards outline a number of risks that may be hedged. For example, market price risk, credit risk, foreign currency risk, and interest rate risk. Foreign Currency Risk: This type of risk arises from the change in price of one currency against another. When companies have foreign currency assets (for example, cross-border sales or business operations across national borders) or foreign currency liabilities (for example, imports), they face currency risk if their foreign currency exposures or positions are not hedged.

Transaction Risk includes the current and prospective risk to earnings that exchange rates will change unfavourably over time for transactions already entered into (but not completed), or for future transactions in which the firm is likely to have a commitment in a foreign currency. The exchange rate risk increases proportionately with the length of time between entering into a contract and settling it (because there is more time for the exchange rate to fluctuate).

Translation Risk is proportional to the amount of assets held in foreign currencies. It is a form of currency risk associated with the valuation of balance sheet foreign currency assets and liabilities between financial reporting dates. At each reporting date, the balance sheet and income statement reflect the change in value of the foreign currency assets and liabilities due to the change in foreign exchange rates.

Courtesy: OANDA’s FXConsulting for Corporations

Pip Booker
Chairman & Founder
Booker and Cropper Capital Group