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What Is Functional Currency, And How Does It Affect Lease Accounting?

What is functional currency, and how does it affect lease accounting?

The effects of globalization have reached virtually every aspect of business operations in many industries, including airlines, shipping and manufacturers. Lease management and administration can become even more complex when different currencies are added to the myriad of details. Here is a short guide to functional currency and how it may affect lease accounting for companies operating across borders.

What is functional currency?

As defined in Statement no. 52, functional currency is the currency of the primary economic environment in which the entity operates.  This is normally the local currency the company uses to transact on a day-to-day basis in the country the entity operates, however, be the currency in the country which the parent company operates if the subsidiary is a fundamental component of the parent’s operations.

Functional currency is not a choice, it’s determined by the economic environment in which the business operates. In contrast, functional currency may be different from the reporting currency, also known as presentation currency, used for financial reporting. Choosing the best presentation currency is a business decision.

What are risks associated with functional currency?

The fluctuating value of foreign currencies is amongst the complexities of lease accounting across borders. Constant conversions resulting from a large number of transactions in a foreign currency can have a big impact on profit and loss. Changing functional currency is a significant undertaking, and the transition should happen based on a specific date when circumstances change. If the transition date is unclear and some judgement needs to be applied on selecting a transition date, best practices dictate choosing the first day of a new reporting period.  Some industry experts allege lease contracts denominated in a currency different from the lessee’s functional currency could increase volatility in profit or loss, although there are ways to alleviate this effect. Mitigate risk and increase accuracy in reporting by choosing a lease accounting software solution that can keep up with leases originating in functional and foreign currency.

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