Presentation Currency, Functional Currency, and Local Currency

A multinational corporation is a firm that has business operations located in at least one country besides its home country. It may engage in transactions that are denominated in foreign currency or invest in foreign subsidiaries that keep their financial records in a foreign currency. This exposes the firm to foreign currency effects. There are three different forms of currencies, as demonstrated below:

Assume that we have a sizable US-based organization, XYZ, i.e., the parent company with three subsidiaries in India, Kenya, and Mexico. At the financial year-end, the Indian company prepares its financial statements in Indian Rupees (INR), the Kenyan company in Kenyan Shillings (KES), and the Mexican company in Mexican Pesos (MXN).

The subsidiaries use their local currency to prepare their financial statements, whereas the parent company uses USD to prepare its consolidated financial statements. USD, in this case, is called the presentation currency. If the Kenyan subsidiary carries out all its transactions in KES, then we say that KES is the functional currency. Assume that XYZ entirely controls the Mexican subsidiary. This means that it makes all operation decisions for the subsidiary, and consequently, all transactions are in USD. In this instance, USD is the functional currency for the Mexican subsidiary.

To summarize the above explanations, we have:

1. Presentation (Reporting) Currency

Presentation currency refers to the currency that the parent company uses to prepare its financial statements. Mostly, a company’s reporting currency is the currency of the country where the company is located.

2. Functional Currency

It is the currency of the primary economic environment in which an entity operates. A company’s management determines its functional currency. It is the currency in which an entity generates and expends cash. The functional currency can be the local currency or some other currency.

3. Local Currency

The national currency of the country in which a foreign firm operates is called the local currency. Typically, the local currency is the entity’s functional currency. For accounting purposes, any currency other than the entity’s functional currency is a foreign currency for that entity.

Question

The most accurate definition of the local currency is:

A. Any currency other than the parent currency.

B. The currency used by the parent company to prepare its financial statements.

C. The currency of the country in which a company operates.

Solution

The correct answer is C.

The local currency is the national currency of the country in which a foreign firm operates.

A is incorrect. For accounting purposes, any currency other than the entity’s functional currency is a foreign currency for that entity. 

B is incorrect. The presentation currency is the currency that the parent company uses to prepare its financial statements.

Reading 13: Multinational Operations

LOS 13 (a) Compare and contrast presentation in (reporting) currency, functional currency, and local currency.