Functional currency: follow prices and costs before the bank account

Start with what sets prices and costs

Functional currency is decided entity by entity, and IAS 21 puts the economic drivers first. The primary indicators concern the currency that mainly influences sales prices, including the market whose competitive forces and regulations set them, and the currency that mainly influences labour, material and other costs. Where funds are raised and where operating receipts are retained are supporting evidence. For a foreign operation, paragraph 11 adds evidence about its autonomy from, or dependence on, the reporting entity.

This article applies UK-adopted full IFRS for a 2026 annual period, without early adoption of IFRS 18 or the 2027 IAS 21 presentation-currency amendment, and without an IFRS 19 reduced-disclosure election. It does not cover FRS 102, IFRS for SMEs, Ind AS or US GAAP.

Worked hypothetical: two companies, two answers

The two companies below are hypothetical and independent cases, not a menu of currencies to choose from. Company A is incorporated in the UK. It invoices a US customer in dollars, raises dollar debt and keeps dollar cash. Its contracts, however, set the price as a fixed GBP100 per unit converted at the invoice-date rate. UK market competition sets that GBP price, and its labour and production costs are mainly in GBP.

At an invented rate of GBP0.80 per USD1, GBP100 is billed as USD125. At GBP0.75 it becomes USD133.33. The invoiced dollars move while the pound price stays at GBP100. On these assumed facts GBP is the supported functional currency, because the economic price driver is GBP and invoice denomination alone would hide that. The calculation explains the pricing clause; it is not an exchange-accounting entry.

Company B is also UK incorporated but sells internationally at USD commodity benchmark prices, buys its main inputs and pays production costs in USD, and raises finance and keeps operating cash in USD. On those assumed facts USD is supported, despite UK registration and a shareholder request for GBP presentation.

When the indicators disagree

Mixed evidence is common. If prices point to USD and labour and materials point to GBP, counting invoices, bank accounts or indicators does not settle it, and percentages are not IAS 21 thresholds. Management uses judgement to decide which currency most faithfully represents the underlying economics, giving priority to the paragraph 9 indicators. More evidence may be needed. The judgement resolves conflicting evidence; it is not a free choice.

Once determined, the functional currency changes only when the underlying conditions change. Switching the accounting system's base currency changes no economics. A convenient currency also cannot be used to avoid IAS 29. Exchangeability and hyperinflation need further work outside this article.

Presentation currency and later changes

A group does not have one functional currency because it presents its accounts in one currency. Each entity determines its own functional currency, and the presentation currency can differ. Where an entity keeps its records in another currency, those records still have to produce functional-currency amounts.

Documenting the assessment creates no journal. A genuine change is applied prospectively from the date of change, and translated amounts of non-monetary items at that date become their historical cost. The earlier assessment is not rewritten because reporting preferences changed. If the earlier assessment was simply wrong, that is not automatically a prospective change; whether it is an error needs separate assessment. A different presentation currency and a change of functional currency each carry specific disclosures.

For each entity, keep a signed memo with the actual price-setting clauses, competitor and regulatory price evidence, cost data, debt and cash-retention facts, any dependence on the parent, the indicators pointing the other way, the reasoned conclusion and the date of any change. IAS 21 does not prescribe that memo, but it holds the evidence a reviewer will ask for.