Changing functional currency under IFRS – some implications…

by John Hughes

The IFRS conversion effort is forcing quite a few companies to reconsider their functional (measurement) currency, or that of their subsidiaries. IFRS defines the concept much more specifically than Canadian GAAP, as the currency of the “primary economic environment in which the entity operates.” The key factors in assessing this are the currency mainly influencing sales prices for goods and services (usually the currency in which those prices are most often denominated and settled), the currency of the country whose competitive forces and regulations mainly determine those sales prices, and the currency mainly influencing labour, material and other costs of providing those goods or services (usually, again, that in which they’re denominated and settled).

These factors often point in different directions – for example, many Canadian companies incur most of their costs in Canadian dollars while selling primarily into the US market  – and in this case financing and treasury activities may also provide relevant evidence. Then, in asking whether a subsidiary or other foreign operation has the same functional currency as the reporting entity, IAS 21 also sets out further factors to consider, largely along the lines of those applied under Canadian GAAP in determining whether the foreign operation is integrated or self-sustaining (IFRS doesn’t use those terms though).

Under Canadian GAAP, EIC-130 says the functional currency “is not a matter of free choice but a determination based on the facts in the particular circumstances.” It also says that CICA 1650 “provides guidance on determining the functional currency of an operation,” but this is barely true – there’s very little in there on the subject. It’s tempting to think that in practice the basic fact of being a Canadian entity has gone a long way to justifying the choice of a Canadian dollar functional currency, regardless of the entity’s economic profile. Looking to US GAAP, FAS 52 sets out a more specific set of indicators and may have been a useful reference point for Canadian GAAP, but these indicators seem to focus primarily on identifying whether a foreign operation’s functional currency differs from that of the parent, rather than on identifying the parent’s own functional currency.

Against this backdrop, it’s no surprise that some entities identify a change in their functional currency, or in that of their foreign operations, as a direct consequence of the extra specificity in IFRS. Winpak provides an illustration of this:

Day4 Energy, in contrast, provides an example where going through the IFRS conversion process prompts a change in functional currency resulting from an evolution in the business, not just the different words in the standards. Because it results from a change in circumstances, it’s accounted for prospectively:


Theoretically, other variations could exist too – an entity might for example identify a prospective change under Canadian GAAP but a retroactive one under IFRS. The accounting consequences should, again, not be a free choice; they should flow from the facts applying in each case. But given the murkiness in Canadian GAAP, it seems at the very least that some fact patterns may provide room for debate.

In a situation where (say) a company concludes its functional currency is the Canadian dollar under Canadian GAAP but the US dollar under IFRS, then this seems to entail measuring the final year of reporting under Canadian GAAP (the comparative period in the first IFRS statements) from two different perspectives. I don’t know how many accounting systems are capable of doing this automatically, but for those that aren’t, it seems to me that as long as information remains available on the underlying Canadian and US dollar transaction streams (not just on the translated amounts), then it should be possible to apply a practical approach in translating from one currency to the other. The risk of erroneously translating the opening or closing balance sheet should be minimal; for the income statement connecting the two, the emphasis should be on avoiding significant misclassifications between revenue/expense categories and the reported exchange gain or loss – for example, on not misstating gross profit margin by incorporating the bottom-line impact of exchange movements. But even then, the reporting benefit of such a one-time misclassification would be minimal to say the least; any false portrayal of things couldn’t be sustained once the new functional currency and accompanying translation procedures are established and operating effectively.

Will Canadian regulators take issue with IFRS transition disclosures pointing to a possible error in how the functional currency was previously identified under Canadian GAAP? It’s possible of course, although indications are they’ll also take a practical approach, minimizing the time they spend on past issues of diminished relevance (particularly, you might assume, where the terrain is as fuzzy as it is here). You might speculate the regulatory risk would be greater where some indication exists that the methodology applied under Canadian GAAP might have materially misled investors about the company’s risk profile. Even then though, the MD&A is probably more central to investors’ understanding of this than the numbers that happen to fall into the financial statements (having used the wrong functional currency in the past might only mean your previously reported numbers were more volatile and cautionary than they had to be).

Even more than usual, this is obviously a highly inadequate summary of a potentially very complex topic. On the whole though, I think it’s one of those areas where the transition to IFRS can be potentially beneficial, pointing the way to more rational internal and external reporting. More next time on another aspect of this…

The opinions are solely those of the author.