Consolidating Financial Statements: Determining the Functional Currency

Selected GAAP Guidance for Determining Functional Currency:

When the subsidiary is a relatively self-contained, independent business operation, operating primarily in local markets, then the local currency is the functional currency.

When the subsidiary is heavily integrated with the parent company and it serves as sales outlet type function for the parent, then the subsidiary's functional currency is the parent's reporting currency.

While GAAP and IFRS require certain disclosures regarding the treatment of foreign currency when consolidating multinational operations, parent company management retains some discretion in determining the functional currency. A well trained financial analyst must be aware that two companies in the same industry may use different translation methods. For comparability purposes, it is recommended to move all translation adjustments to equity from the balance sheet to the income statement.