Functional Currency Determination

Functional Currency Determination Case

10/10/2011[pic 1]

ABSTRACT

     In the dynamic global market, companies of all sizes, whether small, medium or transnationals interact with foreign companies and in most cases operate with currencies that are different from those that they commonly use. Foreign companies use foreign currencies for their expenditures, hedging strategies, and investing and financing activities. As a result these business activities must be reflected on the financial statements in the corporation’s reporting currency. FASB 52 and IAS 21 provide the appropriate guidance on the consideration of which functional currency should be implemented by the foreign subsidiaries. This case focuses in Sparkle a Nigerian subsidiary of a joint venture formed by U.S. – based companies with US functional currency; This Company is assessing several factors that will be discussed in the following paragraphs to determine its functional currency.

Currency Determination

     Sparkle Company is a Nigerian diamond company owned by U.S. established companies, during 2009 had the subsequent transactions:

• Loans: $1 million dollars from Brighten, $1 million from Shine and 300 million NGN.
• Expenditures: 850 million NGN for labor and operating expenses for 75 million NGN. They also bought a $15 million machinery from Brighten.
• Revenues: $8.75 million worldwide and $ 35 million in the U.S.

     U.S. laws govern the diamond trade worldwide and all sales are made in US dollars, also $1 US dollar is equivalent to 140 NGN that is the Nigerian currency. During the year 2010, Shine sold its share in the joint venture to Brighten. Where do these factors lead? Sparkle Company is involved in global transactions denominated in dollars. This Company operates in a global market regulated by the Central Selling Organization (CSO), whose headquarters are in Johannesburg, South Africa and the main market for diamonds in the world is located in Antwerp, Belgium.

Due to the highly regulated market, prices of diamonds are not volatile since CSO seeks to maintain yields about 3% for those with investments in diamonds. Another issue to address is that one of the main differences between IFRSs and U.S. GAAP is the fact that the international standards for determining the functional currency of a subsidiary are hierarchized, on the other hand, U.S. GAAP is more homogenous and also relies more in the judge of the managers. Also, IFRSs uses the hierarchy of factors, with more emphasis on pricing factors. However, U.S. GAAP bases its decision on cash flows

     As a result of the previous details arise two questions:

1. Under IFRSs, what is the functional currency of Sparkle in 2009?
2. For both, U.S. GAAP and IFRSs, determine the functional currency of Sparkle in 2010.

DISCUSSION

     Before starting the discussion on determining the functional currency of Sparkle, the issue of hyperinflationary economies should be addressed, according to IAS 29 and FASB 52 it’s presented in countries in which “the cumulative inflation rate over three years is approaching, or exceeds, 100%”.  If this condition is presented in a country where a parent has a subsidiary they must not use the local currency as their functional currency, instead, the currency of the parent should be adopted.