Question

Origin Enterprises Ltd is incorporated in Australia. The company’s shares are listed on both the Australian and London securities exchanges. Operations of the company are diversified across the following countries: the United Kingdom, Europe and Australia. One third of the company’s operations take place in each of these countries.

The majority (approx. 80%) of its sales contracts are dominated in United Kingdom pounds and this proportion of receipts from operating activities is retained within accounts in the UK. Most of the company’s labour, material and other costs of providing its goods and services are incurred within the individual countries which it operates.

The company has 60% of its operations financed through sources within the UK, with the balance from Australian sources.

Discuss what functional currency is and how it is determined. With the assistance of the class and using the above information, determine the functional currency of Origin Enterprises Ltd.

Answer 1

Functional Currency : (FC)

It is the primary type of currency that a company uses in the business activity. With the help of functional currency, overall business performance can be measured.

In other words, it is the main currency used by the business or units of the business.

However, FC must be consistent over the years. Any change in currency occurs, it is treated as change in estimate.

How to determine Functional Currency : (The benchmarks apply to the following)

1. Selling Price - FC is the foreign currency when the foreign operation's selling price of products or services arises from local factors like government.

2. Market - FC is the foreign currency when the foreign activity has a strong local sales market for products or services.

3. Cash Flows - FC is when the foreign operation's cash flows are predominantly in foreign currency not directly impacting the parent's cash flow.

4. Financing - FC is when financing the foreign activity is in foreign currency and funds obtained are adequate to satisfy the debt payments.

5. Expenses - FC is when the foreign operation's costs or services are usually incurred locally.

Determination of FC of Origin Enterprises Ltd :

In this case the benchmarks will apply for Sales and Expenses since it applies for the given question.

Hence, the Functional Currency in the present case will be currency of United Kingdom i.e.. UK Pounds, since 80% of the sales contracts are dominated in UK, and 60% of its operations are financed through sources within UK.