More than accounting. Functional currency

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1 19 July 2011 Functional currency More than accounting Nangnoi Charoenthaveesub

2 Agenda 1. Functional currency determination 2. Consolidation 3. Functional currency adoption impacts 2

3 Functional currency determination 3

4 Functional currency determination Functional currency is the currency of the primary economic environment in which the entity operates. The primary economic environment is the environment in which it normally generates and expends cash. Careful analysis of primary and secondary indicators are required in determining the functional currency not a choice Once determined, the functional currency of an entity cannot be changed unless there is a change in the transactions, events and conditions that lead to the initial determination of functional currency. PwC 4

5 Functional currency determination Primary economic environment Is it where the entity is located? What is primary economic environment? Is it the currency that transactions are denominated? PwC 5

6 Functional currency determination Primary economic environment Is Thailand the primary economic environment for all Thai companies? No. Location of the business operation is not the sole indicator of the entity s primary economic environment. Otherwise, there is no point in determining the functional currency!! Does the primary economic environment have to be a country? No. If the sales and costs of the entity are mainly influenced by global demand and supply, the primary economic environment can be a global environment. Does the currency that the transactions are denominated and settled indicate the primary economic environment? Not necessarily. IAS 21 focuses more on the currency of the underlying economy that determine the pricing of the transactions rather than the currency in which the transactions are denominated and settled. PwC 6

7 Functional currency determination Summary of indicators Currency that mainly influences sales prices Currency of the primary economic environment Financing currency: debt and equity funding retention of funds PwC Foreign operations: extension of parent or autonomous? level of transactions with parent impact / availability of funds to parent ability to independently fund debt Currency of the country whose competitive forces and regulations mainly determine sales prices Currency that influences labour, material and costs

8 Functional currency determination Examples Saudi Arabian crude oil trading US$ Denominated and settled Revenue 100 US$ Cost of sales Cash expenses % Riyal, 80% USD Depreciation Other cash expenses % Riyal 8 What is the functional currency? PwC 8

9 Functional currency determination Examples Saudi Arabian crude oil trading Answer: Sales is subject to the worldwide competitive forces which for crude oil are linked to the US dollar, therefore the prices are determined in US Dollar. its cash costs are 80% in US dollars. Therefore, USD mainly influence the costs of providing the goods. Depreciation and other non-cash expenses are not considered in the determination of functional currency. The functional currency is USD. PwC 9

10 Functional currency determination Examples Holding company (Thailand): Manufacture and sells in Thailand and export Baht Holding? Subsidiary (Subsidiary): Subsidiary Imported product from Holding in Baht. Sell products in Singapore in SGD compete with local competitors. Expenses are in SGD. Long term financing in SGD. What is Subsidiary s functional currency? PwC 10

11 Functional currency determination Examples Indicators Analysis Functional currency Sales and cash inflows Expenses and cash outflows Denominated and settled in SGD Local competition drives the price Purchases are denominated and settled in Baht. Other expenses are in SGD SGD Mixed Mixed but overall favour SGD Financing Long term borrowing in SGD SGD Retention of cash Cash is used to pay SGD loan SGD Volume of intercompany transactions Significant volume of transaction Purchases Dividend distribution Baht Baht? PwC 11

12 More questions? What is the functional currency of coal mining company? What is the functional currency of petrochemical company? What is the functional currency of ship lines company? What is the functional currency of an entity manufacturing electronic parts for export? PwC 12

13 Consolidation 13

14 Consolidation Parent s functional currency and group presentation currency No concept of Group s functional currency. Each entity must determine its own functional currency. A functional currency more closely aligned with the exposures in the entity will naturally reduce the impact on results of movements in exchange rates. There is a Group s presentation currency a choice to be made by the Group. PwC 14

15 Consolidation Impacts on consolidation P Limited FC = USD PC = Baht Sub 1 FC = USD Sub 2 FC = AUD PwC 15 Subsidiaries accounts will be translated into Baht (PC of parent) for consolidation. Translation differences will arise. Sub 3 FC = Baht

16 Consolidation Impacts on consolidation USD Baht Assets 100 Liab 40 Assets 4000 Liab 1600 Share cap 30 Share cap 900 B/f RE 20 Profit B/f RE 600 Profit 350 FCTR Ex 31 Dec 10 = 40 Ex rate (historical) = 30 Ex rate (FY 10 average) = 35 PwC 16

17 Functional currency adoption impacts 17

18 Functional currency adoption impacts Economic or cash flow exposure Earnings impacts Dividends Impacts of the adoption of functional currency Tax consideration Systems and process Reporting/ communicatio n Risk management PwC 18

19 Functional currency adoption impacts Economic considerations Setting the economic strategy for the management of FX risk involves: Measuring the Understanding correlations (in particular exposures between currency exchange rates and commodity prices) Managing the risk in line with the risk management strategy Consider how management incentives are remunerated. A change in functional currency does not change the entity s economic exposure as there is no change in cash flows. PwC 19

20 Functional currency adoption impacts Systems and process considerations Understanding the systems functionality eg. Dual ledger, consolidation of multiple subsidiaries with differing presentation currencies. Understand the capabilities of existing systems eg. automated and/or manual processes that may be required Understand the implications around transition. In cutting over to a new carrying basis, what information might need to be retained (for example for tax purposes?) Documentation of system configuration PwC 20

21 Functional currency adoption impacts Systems and process considerations Can the software: fully supports multiple currencies business transactions can be recorded at both the transaction currency and the functional currency as they occur - keeps records of original transaction currency and exchange rate employed in translation revalues foreign currency items at market rates on balance sheet date supports the translation of foreign currency financial statements in consolidation Insight: Once dual ledgers are achieved it is important to understand what ledgers record which transactions and the associated impacts of this. PwC 21

22 Functional currency adoption impacts Tax considerations A key step will be to Understand the tax implications of a change in functional currency If the tax treatment is linked to the accounting treatment, the change may have cash tax implications that will need to be understood. If not, there will essentially be process implications stemming from the requirement to maintain two sets of books. Understand the impact on the effective tax rate Thailand Revenue Code requires submission of tax return and payment in Thai Baht only. PwC 22

23 Functional currency adoption impacts Tax considerations Country Impact of functional currency on tax New Zealand Tax basis must be in NZD. Dual ledger system is required to maintain NZD tax book. Australia Entities have a choice to submit their tax returns in AUD or its non-aud functional currency. The Philippines If functional currency is not Peso, income statement must be translated into Peso using average monthly exchange rate for tax submission. Malaysia Tax basis must be in MYR. Dual ledger system is required to maintain MYR tax book. Singapore Tax book is prepared in functional currency and translated to SGD using a prescribed exchange rate for submission. Indonesia Tax submission must either be in IDR or USD. PwC 23

24 Functional currency adoption impacts Dividends The functional currency decision may or may not impact the currency in which dividends are set and paid (there may be legal and regulatory requirements for this to be in local currency in some jurisdictions) Depending on the currency in which dividends are set and paid, the dividend outflow would need to be considered in the context of the overall currency risk management strategy. PwC 24

25 Functional currency adoption impacts Recently changes in functional currency Recent changes in functional currency Shell from EURO to USD (in 2004) Woodside Petroleum from AUD to USD (in 2010) PwC 25

26 Recent changes in functional currency Royal Dutch Shell Woodside Petroleum US dollars reflects the fact that the majority of the Shell Group s business is influenced by pricing in international commodity markets, with a dollar economic environment. PwC 26

27 Recent changes in functional currency Royal Dutch Shell Woodside Petroleum With approximately 90% of revenue and more than 90% of debt denominated in US dollars, Woodside s directors adopted a US dollar functional currency and presentation currency effective from 1 January This change provides shareholders with a more accurate reflection of the company s underlying performance, while increasing comparability of our financial results with those of our industry peers. PwC 27

28 Q&A

29 Contacts : PWC Nangnoi Charoenthaveesub - Partner Tel: +66 (0) nangnoi.charoenthaveesub@th.pwc.com Natcharee Pongrattanadej - Director Tel: +66 (0) natcharee.pongrattanadej j@th.pwc.com Kanokporn Tirabanchasak - Senior Manager Tel: +66 (0) kanokporn.tirabanchasak@th.pwc.com PwC 29

30 Thank you This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, [insert legal name of the PwC firm], its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers ABAS Ltd. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers ABAS Ltd. which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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