Before the financial statements of a foreign branch, division, or subsidiary are translated into US dollars, the management of the US company must make a decision as to which currency is the functional currency of the foreign entity. Once chosen, the functional currency cannot be changed unless economic facts and circumstances have clearly changed. Additionally, previously issued financial statements are not restated for any changes in the functional currency. The functional currency decision is crucial because different translation methods are applied which may have a material effect on the US company's financial statements.
FASB defines functional currency but does not list definitive criteria that, if satisfied, would with certainty result in the identification of an entity's functional currency. Rather, realizing that such criteria would be difficult to develop, FASB listed various factors that were intended to give management guidance in making the functional currency decision. These factors include
Cash flows (Do the foreign entity's cash flows directly affect the parent's cash flows and are they immediately available for remittance to the parent?)
Sales prices (Are the foreign entity's sales prices responsive to exchange rate changes and to international competition?)
Sales markets (Is the foreign entity's sales market the parent's country or are sales ...