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The original standard issued by FASB in 1981 (now Topic 830 in the Accounting Standards Codification) states that if the foreign operation is in control of its operations and financing, then the functional currency would be the local currency of the branch. This analysis leads to the conclusion that either dollars or pounds could be used as the functional currency.
Also, this is a matter of fact and should be based on the currency where the majority of the cash is received and expended. Here the company chose pounds as the functional currency because it is the local currency.
More specifically, this Statement replaces FASB Statement No.
8, Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements, and revises the existing accounting and reporting requirements for translation of foreign currency transactions and foreign currency financial statements.
An entity's functional currency is the currency of the primary economic environment in which that entity operates.
This helps to reduce the volatility of consolidated earnings.
It is also more helpful for management, shareholders and creditors in evaluating a company because losses and gains resulting from the exchange rate are excluded for the consolidate earnings.
Accordingly, the exchange gains and losses in such an operation are included in net income.
Contracts, transactions, or balances that are, in fact, effective hedges of foreign exchange risk will be accounted for as hedges without regard to their form.
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A currency in a highly inflationary environment (3-year inflation rate of approximately 100 percent or more) is not considered stable enough to serve as a functional currency and the more stable currency of the reporting parent is to be used instead. Translation adjustments are not included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until complete or substantially complete liquidation of the net investment in the foreign entity takes place.