The fund custodian, Shady Rest, prepared the fund’s books in Euros, since it was a country fund that invested solely in securities listed on the Madrid Stock Exchange. However, this decision is very detrimental because of several reasons. The custodians could have chosen an appropriate functional currency that could have minimized complications in the operations of the fund. The auditors claimed that the functional currency should have been the U.S. dollar; this paper explains why the auditors were right.
Adoption of the U.S. dollar as the functional currency will present a lot of benefits in the management of the fund. Because the work of rewriting and reworking the accounting transactions was a massive task that delayed the publication of the annual accounts, then it is clear that something went wrong, which needs to be addressed. Although, the concept of functional currency is not commonly practiced in Spain, this should not be a good reason for managers to fail to explain the effects of functional currency appropriately. Shady Rest should develop a multicurrency accounting system, so that the U.S. functional currency can be executed without problems. Furthermore, the fact that payment for the purchase could affect the current period’s income statement can still be addressed, and the U.S. dollar introduced as the functional currency. There are more problems, which are expected to be faced from day to day because the fund manager had not contemplated on the financial effect, but now with all these issues being considered and tackled appropriately, a functional currency can be introduced without many challenges (Choi & Meek, 2010).
Because the fund was set up to be invested in Spain, then it means that the U.S. shareholders are interested in making a currency play that affects the measure of cash flow and equity directly. Furthermore, it was funded with the U.S. shareholders’ capital, and hence, they need to maximize their benefits. Because most expenses are incurred and paid in the U.S. dollars, then the shareholders will want to enjoy transacting gains from the effect of exchange rate adjustments on dealings, which are mainly done with currencies other than the U.S. dollar. The dividends are determined and paid in the U.S. dollars, therefore, this is part of what determines the net income for a particular period that exchange rate adjustments take place – unless the deals are hedged with a net investment or a foreign currency in a foreign firm. Also, use of the U.S. functional currency will help in intercompany transactions of a long-standing venture character, which is part of the parent company’s net investment that do not lead to losses or gains. Other factor that will necessitate use of the U.S. dollar as the functional currency include administration and advisory fees being calculated on the U.S. net assets and paid in the U.S. dollars, and accounting records being kept in the U.S. dollars. Also, the fact that the fund is subjected to the U.S. tax SEC, and 1940 Exchange Act regulations call for use of the U.S. dollar as the functional currency (Choi & Meek, 2010).
Because financial reporting is under the U.S. GAAP and in the U.S. dollars, then use of the U.S. dollar as the functional currency will help comply with the accounting reporting standards that require translation of foreign currency financial statements and foreign currency transactions (Mirza, Holt & Orrell, 2006). This standard is intended to provide information that is well-matched with the probable economic impacts of the exchange rate on the entity’s equity and cash flow; this will reveal the relationships and the financial results in the consolidated statements, as determined in the currency that each entity runs its business. Furthermore, a currency that is exposed to high inflationary environment is not suitable, and therefore, a stable currency such as the U.S. dollar is an ideal currency in this case.
References
Choi, F., & Meek, G. (2010). International Accounting. Upper Saddle River, N. J.: Pearson Education.
Mirza, A. Holt, G., & Orrell, M. (2006). International Financial Reporting Standards (Ifrs) Workbook and Guide: Practical Insights, Case Studies, Multiple-Choice Questions. London: John Wiley & Sons.