Functional currency in shipping

How does IAS 21 decide the functional currency?

The functional currency is the currency of the primary economic environment in which an entity operates. IAS 21 looks first at the currency that mainly influences sales prices, the currency of the country whose competitive forces and regulations mainly determine those prices, and the currency that mainly influences labour, material and other costs. If these point clearly to one currency, that is the answer. Only if they are mixed does it look at secondary indicators: the currency in which financing is raised and in which receipts from operations are retained.

Why is the US dollar usually the answer in shipping?

International freight and charter markets quote rates in dollars, and charterers pay in dollars. Ship prices, newbuilding contracts, second-hand sales and broker valuations are in dollars. Bunkers are priced in dollars, and many crew costs, insurance premiums and spare parts are dollar-denominated or linked to dollars. Bank loans and leasing finance for vessels are mostly in dollars. So for a company owning and chartering ocean-going vessels, the primary indicators point to the dollar, even if its office, shareholders and stock exchange listing are elsewhere. The analysis is done entity by entity: a group's vessel-owning subsidiaries usually have dollar functional currencies, while a local agency or a crewing company may not.

How are local currency costs and borrowings treated?

Transactions in other currencies are foreign currency transactions. Office salaries and rent of, say, US$ 2 million equivalent paid in euros are translated at the rates on the transaction dates. Monetary items, such as cash, payables and bonds in other currencies, are retranslated at the closing rate, with exchange differences in profit or loss. Suppose a Norwegian-listed owner with a dollar functional currency issues a NOK 1,000 million bond when the rate is 10.0 kroner per dollar, equal to US$ 100.0 million. If the krone weakens to 11.0 per dollar by the year end, the bond is worth US$ 90.9 million and the owner recognises an exchange gain of 9.1 million; if the krone strengthens, it recognises a loss. Owners usually hedge such bonds with cross-currency swaps, often in a hedge accounting relationship. See IFRS 18, foreign exchange and derivatives.

Can the financial statements be presented in another currency?

Yes. A company can choose a presentation currency different from its functional currency, for example to meet local listing or legal requirements. Assets and liabilities are translated at the closing rate, income and expenses at the rates on the transaction dates or an average, and the differences go to other comprehensive income. Many shipping groups listed in Europe or Asia present in dollars to avoid this translation noise. A group with a parent in local currency and dollar subsidiaries translates the subsidiaries on consolidation, building a translation reserve that is reclassified to profit or loss only on disposal.

When is the functional currency not the dollar?

Ferry operators, domestic coastal shipping, port operators, towage and offshore service companies working in one country often earn and spend mainly in local currency, so their functional currency is local. Companies with a mix, such as a cruise line selling tickets in several currencies, weigh the indicators and may reach different answers for different entities. When the facts change, such as a ferry company moving into international charters, the functional currency changes prospectively from the date of the change, with all items translated at the rate on that date.

How does the dollar functional currency affect tax?

Where a company pays tax on profits calculated in local currency, but its functional currency is the dollar, movements in exchange rates change the local currency tax base of its vessels and other non-monetary assets without changing their dollar carrying amounts. IAS 12 treats the resulting differences as temporary differences, so deferred tax is recognised in profit or loss. Many owners pay tonnage tax instead, which is not based on profits and so does not give rise to deferred tax. See deferred tax under IAS 12.

How does US GAAP differ?

ASC 830 uses similar indicators and also leads most international shipping companies to a dollar functional currency, with remeasurement of other currency items through profit or loss and translation adjustments in other comprehensive income for subsidiaries with other functional currencies. Airlines face the opposite problem: most have local functional currencies but dollar lease liabilities; see aircraft leases under IFRS 16 and shipping accounting.

This guide is general information. It is not tax or legal advice for your situation.