Amendment to the Accounting Act - functional currency

Functional currency - basic definition

A functional currency that can be used an accounting currency is a different (foreign) currency if it is the euro, the US dollar or the British pound.

The amended Accounting Act defines a functional currency as 'the currency of the primary economic environment in which the entity operates'. Thus, by definition, the functional currency under the Czech law will be identical to the functional currency in IFRS (IAS 21). The difference with IFRS remains for the time being voluntary - even those Czech accounting units whose functional currency is effectively a foreign currency may stick to the Czech koruna as the accounting currency. Another difference is the limitation of the functional currency to euro, dollar and pound and the impossibility to switch to the functional currency during the accounting period.

Advantages of the functional currency

The main advantages include the elimination of exchange rate differences and some of the reasons for implementing various derivative hedges of currency risks.

Possibility to switch to a functional currency

As noted above, the transition to a functional currency is voluntary, but entities must demonstrate that the conditions for such a transition (the primary economic environment) are met. The change can only be made on the first day of the accounting period. A subsequent return to the Czech koruna can also be made only on the first day of the accounting period, but only if the foreign currency previously used as the functional currency has ceased to be the functional currency (and this must be documented).

The conversion to the functional currency will be carried out in accordance with the implementing decree - the closing balances of the accounts will be converted at the general rate for the balance sheet date of the previous accounting period to determine the opening balances of the accounts. We would like to point out here that this procedure will not allow accounting entities that account in Czech currency and at the same time have set their internal functional currency for IFRS e.g. in euro to set the same foreign currency values of non-monetary assets and debts for the purposes of Czech statutory accounting and IFRS.

The changeover to the functional currency will also trigger a recalculation of the previous accounting period's figures presented in the financial statements for the period in which the functional currency will be used for the first time - the recalculation procedure will also be set out in the implementing decree.

Tax implications of the introduction of a functional currency

The tax legislation has so far not reacted much to the amendment to the Accounting Act concerning the functional currency. It will continue to be obligatory to record and report VAT, pay payroll tax and insurance premiums only in Czech crowns.

In the future, it should not only be possible to pay corporate income tax in the functional currency, but it will also be possible to file tax returns completely in the functional currency. For the time being, however, it will be necessary to file the tax return in Czech crowns. If the payment is made in the functional currency, no overpayments or underpayments of tax due to exchange rate differences will arise according to the amendment to the Tax Code.

For conversions from the functional currency to CZK, the accounting will use the rates announced by the ECB, FED, etc., not the CNB. For tax purposes, however, tax-relevant items will generally be converted at the CNB rate for the last day of the tax period.

In general, while the introduction of the option to keep accounts in a functional currency is certainly a welcome innovation, caution should be exercised when considering its use. Implementing decrees are not yet available and entities will need to have detailed reasoning to demonstrate that the chosen currency is indeed their functional currency. The entity's accounting and reporting system must then, of course, reflect this. If entities would like to switch to a functional currency from next year, this information must already be included in the 2023 financial statements.

Author:

Olga Těhlová, Tax Senior