As we informed you in our latest Newsletter, the Ministry of Finance has published a draft of a new Accounting Act. The Act should come into force from 1 January 2024, although 2025 seems more realistic. Gradually, we would like to inform you about the most important news in the form of our special alert.
Firstly, some time ago we brought a reflection by Jana Skálová, Partner of TPA, on the question of: Why do we need a new Accounting Act? If you are interested about the background of the new act, please see more details here on our blog: https://blog.tpa-group.cz/en/taxes-and-accounting/why-do-we-need-a-new-accounting-act/
Further herein, we would like to focus on accounting in a functional currency.
New Accounting Act – foreign currency
One of the most frequently mentioned innovations contained in the draft Accounting Act is the so-called “euro accounting” option. In fact, this is a general option to account in a foreign currency if it is the so-called functional currency of the accounting entity and the entity likewise chooses to do so. This passage can be found in the draft law from Section 55 onwards.
The concept of functional currency is based on International Accounting Standard 21 (hereafter “’IAS 21”), but has been modified in some respects for the purposes of the new Accounting Act. The functional currency is the currency of the primary economic environment in which the entity operates. The purpose of introducing a functional currency into the Czech legal system is to enable accounting entities to use a currency for accounting purposes that is the same as the currency in which the entity actually carries out its activities and in which the majority of its transactions take place. This helps to make accounting more efficient in practical terms by reducing the number of conversions and minimising exchange rate differences.
The following indicators may be relevant in assessing whether the currency that an entity has chosen to use as its functional currency meets this defining characteristic:
- the proportion of the entity’s transactions denominated in that currency exceeds 50 per cent,
- the extent to which the currency affects the prices of the entity’s goods and services,
- the currency of the country whose competitive environment and business conditions predominantly affect the prices of the entity’s goods and services,
- the extent to which the currency affects the labour and other costs that the entity must incur in producing and selling goods and services.
Another possible indicator that can be assessed for the purpose of determining functional currency may be the currency in which resources are generated from financing activities (e.g. debt and equity instruments) or in which currency income from foreign operations is received.
In assessing whether a currency is the entity’s functional currency, an accounting entity bases its judgement on both past accounting periods and the entity’s expected future development.
For a newly-formed accounting entity that cannot base its accounting information on past accounting periods, it is sufficient if it has a realistic and demonstrable expectation arising from the planned development of the accounting entity’s operations. The burden of proving that the conditions for the use of a foreign currency are met rests with the accounting entity.
The use of a functional currency as an accounting currency is a right, not an obligation as under IAS 21. This means that an accounting entity that fulfils the materials requirements for use of foreign currency as a functional currency does not necessarily need to use that currency. It may choose to use the Czech currency for accounting purposes even though the Czech currency is not the currency of its primary economic environment, i.e., the functional currency.
New Accounting Act for Real Estate: Accounting in Euro
For the real estate industry, having the accounting in a functional currency will be widely welcomed. Many projects in the Czech Republic have Euro-denominated leases as well as Euro-denominated financing. Thus, in our opinion, the conditions of a “primary economic environment” in accordance with IAS 21 may be met and such real estate SPVs will have the option to switch their books into Euro. That will surely avoid many unpopular side-effects of accounting in Czech Crown, such as large FX gains and losses, a strongly fluctuating financial result and unexpected ups and downs in tax basis.
This change may even attract new investors to enter the Czech real estate market. The last major element of currency risk will be gone and the Czech real estate market may enter the Euro zone years before the rest of the Czech Republic does. So much the better…
