Functional currency is defined as the primary currency that a company uses for its economic activities and operations. For example, this currency is typically the one used for reporting expenses, revenues, and financial impacts. For a business operating predominantly in the United States, the functional currency would often be USD. However, for companies with multinational operations, the functional currency is determined based on the dominant economic environment in which the company functions. It's crucial for accounting purposes because financial statements are prepared and reported in the functional currency.

For instance, let a company based in Canada conducts the majority of its transactions in USD because it exports goods to the U.S. In this situation, despite being based in Canada where the local currency is CAD (Canadian Dollar), the functional currency might be USD due to the nature of its transactions. IFRS and GAAP standards dictate the considerations for determining the functional currency to ensure consistency in accounting practices.

Furthermore, not to be confused with the presentation currency, which is the currency in which financial statements are presented, the determination of functional currency affects how a company accounts for foreign exchange variations and translates its financial results when consolidated into the parent company's financial statements.