Functional currency
In one sentenceThe currency of the main economic environment in which the business operates, that is, the currency it mostly sells in and pays its costs in; the books are kept in it.
Simply put
The business does not choose it at will; reality determines it: in which currency are your selling prices set? In which currency do you pay salaries and materials?
Every transaction in another currency is a foreign currency transaction: it is recorded at the exchange rate on the day it occurs, and currency differences then arise on settlement or when the statements are prepared.
Example
A trading business in Jeddah sells and pays salaries in riyals and imports some goods in dollars: its functional currency is the riyal, and the dollar purchases are foreign currency transactions.
Don't confuse it with
Presentation currencyThe presentation currency is only the one in which the statements are shown, and it may not be the functional currency.