Choice of a Functional Currency. Choosing the functional currency is a key decision for translating the ?nancial statements of foreign entities of U.S. ?rms into U.S. dollars. Qing Corporation, a U.S. ?rm that sells car batteries, formed a wholly owned subsidiary in Mexico to manufacture components needed in the production of the batteries. Approximately 50% of the subsidiary's sales are to Qing Corporation.
The subsidiary also sells the components it manufactures to independent third parties, and these sales are denominated in Mexican pesos. Financing for the manufacturing plants in Mexico is denominated in U.S. dollars, but labor contracts are denominated in both dollars and pesos. All material contracts are denominated in Mexican pesos. Senior managers of the subsidiary are employees of Qing Corporation who have been transferred to the subsidiary for a tour of international service.
Is the functional currency of the subsidiary the peso or the U.S. dollar? Explain your reasoning.