By Forex Mansion
Foreign Currency Translation is the accounting figures for foreign currencies to meet the requirements of financial reporting according to the GAAP regulations. As the items on the balance sheet are converted at the listed exchange rate, the income statements are converted instead by a weighted average of the exchange rate for that year. Taking this into a real example, the purpose of this article is to broadly paint a picture of the first steps to meet the US GAAP requirements. For purposes of understanding, this example will be according to the US tax laws. There are two main methods involved that are important to reaching accurate final numbers; more information on federal accounting procedures is available at the US FASAB.
1. The Current Rate Translation Method. When a subsidiary company uses a currency or currencies aside from that of the parent company. In order to translate this into a currency unit that can be listed on the books, the primary currency responsible for the majority of transactions first has to be established. Once a currency is decided upon, all of the other currency has to be converted to that currency, called the functional currency. The rules governing this are listed by the IRS section on international businesses. The next step is to convert all of the foreign currency to local currency using the exchange rate at the time of the financial statements.
What happens if the stock day trading outside of the home country? US currency is used to calculate all business transactions if the place of business is outside of the US. In this case, the GAAP requires the use of a method called the Re-Measurement Method.
2. The Re-Measurement Method. In a situation where the subsidiary company is in a country that has a cumulative rate of 100% inflation, the Current Rate Translation Method cannot be applied according to the GAAP. In such a case, the cash as well as any transaction that must be settled in cash, which includes loans and other unsettled accounts, must be converted using the exchange rate according to the date of the financial statements. However, all assets, equity, inventory and liabilities will be converted according to the historical conversion rate as of the date of the transaction occurrence.
The COGS that affect the balance sheet are taken at the historical value as opposed to the value of the exchange rate at the time of the financial statement creation. For very minimal transactions, the weighted average of the currency rate conversion is used.
Abiding by the appropriate tax laws and tax tools is important for the company to be in line with the GAAP standards, but these practices obviously vary according to the country of the parent company. The reason that this is important lies in properly valuing a company not only for purposes of taxes but also for publicly traded companies to show a realistic value for shareholders. Regardless of the company origin, foreign currency translation is understood to be a necessary practice in order to understand the bottom line in a meaningful way and not simply averaging figures.
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