Matakuliah
Tahun
: F0142/Akuntansi Internasional
: 2006
Session 06
Foreign Currency
Translation
1
Reasons For Translation
• Process of restating financial information from
one currency to another is called translation
• Many of the problems associated with currency
translation stem from :
– The relative value of foreign currencies are seldom fixed
– Recording foreign currency transactions, measuring a
firm’s exposure to the effects of currency gyrations and
communicating with foreign audiences of interest
– For accounting purposes, a foreign currency asset or
liability is said to be exposed to currency risk if a change
in the rate at which currencies are exchanged causes the
parent (reporting) currency equivalent to change
– The expanded scale of international investment
increases the need to convey accounting information
about companies domiciled in one country to users in
others.
Background And Terminology
• Translation is not the same as conversion, which is the
physical exchange of one currency for another
• Translation is simply a change in monetary expression.
• Foreign currency transactions take place in the Spot,
Forward, or Swap Markets
– The U.S dollar price of Indian Rpe might be $ 0.022737 and
indirect quote approximately Rpe 43.98 to acquire 1 U.S $
– The cash balance of a U.S subsidiary located in Bombay on
January 31 is Rpe 1,000,000.
– Spot exchange rate on that date is $ 0.0218
– The U.S $ equivalent of the Rpe cash balance is :
• Rpe 1,000,000 x $ 0.0218 = $ 21,800 or
• Rpe 1,000,000 : Rpe 43.98 = $ 21,800
The Problem
• If foreign exchanges rates were relatively
stable, currency translation would be no
more difficult than translating inches or feet
to their metric equivalents.
• The currencies of most industrialized
countries are free to find their own values in
the currency market
Financial Statement Effects of Alternative
Translation Rates
• The following three exchange rates can be used to
translate foreign currency :
– Current rate, is the exchange rate prevailing as of
the financial statement date
– Historical rate, is the prevailing exchange rate when
a foreign currency asset is first acquired or a foreign
currency liability first incurred
– Average rate, is a simple or weighted average of
either current or historical exchange rates.
– Translation is simply a change in monetary
expression.
• We must distinguish between translation gains
and losses and transaction gains and losses
Financial Statement Effects of Alternative
Translation Rates
Types of Exchange Adjustments
Exchange Gain/Losses
Transaction Gain/Loss
Transaction
Date
Financial
Statement
Date
Unsettled
Transaction
Settled
Transaction
Translation Gain/Loss
Settlement
Date
Initial
Financial
Statement
Date
Subsequent
Financial
Statement Date
Foreign Currency Transactions
• A foreign currency transaction may be denominated in
one currency but measured or recorded in another.
• FAS No. 52, the U.S authoritative pronouncement on
accounting for foreign currency mandates the
following treatment for foreign exchange transaction :
– At the date the transaction is recognized, each asset,
liability, revenue, expense, gain or loss arising from the
transaction shall be measured and recorded in the
functional currency of the recording entity by use of the
exchange rate in effect at that date
– At each balance sheet date, recorded balances that are
denominated in a currency other than the functional
currency of the recording entity shall be adjusted to
reflect the current exchange rate
Foreign Currency Transactions
• Single Transaction Perspective
– Under a single transaction perspective, exchange
adjustment are treated as an adjustment to the
original transaction accounts on the premise that
a transaction and its settlement are a single event.
• Two Transaction Perspective
– Under a two transaction perspective, collection of
the receivable is considered a separate event from
the sale that gave rise to it.
Foreign Currency Translation
• Single Rate Method
– Applied a single exchange rate, the current or
closing rate, to all foreign currency assets and
liabilities
• Multiple Rate Methods
Multiple rate methods combine current and
historical exchanges rates in the translation
process
– Current - Non Current Method
• A foreign subsidiary’s current assets and current
liabilities are translated into their parent company’s
reporting currency at the current rate. Non current
assets and liabilities are translated at historical rates
Foreign Currency Translation
• Multiple Rate Methods
– Monetary – Non Monetary Method
• Monetary assets and liabilities are translated at the
current rate. Non monetary items are translated at
historical rates.
– Temporal Method
• Currency translation is a measurement conversion
process or a restatement of a given value
Foreign Currency Translation
• Which Is The Best ?
We pose three questions
– Is it reasonable to use more than one translation
method ?
• More than one translation method is needed. A single
translation method cannot equally serve translations occurring
under different condition
– If so, what should be the acceptable methods and
under what conditions should they be applied ?
• Three different translation approach can be accepted (the
historical method, the current method, no translation at all)
– Are there situations in which translations should
not be done at all ?
• No translation is appropriate between highly unstable and
highly stable currencies
Foreign Currency Translation
• Appropriate Current Rate
– The rates of exchange used in translation
methods as either historical or current
– Average rates are often used in income
statements for expediency.
– Sometimes a country applies different exchange
rates to different transactions. Several
possibilities have been suggested :
• Dividend remittance rates
• Free market rates
• Any applicable penalty or preference rates
Foreign Currency Translation
• Translation Gains and Losses
– Deferral
– Deferral and Amortization
• Some favor deferring translation gains or losses and amortizing
these adjustments over the life of related balance sheet items.
– Partial Deferral
• Recognize losses as soon as they occur, but to recognize gains
only as they are realized
– No Deferral
• Recognize translation gains and losses in the income
statement immediately.
Translation Accounting Development
• Chronicle financial reporting initiatives in the
United States as they are representative of
experience elsewhere :
– Pre 1965
• Before 1965 the translation practices of many U.S companies
were guided by Accounting Research Bulletin No. 4 (ARB No.
4). This statement advocated the current – non current method.
– 1965 - 1975
• Translating all foreign currency payables and receivables at the
current rate was allowed after Accounting Principles Board
Opinion No. 6 was issued in 1965.
– 1975 - 1981
• FASB issued the controversial FAS No. 8 in 1975
– 1981 - Present
• FASB reconsidered FAS No. 8 and after many public meetings
and two exposure drafts, issued Statement of Financial
Accounting Standards No. 52 in 1981.
Features of Standard No. 52
• Standard No. 52, its translation rules are thus
designed to :
– Reflect, in consolidated statements, the financial results
and relationships measured in the primary currency in
which each consolidated entity does business (its
functional currency).
– Provide information that is generally compatible with
the expected economic effects of an exchange rate
change on an enterprise’s cash flows and equity
• These objectives are based on the concept of a
functional currency
Features of Standard No. 52
• Translation When Local Currency Is The
Functional Currency
– If the functional currency is the foreign currency
in which the foreign entity’s records are kept, its
financial statements are translated to dollars
using the current rate method.
– The following current rate procedures are used :
• All foreign currency asset and liabilities are translated to
dollars using the exchange rate prevailing as of the balance
sheet date
• Revenues and expenses are translated using the exchange
rate prevailing on the transaction date
• Translation gains and losses are reported in a separate
component of consolidated stockholders’ equity.
Features of Standard No. 52
• Translation When The U.S Dollar Is The
Functional Currency
– When the U.S Dollar is a foreign entity’s
functional currency, its foreign currency
financial statements are re measured to dollars
using the temporal method.
– All translation gains and losses, specifically :
• Monetary assets and liabilities and non monetary assets
valued at current market prices are translated using the rate
prevailing as of the financial statement dates.
• Revenues and expenses are translated using average
exchange rates for the period except those items related to
non monetary items, which are translated using historical
rates
• Translation gains and losses are reflected in current income
Features of Standard No. 52
• Translation When Foreign Currency Is The
Functional Currency
– The financial statements are first remeasured from
the local currency into the functional currency
(temporal method) and then translated into U.S
dollars using the current rate method
– Where an entity has more than one distinct and
separable operation, each operation may be
considered as a separate entity with its own
functional currency.
– Once the functional currency for a foreign entity is
determined, FAS No. 52 requires that it used
consistently unless changes in economic
circumstances clearly indicate that the functional
currency has changed
The Debate
• FAS No. 52 was designed to quiet many of
criticisms leveled at FAS No. 8
• Reporting Perspective
– FAS No. 52 accommodates both local and parent
company reporting perspectives in the
consolidated financial statements
– It has also been suggested that FAS No. 52 is
inconsistent with the theory of consolidation
• What Happened to Historical Cost ?
– Translated amount defies theoretical description
of historical cost
The Debate
• Concept of Income
– Under FAS No. 52, adjustments arising from the
translation of foreign currency financial
statements and certain transactions are made
directly to shareholders’ equity, thus by passing
the income statement.
• Managed Earnings
– FAS No. 52 provides opportunities to manage
earnings
Foreign Currency Translation And Inflation
• Translation When Foreign Currency Is The
Functional Currency
– The FASB decided against inflation adjustments
before translation, believing such adjustments to
be inconsistent with the historical cost valuation
framework used in basic U.S statements.
– As a solution, FAS No. 52 requires use of the U.S
dollar as the functional currency for foreign
operations domiciled in hyperinflationary
environment
Foreign Currency Translation Elsewhere
• Translation When Foreign Currency Is The
Functional Currency
– The main difference between the Canadian
standard (CICA 1650) and FAS No. 52 concerns
foreign long term debt.
– The major difference between the U.K and U.S
standard relates to self contained subsidiaries in
hyperinflationary countries.
– Compared to FAS No. 52 the Australian standard
calls for revaluing noncurrent, nonmonetary assets
for subsidiaries in high inflation countries prior to
translation. The New Zealand standard is silent on.
– Most continental EU countries, including France
and Germany have no standards. As a result,
practice is up to the companies
Current Trends
• Foreign currency translation remains a vexing
and controversial technical issue.
• In the United States, foreign companies are
allowed to follow the International Standard
(IAS 21) instead of the U.S standard (FAS No.
52) in foreign currency translation.
• In time, the FASB may resolve the differences
between FAS No. 52 and IAS 21 in favor of the
international standard.