Firms that combine the outcomes of foreign operations termed in local currencies must translate the foreign financial statements into U.S. dollars (USD). ASC 830 (FAS 52) gives the accounting and reporting requisites for foreign currency deals and the translation of financial statements from a foreign currency to the reporting currency. ASC 830 also appeals to the translation of financial statements for consolidation or combination or the equity method of accounting. In addition, businesses broadcasting under international financial reporting standards (IFRS) are concerned to international accounting standard no.21, the effects of changes in foreign exchange rates (IAS 21), which is considerably similar to ASC 830.
Remeasurement and translation The whole task of foreign currency translation can be understood as determining the correct exchange rate to convert each financial statement line item from the foreign currency to the U.S. dollar. The translation adjustment is an intrinsic result of this process, in which balance sheet and income statement items are translated at different rates. ASC 830 establishes the followings steps:
Determine the functional currency The functional currency is determined as the primary economic environment’s currency in which the entity operates. In general, it is the currency in which most of the subsidiary’s business activities are transacted. This task can be more complex than it seems and may require significant judgment. The functional currency is not mandatorily the domestic currency or the currency in which the subordinate keeps its books. The organization’s functional currency might be the currency of the country in which the entity is detected (the home currency), the reporting currency of the entity’s parent or the currency of another country.
Foreign currency transactions and remeasurement If the subsidiary’s functional currency is not its home currency, the temporal (historical) method is used. Under this method, non-monetary balance sheet accounts and related income statement accounts are remeasured using historical exchange rates. The remeasurement process should produce a similar result as if the accounting records of the entity had been sustained in the functional currency. Adjustments resulting from the remeasurement process are normally recorded in net income.
Translation of foreign currency financial statements The current rate method is used after the remeasurement process is complete or if the functional currency is the home currency. The current approach translates all assets and liabilities at the current spot rate at the translation date. Other than retained earnings, equity items are translated at the spot rates in effect on each related transaction date (specific identification). Retained earnings are translated at the weighted-average rate for the appropriate year, except for any identifiable components with particular dates, in which case the spot rates for those dates are utilized. Income statement items are translated at the average rate for the period, besides where particular identification is practicable. The derived adjustment is not acknowledged in latest earnings but rather as other comprehensive income, a separate component of stockholders’ equity.
Under FAS 52, the temporal technique is also utilized when the subsidiary operates in a highly inflationary environment. Again, the resulting adjustment is acknowledged in net earnings. Companies broadcasting under IFRS treat this differently by remeasuring the financial statements at the current balance sheet rate to present current purchasing power. On the other hand, GAAP does not generally permit inflation-adjusted financial statements. Instead, it requires using a more stable currency as the functional currency.
Equity method investees According to accounting standard codification (ASC) 830-10-15-5, foreign currency financial statements of a foreign investee accounted for by the equity medium shall be translated to the reporting currency in the similar form as the financial statements of a combined foreign investee. Initially, the functional currency of the equity method investee shall be decided and transactions termed in currencies other than its functional currency have to be remeasured. Then, suppose the functional currency of the equity method investee is different from the reporting currency of the equity method investor. In that case, the investee’s financial statements shall be translated into the reporting currency at the current rate before regulating the balance of the investor’s equity investment.
Foreign currency translation is more than an uncomplicated automatic exercise. A rigorous understanding of ASC 830 or IAS 21 is needed. In addition, many aspects of this process require significant management judgment, especially regarding determining the subsidiary’s functional currency.
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