International Accounting Chapter 6

International Accounting, Chapter 6: Foreign Currency Translation

• Firms translate currencies to prepare consolidated financial statements, aiding in understanding the performance of multinational companies. Foreign exchange risk measurement is facilitated, and the reporting of domestic accounts to international audiences is enhanced
• Spot transactions involve immediate currency exchange. Forward transactions are agreements to exchange at a future point. Swap transactions are simultaneous spot purchase/forward sale or sale/purchase of a currency
• Exchange rates used in currency translation affect financial statements. Direct quotes show domestic currency units needed for foreign currency, and indirect quotes show foreign currency units needed for domestic currency.
• Translation gains or losses differ from transaction gains or losses. Translation gains/losses arise from restatement and result from exchange rate fluctuations. Transaction gains/losses stem from physical currency exchanges at different rates
• Various methods exist for translating financial statements, such as the temporal method, contrasting with the current rate method. The temporal method translates items at the original exchange rate. The current rate method uses the exchange rate at the statement date.
• Currency translation and inflation are related. Inflation can impact a currency's external value. Inflation's inverse relationship with currency is addressed by the International Accounting Standards (IAS 21) and FAS.
• Spot transactions involve immediate exchange. At the transaction date, assets, liabilities, revenue, and expenses are calculated in the reporting entity's functional currency.
• Foreign exchange gains/losses occur when exchange rates shift between transaction and financial statement dates.
• There are different translation methods, such as the single rate method which uses a single current rate for all foreign currency transactions. Multiple rate methods use various exchange rates for translation.
• The monetary-nonmonetary method translates monetary items at current rates and nonmonetary ones at historic rates using average rates for revenues and expenses (excluding depreciation and amortization). It uses historic rates for depreciation and amortization.
• The temporal method translates monetary assets/liabilities at the current rate, and non-monetary items using rates maintaining historic cost. Revenues and expenses are often calculated using average rates and depreciation/amortization is often calculated at historic rates related to the assets' acquisition date.
• Current (Single) Rate method translates all foreign assets/liabilities at the current rate, and all revenues/expenses at an appropriately weighted average of current exchange rates over the period.
• FASB 52 and IAS 21 guiding principles are based upon the reporting entity's functional currency. Functional currency may be parent currency, or local currency based on factors such as cash flow, sales price, sales market, and expenses
• Currency translation and inflation often have an inverse relationship. Inflation can be relevant in translating foreign currency financial statements. The parent currency is often used as the functional currency in cases of hyperinflation.
• Several illustrative exhibits show practical applications of the concepts.