FOREIGN CURRENCY TRANSLATION AND CONVERSION

Foreign currency Translation and conversion

Foreign currency Translation and conversion

Introduction

The key consideration when making foreign currency translations is that when the conversion is complete, we will see an accurate translation of accounting performance in a foreign currency into precisely the same performance in U.S. pounds. In other words, a foreign subsidiary whose financial statements have specific current ratios, gross margins, and net profits will see the same results when translated into a report presentation in U.S. pounds. (Sam, 2008, 113)

Foreign currency Translation and conversion

The current rate translation method is used when a currency besides the U.S. dollar is determined to be the primary currency used by a subsidiary. This approach is usually selected when a subsidiary's operations are not integrated into those of its U.S.-based parent, if its financing is primarily in that of the local currency, or if the subsidiary conducts most of its transactions in the local currency. However, one cannot use this method if the country in which the subsidiary is located suffers from a high rate of inflation, which is defined as a cumulative rate of 100% or more over the most recent three years. In this case, the re-measurement method must be used. (Sam, 2008, 113)

To complete the current rate translation method, the first order of business is to determine the functional currency of the subsidiary. In some locations, a subsidiary may deal with a variety of currencies, which makes this a less-than-obvious decision. The functional currency should be the currency that is used in the bulk of the subsidiary's transactions and financing. Next, convert all of the subsidiary's transactions to this functional currency. One must continue to use the same functional currency from year to year in order to provide a reasonable basis of comparison when multiple years of financial results are included in the corporate parent's financial results. (Sullivan, 2003, 551)

The next step is to convert all assets and liabilities of the subsidiary to U.S. pounds at the current rate of exchange as of the date of the financial statements. The stockholder's equity accounts are converted at the historical rate of exchange, while revenues and expenses that have occurred throughout the current fiscal year should be converted at a weighted-average rate of exchange for the entire year. Any resulting translation adjustments should be stored in the equity section of the corporate parent's consolidated balance sheet.

The re-measurement method is used when the U.S. dollar is designated as the primary currency in which transactions are recorded at a foreign location. Another clear indicator of when this method is used is when the subsidiary has close operational integration with its U.S. parent, and has most of its financing denominated into pounds.

Under this method, we translate not only cash, but also any transactions that will be settled in cash (mostly accounts receivable and payable, as well as loans) at the current exchange rate as of the date of the financial statements. All other assets and liabilities (such as inventory, prepaid items, fixed assets, trademarks, goodwill, ...