What Are Two Major Issues Related to the Translation of Foreign Currency Financial Statements?

by Will Gish

The world of international business often faces difficulty when reporting to national governments. The need to translate foreign currency financial statements arises from situations in which a company based in one country maintains a majority shareholder stake in a company in a second country and must keep financial records of assets posted in a foreign currency. Two major issues relate to this process, one of them related to converting currency values and the other stemming from bookkeeping.

Translating Foreign Currency Financial Statements

The need to translate foreign currency financial statements arises when a company based in one country maintains a parent-subsidiary relationship with a company based in a second country. Basically, any company owning more than 50 percent stock in a company in another country qualifies. In most instances, the parent company must incorporate the financial records of the subsidiary in its own financial records. During this process, the parent company must translate all foreign currency values into domestic currency values.

Basic Problems with Translating Value

The first major problem associated with translating foreign currency financial statements arises from choosing a method of translation. Simply explained, a parent company must decide how to translate the value of all assets it owns through investment in a subsidiary. Various complications arise from this process, including changes in currency exchange rates and the valuation of items with different types of values. For example, cash amounts on transactions translate at direct values, while the value of an asset such as a building changes over time, and could be worth wildly varying amounts based on the state of a national economy or real estate market or fluctuations in currency values.

The Complexities of Translating Value

Sources such as the book "Wiley Interpretation and Application of International Financial Reporting" cite the preferred and most accurate method of translating as using the closing rate on all monetary value and the historical rate on assets. Closing rate equals the current exchange rate at the end of a reporting period, while historical rate equals an average of the historical relationships between two currencies. In addition to current asset values, accountants must translate closed transactions from the same reporting period based on the exchange rate at the time of closure. Because companies ostensibly use multiple translation methods on one set or records, a direct conversion of all values at the current rate does not match a fully translated financial record. What's more, a change in exchange rate after reporting may give the impression of losses or gains that don't match actual losses or gains.

Problems with Bookkeeping

The second major problem associated with translating foreign currency financial statements arises from deciding where to record foreign currency financial statements on a company's books once translated. Two options exist. A company may record the value of all translated foreign currency in its equity ledgers or balance sheets reserved for invested capital. As per this method, the company records a loss or gain based on whether financial statements translate to more or less than the initial investment. Or, since a parent company owns a majority shareholder in a subsidiary, it can simply claim all translated financial statements as its own assets and create a consolidated financial account by combining the records of both companies. This connects back to the initial problem, as accountants must integrate translated foreign currencies with figures posted in domestic currencies and not subject to change along with exchange rates.

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